Earnings Call Transcript - SEM Q1 2022

Operator, Operator

Good morning, and thank you for joining us today for Select Medical Holdings Corporation's earnings conference call to discuss the first quarter 2022 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 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.

Robert Ortenzio, Executive Chairman and Co-Founder

Thank you, Operator. Good morning, everyone. I'd like to welcome you to Select Medical's earnings call for the first quarter of 2022. I would like to first commend and thank all of our operators and clinicians for their continued professionalism and dedication during the last two years of the pandemic. The prolonged challenges we have faced resulted in us emerging, I believe, as a stronger and more unified organization. And every day, we continue to be amazed by the stories we hear from grateful patients and employees giving back that reaffirms our vision of improving the quality of life for the communities in which we live and work. Our clinical teams continue to overcome obstacles and provide exceptional patient care. I want to preface my remarks today by noting that we are modifying our format this quarter to provide more commentary on each of our four business segments. The financial details we normally provide on this call are available in our earnings release and Form 10-Q that was provided last night, and I will only provide highlights in my remarks. From a broad perspective, for the quarter, all four divisions of the company experienced revenue growth with an increase of 3.4%, even as we continue to operate in a very challenging labor environment. Labor costs continued to put pressure on performance, primarily driven by elevated nursing agency costs and incentive bonuses for employed staff in our Critical Illness Hospital segment. For the quarter, total company adjusted EBITDA was $163.8 million compared to $258.3 million in the prior year. Our consolidated adjusted EBITDA margin was 10.2% for Q1, compared to 16.7% in the prior year. I would note, however, that the results of Q1 of the prior year included $16.1 million of CARES grant income and $17.9 million related to the positive outcome of litigation with CMS within the Critical Illness segment. Excluding these items, the adjusted EBITDA margin would have been 14.5% for Q1 2021, compared to 10.2% in Q1 of this year. The delta in EBITDA margin is entirely attributed to increased labor costs within both inpatient segments and our outpatient Rehab division. As the quarter progressed, we experienced improvement in our labor costs, which has continued into the second quarter. We remain optimistic that the labor environment will stabilize as the year progresses. In regards to our allocation and deployment of capital, our Board of Directors declared a cash dividend of $0.125, payable on June 1st, 2022 to shareholders of record as of the close of business, May 19th, 2022. We will continue to be optimistic and evaluate stock repurchases, reduction of debt, and development opportunities. Now I'll provide some data points and commentary on each of our operating divisions. Our Critical Illness division experienced an increase of 1.2% in net revenue due to a rise in revenue per patient day from $2,024 to $2,075. This was offset by a decrease in our average daily census of 43. Our case mix index remained consistent with the prior year, while our occupancy decreased to 71% from 75% in the prior year. Many of our referral short-term acute care hospitals had lower volumes in their ICUs, which contributed to the decrease in our census compared to the prior year for the quarter. Our census in April, however, was right in line with the prior year. The relationships that we have built with the short-term acute care hospitals and our community partners, we believe, are stronger than ever, and it is our expectation that when the ICU volumes in many of our referring hospitals increase, we will continue to see those patients in our facilities. EBITDA margin for the Critical Illness Rehab - Recovery Hospitals was 6% for Q1, compared to 19% in the prior year. As I mentioned earlier, the results of Q1 of the prior year include $17.9 million related to the positive outcome of litigation with CMS. Excluding this item, the EBITDA margin would have been 16% for Q1 2021. The increase in nursing agency costs along with incentive bonuses for employed staff were the drivers for the decrease in our EBITDA margins. The salary wages and benefit revenue ratio for critical illness increased 18% from prior year Q1 but improved by 2% from Q4 2021. Nursing agency rates and usage levels significantly increased from prior year Q1. In Q1, the RN agency rate per hour increased by 21% from the prior year and by 4% from Q4 2021. Additionally, the utilization of our agency nurses increased by 36% from prior year Q1, which remained consistent with Q4 2021. Within the quarter, our agency utilization was relatively consistent. However, we did see a decline in the agency rates for RNs as the quarter progressed, with the improvement continuing into April. In Q1, we opened a new Critical Illness Recovery Hospital in