Select Medical - Q2 2023
August 4, 2023
Transcript
Operator (participant)
Good morning, thank you for joining us today for Select Medical Holdings Corporation's Earnings Conference Call to discuss the Second Quarter 2023 Results and the Company 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, then the call will open for questions. Before we get started, we would like to remind you that this conference may contain forward-looking statements regarding future events
or future financial performance of the companies including without limitation, statements regarding operational 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, the company assumes no obligation to update these statements as circumstances change. I would now like to turn the conference over to Mr. Robert Ortenzio. Please go ahead, sir.
Robert Ortenzio (Executive Chairman and Co-Founder)
Thank you, operator. Good morning, everyone. Welcome to Select Medical's earnings call for the second quarter of 2023. Before providing detail on each of our four operating divisions, I'd like to provide some updates and commentary. As you are aware, we announced our preliminary estimate of certain financial results for the second quarter on 19 July in connection with plans to launch a refinancing of some of the company's debt. We completed our refinancing on 31 July and Martin Jackson will provide further details in his commentary. I wanted to highlight that on 1st August U.S. News & World Report released its annual Best Hospitals list. I'm pleased to share with you that our Kessler Institute for Rehabilitation and six of our partnered inpatient rehab hospitals are ranked among the nation's best for 2023/2024. Number three, Kessler Institute for Rehabilitation.
Number 21, California Rehabilitation Institute. Number 22, Baylor Scott & White Institute for Rehabilitation in Dallas. Number 34, OhioHealth Rehabilitation Hospital in Columbus. Number 38, Cleveland Clinic Rehabilitation Hospital. Number 46, TriHealth Rehabilitation Hospital in Cincinnati. Number 48, Banner Rehabilitation Hospital in Phoenix. This marks the 31st consecutive year that Kessler Institute has been named among the nation's Best Hospitals for rehabilitation, and the third year in a row for Baylor Scott & White Dallas and OhioHealth. This recognition is a testament to our teams and the attention to quality at each of these institutions. On the financial front, we had another strong quarter, with all four of our operating divisions exceeding prior year revenue. Overall revenue grew 6% and adjusted EBITDA by 21% compared to prior year Q2.
The full reinstatement of Medicare sequestration and CARES Act grant income received in Q2 prior year were headwinds when compared to prior year's same quarter financial performance in the amounts of $4.8 million for Medicare sequestration and $15.1 million for CARES grant income. For the quarter, total company adjusted EBITDA was $219.5 million, compared to $181 million in the prior year. Our consolidated adjusted EBITDA margin was 13.1% for Q2, compared to 11.4% in the prior year. Excluding grant income and the Medicare sequestration impact of Q2 prior year, our prior year adjusted EBITDA was $161.1 million, with a 10.2% margin.
Our Critical Illness Recovery Hospital division experienced the most significant increase in performance compared to prior year, with a 227% increase in adjusted EBITDA, along with an eight point reduction in their salary, wages, and benefit to revenue ratio. The CIRH division SWB to revenue ratio was 56.7%, which was within our target range of 55%-57%, along with a $43 million reduction in agency expenses compared to same quarter prior year. Consistent with last quarter, Martin Jackson will provide additional detail regarding Critical Illness sustained labor improvements within his commentary. Critical Illness had a lot of activity on the development front, with three more openings this past quarter. In May, we opened two hospitals with joint venture partners located in Tucson, Arizona and Alexandria, Virginia. In June, we also acquired a 60-bed critical illness hospital in Richmond, Virginia.
We incurred $5.1 million in startup losses in our new Critical Illness Recovery hospitals this quarter. As previously mentioned, we have an agreement to open a Critical Illness Recovery Hospital with a distinct part rehabilitation unit in Chicago with our joint venture partner, Rush University System for Health, in Q2 of 2024. There is also a strong pipeline of additional opportunities for growth that are under consideration.. The inpatient rehab hospital division continued their strong performance, exceeding prior year quarter revenue and adjusted EBITDA. As mentioned in Q1, the development pipeline remained strong, with a 36-bed inpatient rehab hospital in Fort Wayne, Indiana, expected to close in Q3 with our joint venture partner, CHS. As previously noted, we have partnered with AtlantiCare to build a new rehabilitation hospital in Southern New Jersey.
Contingent upon regulatory approval, the hospital will be called Bacharach Institute for Rehab and is slated to open in either 2025 or 2026. The pipeline for growth is strong, and we anticipate strong performance throughout this year. Concentra continued their exceptional performance, exceeding prior year revenue, EBITDA, and patient volume. During the quarter, Concentra completed two transactions. The acquisition of Holland MediCenter in Michigan included a standalone clinic location, as well as a mobile unit used for episodic events, extending our footprint approximately 30 miles from Grand Rapids into nearby Holland, Michigan market. Concentra also acquired OneSource Occupational Medicine, a transaction that resulted in a fold-in of the practice into our nearby clinic located in Tulsa, Oklahoma. Concentra has four signed leases for new de novo locations that are expected to open in Q4 2023.
Additionally, there's a strong pipeline of acquisition in de novos that are currently being evaluated. This quarter, our outpatient rehabilitation division surpassed prior year revenue and patient volume. Outpatient entered into a joint venture partnership with AtlantiCare in our South Jersey market, contributing 13 clinics, where we are the managing partner and majority owner. Division added eight clinics this quarter via the acquisitions in de novos. The pipeline for additional growth remains strong, with 27 executed leases for de novo clinics, which are scheduled to open in the second half of 2023. There are also many additional opportunities for acquisitions and de novo development that are under consideration. At this point, I'll provide some further data points on each of our divisions.
Critical Illness Recovery Hospital division experienced increases of 5% of net revenue, 2% in occupancy rates, and 227% in EBITDA for an extremely successful quarter. Our occupancy was 68%, up from 67%. Our case mix index decreased from prior-year of 1.29 to 1.26. Nursing agency rates decreased 31%, and nursing agency utilization decreased 44% when compared to prior-year Q2. Nursing agency rates decreased 7%, while nursing agency utilization remained consistent compared to Q1 2023. Orientation hours decreased 14% compared to prior-year Q2, but increased 24% compared to Q1 2023, as we