Nashville as part of our joint venture with Ascension. In addition, we are expanding our footprint in the Youngstown, Ohio market with a two hospital acquisition expected to close at the end of the second quarter or early Q3. We have also signed agreements with joint venture partners to open four hospitals in Jackson, Tennessee; Tucson, Arizona; Venice, Florida; and Alexandria, Virginia, all expected to open by the end of this year or the first half of 2023. Finally, in April, the long-term acute care hospitals proposed rules were posted by CMS. If adopted, we would see an increase in the standard rate of 2.77% and an increase in the high-cost outlier threshold. We expect the rule to be finalized in August after the required comment period. I'll turn to the inpatient rehab division, which experienced an increase of 6.2% in net revenue, with patient volumes increasing 1.3%. Our occupancy remained consistent with the prior year at 84%, and revenue per patient day increased $90 from $1,853 to $1,943. The EBITDA margin for inpatient rehab was 19.2% for Q1 compared to 24.3% in the prior year. The decline in EBITDA margin was attributed to elevated agency costs along with an increase in nursing incentive bonuses for employed staff. The overall salary wage and benefit to revenue ratio for the inpatient rehab hospitals increased by 8% from prior year Q1 but improved by 1% from Q4 2021. Nursing agency rates and usage levels also increased significantly from the prior year, but our agency rates did improve from Q4 2021, and this trend has continued in April. The increase in agency within our inpatient rehab division was predominantly in California and New Jersey and North Jersey. In Q1, we expanded our West Gables inpatient rehab hospitals in Miami by 30 private beds and opened our third hospital with Banner Health system in Phoenix, Arizona in April. CMS also posted their proposed inpatient rehab rule in April. If adopted, we would see an increase of 2.66% in the standard federal rate and an increase in the high-cost outlier threshold. These rules are expected to be finalized in August after the required comment period. Turning now to Concentra, Concentra had an exceptional quarter, experiencing a slight increase in net revenue from Q1, while EBITDA increased significantly by $7.5 million. Centers' patient volume increased by 11.5%, but it was offset by an expected decline in the need for COVID-related testing and evaluations. Concentra's work comp net revenue per visit increased 3% and reimbursement for employer services increased 4%. Concentra's overall net revenue per visit of $125 remained consistent with the prior year, as our employer services mix increased, which has a lower level of reimbursement than work comp. The EBITDA margin for Concentra was 21.1% for Q1 compared to 19.4% in the prior year. Concentra experienced an improvement of 3% in their SW&B to revenue ratio from prior year Q1 and a 5% improvement from Q1 2021. Improvement in labor was attributed to improved clinical and back-office efficiencies, as visits continued to increase within our centers. In Q1, Concentra acquired one new center in Gary, Indiana and executed leases for two de novo clinics. There is a very attractive pipeline of potential de novos and smaller acquisitions, and we continue to expect strong volumes in this segment. Turning to our outpatient division, the outpatient division experienced an increase of 7.9% in net revenues, with patient volumes increasing by 10%. The improvement in patient business was slightly offset by a decrease in net revenue per visit from $104 in Q1 of last year to $102 this quarter. The decline in net revenue per visit was primarily driven by a 3% decrease in Medicare reimbursement. In addition, we also experienced a slight increase in our payer mix toward payers with lower reimbursement, such as Medicare, as our volume grew. EBITDA slightly increased compared to the prior year with a decrease in margin to 9.8% from 10.4% in the prior year's same quarter. The decline in EBITDA margin is due to an increase in our salary wages and benefits to revenue ratio. In the first quarter, the outpatient division experienced a 1.5% increase in the salary wages and benefits to revenue ratio compared to the prior year Q1, but improved by 1% from Q4 2021. We have seen significant improvement as the quarter progressed in our outpatient salary wages and benefits to revenue ratio as the Omicron variant dissipated and our volume continued to climb. In Q1, we expanded our clinic count by 20 via acquisitions and de novo growth. We look forward to the remainder of the year and have signed agreements to acquire an additional seven clinics, along with leases that have been executed for 42 de novo clinics. Earnings per fully diluted share were $0.37 for the first quarter compared to $0.82 per share in the same quarter of the prior year. As previously stated and noted in our press release, our Board of Directors has declared a quarterly dividend of $12.5 per share. This concludes my remarks, and I'll turn it over to Martin Jackson for some additional financial details before we open the call up for questions.

Martin Jackson, CFO

Thanks Bob. Good morning, everyone. In Q1, equity and earnings of unconsolidated subsidiaries were $5.4 million, this compares to $9.9 million in the same quarter of the prior year. The decrease is a result of lower earnings in our minority-owned inpatient rehabilitation hospitals due to elevated nurse agency costs and the recognition of CARES grant income recorded in Q1 of our prior year in our non-consolidated joint ventures. Net income attributed to non-controlling interest was $6.8 million, this compares to $26.7 million in the same quarter of the prior year. The decrease is partially due to the repurchasing of membership interest in Concentra in Q4 2021, which we now own 100% of the voting interest. In addition, we experienced lower earnings in a few of our large joint venture hospitals, again primarily as a result of elevated nurse agency costs. Interest expense was $35.5 million in the first quarter, this compares to $34.4 million in the same quarter of the prior year. At the end of the quarter, we had $3.8 billion of debt outstanding and $130.9 million of cash on the balance sheet. Our debt balance at the end of the quarter included $2.1 billion in term loans, $340 million in revolving loans, $1.2 billion in 6.25% senior notes and $94 million of other miscellaneous debt. We ended the quarter with net leverage for our senior secured credit agreement of 4.34x. As of March 31st, we had $253 million remaining availability on our revolving loans. For the first quarter, operating activities provided $69.2 million in cash flow, of which $62.9 million was recouped in the quarter related to the repayment of Medicare advances. At the end of April, there was only $12.5 million remaining of the Medicare advances to be repaid. Since April of last year, we have returned over $312 million of the Medicare advances. Our day sales outstanding, or DSO, was 53 days at the end of the quarter. This compares to 52 days at the end of 2021 and 56 days at the end of the first quarter last year. Investing activities used $55.3 million of cash in the first quarter. This includes $46.8 million in purchases of property and equipment and $8.5 million in acquisition and investment activity during the quarter. Financing activities provided $105.6 million of cash for the first quarter. This includes $180 million in net borrowings on our revolving line of credit, offset in part by common share repurchases totaling $51.7 million. This amounts to a little bit north of 2.1 million shares purchased and dividends of our common stock of $16.7 million. We have the capacity to purchase an additional $533 million worth of shares under this program, which remains in effect until December 31, 2023. We are reaffirming our revenue outlook for the year and expect revenue to be in a range of $6.25 billion to $6.4 billion in 2022. We are reaffirming our previously issued three year compounded annual growth rate target for revenue to be in a range of 4% to 6%. We still expect capital expenditures to be in a range of $180 million to $200 million for the year. As stated last quarter, we will readdress our business outlook and target growth rates for adjusted EBITDA and earnings per common share when we believe the labor market stabilizes and becomes predictable. 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 questions.

Justin Bowers, Analyst

I wanted to clarify the development activity. For LTACs, it seems you're anticipating the acquisition of two more hospitals this quarter, plus four additional developments by the end of this year or into 2023, making it six in total. Regarding Concentra or outpatient services, you're expecting 40 more de novos by year-end. Could you provide some insight on how you expect these to phase in if I understood correctly?

Robert Ortenzio, Executive Chairman and Co-Founder

On the critical illness side, what you're seeing reflects what we discussed a couple of quarters ago. During the pandemic, there was an increased recognition of the value that long-term acute care hospitals and our critical illness recovery hospitals have in alleviating pressure on ICUs. This recognition, albeit delayed, has led to more requests and developments. Notably, the critical illness developments are primarily taking place in main hospitals within hospitals. Unlike our historical focus on inpatient rehab joint ventures, these critical illness projects are now often joint ventures as well. This underscores the importance of this segment in the overall continuum of care. We are developing these hospitals within our Hospitals in Hospitals (HIHs). In Youngstown, Ohio, we have two hospital acquisitions that are set to close, with one being in HIH and the other a free-standing facility, further consolidating our presence in that market. On the inpatient rehab side, we will continue selectively pursuing large, mainly freestanding hospitals, often collaborating with large partners. We recently opened one with Banner Hospital and plan to maintain the same pace of development as seen in the last couple of years. Regarding the outpatient rehab division, we previously mentioned our renewed focus on growth through selective small acquisitions and new clinics. We have a strong presence in many markets with over 1,800 clinics. The 40 new clinics planned essentially represent expansions in familiar markets. Opening a new outpatient center is generally a more efficient use of capital than an acquisition. Where feasible, we will pursue smaller outpatient acquisitions. Lastly, regarding Concentra, while we have commented on one new facility and an acquisition, their pipeline is quite strong. Although announcements may be sporadic, by year-end you will see significant growth through acquisitions and new openings.

Martin Jackson, CFO

No. I think, Bob, you covered it very well.

Justin Bowers, Analyst

Very robust update there. And then just a follow-up on Concentra. I think that's just continued to exceed everyone's expectations throughout the pandemic and now. Is there anything to call out specifically there, new service offerings? Or is it just the economy taking share?

Robert Ortenzio, Executive Chairman and Co-Founder

Well, Concentra will always do better in a strong market for employers, employee hiring in a good economy. But having said that and having consolidated the team at Concentra, having consolidated Concentra and U.S. HealthWorks, they just continue to do an amazing job of focusing on deepening their relationship with employers and doing a really good job on delivering short-term results but also some really good strategic thinking, whose efforts have led to just stronger and stronger market share in the long term. So Concentra, as we've said in the past, will always be under pressure in a recessionary environment when employers are not hiring, but the combination of their clinics and their on-site employer services and what they're doing, I continue to believe that the Concentra division will continue to outperform most people's expectations.

Operator, Operator

Your next question comes from the line of Ben Hendrix, from RBC Capital Markets.

Michael Murray, Analyst

This is Michael Murray on for Ben. So obviously, your results came in a bit better than consensus, yet your comments indicated that agency utilization was essentially flat through the quarter, which the quarter was also flat from Q4. Just could you give us a sense of how this is trending in April? Are there any indications that the utilization is beginning to ease for you guys? And are retention metrics improving, given incentive compensation? Any color would be helpful.

Martin Jackson, CFO

Michael, this is Marty. As we indicated in our statements today, we are seeing some positive trends. We're seeing some reductions in the overall agency RN rates. We saw that start to occur post-January. So February and March rates were lower, and April continues to decline. We continue to see those declines. And it's really two components we need to take a look at. One is the overall rate, and the second one is utilization. Utilization through the first quarter has remained relatively constant. That has remained relatively high in April, but we're starting to see that decline, and we expect to see that decline over the next couple of months.

Michael Murray, Analyst

Okay. That's helpful. Then just another quick one. How much did testing and back-to-work revenue contribute to Concentra's Q1 revenue? And what contribution do you expect moving forward?

Martin Jackson, CFO

When you mention testing, Michael, are you referring to COVID testing? That was quite significant in the first quarter of '21, but there was essentially none in the first quarter of '22. Therefore, we observed that the testing was largely replaced by the 11.5% growth rate in volume in the first quarter of '22.

Operator, Operator

Your next question comes from the line of A.J. Rice from Credit Suisse.

A.J. Rice, Analyst

Just to pursue a little further the question about labor in the LTAC, what are you seeing with your core staffing? Is turnover rate stabilizing at this point? Or is it elevated, your open positions? And what about updates on wages with your permanent staff? How is that trending?

Robert Ortenzio, Executive Chairman and Co-Founder

A.J., for the first time, we have seen some positive trends in Q1 as far as hires versus people leaving, as far as RNs are concerned. So we did have a positive number in the first quarter, and we see that trending well. We saw that trending well into April. Your second part of the question was?

A.J. Rice, Analyst

I was going to ask, if you're beginning to see improvements, shouldn't that indicate a decrease in your need for temporary staff? Or are you not forecasting that for the near term?

Robert Ortenzio, Executive Chairman and Co-Founder

You're correct, A.J. We expect to see a decrease in the use of agency nursing. However, as we are bringing on new nurses, there is a training period that usually lasts four to six weeks. Therefore, we will continue to rely on agencies during that time, and that’s why I mentioned that we will likely see agency nurse utilization start to decline in May and June.

A.J. Rice, Analyst

Right. And then the other question I was going to ask is about the joint venture from the acute or health system partners potentially both, I guess, in rehab and in the LTAC side. They're facing their own labor issues. Is that resulting in them being more open, more willing to talk to you about JVs as a way to manage some of the labor issues they have? Are you seeing discussions post-pandemic pick up?

Robert Ortenzio, Executive Chairman and Co-Founder

Well, to answer your second question, discussions have picked up, but I would say that it doesn't have anything whatsoever to do with labor. That's really not part of the conversation. I think that the joint ventures on the critical illness side are a function of a recognition after the last couple of years that a lot of very large systems feel that they need to have this part of the continuum in their markets and recognizing that it's not perhaps their core competency. So bringing in Select, that really is, I think, the acknowledged leader in this segment of care and has been proven to take care of very high acuity patients that come out of the ICU, that's important. But I would say that staffing is irrelevant to those conversations.

Operator, Operator

Your next question comes from the line of Bill Sutherland from The Benchmark Company.

Bill Sutherland, Analyst

What was the utilization ratio prior to the pandemic for agency registered nurses compared to your total workforce?

Martin Jackson, CFO

Bill, we really haven't provided that nominal number. What we can say is that prior to the pandemic, if you compare those, what we're seeing today is at least 100% greater than what we had historically.

Bill Sutherland, Analyst

Okay. And do you think there's sort of like a different new normal as to where it can return to? Or is there any reason not to think you can have a prepandemic kind of ratio in the future?

Martin Jackson, CFO

I wish we had a crystal ball to tell you what it would be. I think we would anticipate that it's probably going to be maybe 100 basis points higher, maybe.

Robert Ortenzio, Executive Chairman and Co-Founder

I find it hard to believe that the labor environment will return to pre-pandemic levels. However, we do not need it to go back to those levels; we just need to move away from the unsustainable agency rates. Other companies have expressed similar sentiments, acknowledging that while rates are rising, particularly for our experienced staff and new hires, we can manage that moving forward. The current agency rates seem extreme, and it's unlikely that many in health care services see them as sustainable. We are noticing a decrease in those rates. While it's possible they might return to a more typical trend, we still expect to see an increase in minimum wage and salaries across the United States.

Martin Jackson, CFO

Bill, I think the way you should think about this is really take a look at SW&B as a percentage of revenue. There are three large levers that we take a look at: we take a look at rate, we take a look at utilization. But in addition to that, we're also taking a look at what are the increases that we can get on the revenue side. We don't expect to see 2% to 3% increases in our rates. We expect to see higher, in particular, on the commercial side. So that will play a role also.

Bill Sutherland, Analyst

So that's how you can recapture that EBITDA margin even though there is a permanent higher labor cost structure. That's very helpful. And regarding Concentra, could you remind us how significant the COVID comparisons are for the growth comparison for the remainder of this year?

Martin Jackson, CFO

Regarding COVID comparisons, there was almost no impact from COVID in the first quarter of 2022. The increase is notable.

Bill Sutherland, Analyst

Right. I didn't ask the question correctly, Marty. I'm sorry to interrupt you. I meant to say that your growth is only held back by the fact that you had the testing and so forth activity. I mean, it didn't hurt your EBITDA. But just kind of curious on the revenue comps.

Martin Jackson, CFO

I think the way to think about it is to think about it in terms of the 11- as Bob mentioned, the operators have done a great job bringing in incremental business in existing locations. So that 11.5% volume increase in existing locations, the incremental EBITDA margin is substantially higher on those dollars, and that's basically replaced the COVID benefits that we had last year. So that's the way to think about it.

Operator, Operator

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

Kevin Fischbeck, Analyst

I want to go back to the comment you made about one of the levers to offsetting labor being the pricing. How do you think about your overall ability to get the price increases that you need? How long does it take for that to flow through the system? It seems there is clearly a little bit of a lag on the government side of the equation.

Martin Jackson, CFO

Kevin, that's a very good point. When we take a look at Medicare, Medicare is typically an 18- to 24-month lag with regards to seeing that incremental cost come through. Commercial is obviously going to be quicker than that, but as I said, we probably won't see that for 18 months on Medicare.

Kevin Fischbeck, Analyst

I guess a lot of the companies talk about their commercial contracts being 2- or 3-year type contracts. Are yours more annual, so you can get the commercial lever quicker?

Martin Jackson, CFO

Well, in most of our contracts, we have cost-of-living adjustments.

Kevin Fischbeck, Analyst

Okay. So you see it relatively right away. And then it was helpful to kind of hear about your impact on Medicare and your expectations for the rate update. Do you think the final number will be higher by the time we receive the final rule as CMS gathers more data, or should we expect this figure to remain similar in the final rule?

Martin Jackson, CFO

Kevin, you never know. The comment period. You've been around this business for a long time. Your guess is as good as ours.

Robert Ortenzio, Executive Chairman and Co-Founder

There'll be a lot of input. There'll be a lot of people that provide input to those proposed rules. They never change dramatically, but they sometimes, on the margin, change, and it can be meaningful, which is why we tend not to comment on the proposed, because they do change.

Kevin Fischbeck, Analyst

That's helpful. And then I guess maybe the last question. It wasn't 100% clear what you were saying about the LTAC occupancy. Obviously, COVID itself was high. Are you just basically saying that COVID acuity wasn't high, so there was just less ICU occupancy during the spike, during prior spikes? And I guess in the past, you kind of indicated that a lot of your LTAC occupancy strength was not really COVID related, so just trying to understand that trend a little bit better in Q1.

Robert Ortenzio, Executive Chairman and Co-Founder

A significant portion of our LTAC volumes during the peak of the pandemic was related to COVID, as we treated over 10,000 COVID patients in our critical care. Primarily, the LTACs were utilized to alleviate pressure on the busy ICUs in acute care hospitals. In some of our markets, it is challenging to generalize across more than 100 hospitals, but with the extreme pressures on these hospitals and the noticeable decline in COVID cases and hospitalizations, many are now working towards returning to their traditional operational profiles. Their ICUs have faced significant strain, which has contributed to fewer elective surgeries and overall lower ICU volumes, ultimately affecting our volumes as well. We previously noted a 44% Average Daily Census, which I don’t expect to sustain. There is substantial pent-up demand for acute services, and ICUs are likely the most under-resourced area in healthcare. This will lead to increased demand for our services and for our critical illness recovery hospitals moving forward. We intended to provide some insights into the reduction in ADC. While a 71% occupancy level is decent, we had seen 75% a year ago, which reflected the impact of COVID. I'm not disappointed with a 71% ADC in critical illness, but given our previous 75%, there is potential for it to increase as demand rises.

Martin Jackson, CFO

Kevin, I think the other thing that's important to note here is that prepandemic, case mix index was substantially lower than it is today. The pandemic actually accelerated the acute care hospital sending these critically complex patients to us. One of the things that we're very pleased to see is, as the pandemic goes away, our case mix index continues to remain high. So we're continuing to get those higher acuity patients.

Operator, Operator

There are no further questions at this time. I would now like to turn the call back over to Mr. Robert Ortenzio.

Robert Ortenzio, Executive Chairman and Co-Founder

Thanks, Operator. Thanks, everyone, for joining us.

Operator, Operator

This concludes today's conference call. Thank you for participating, and have a wonderful day. You may all disconnect.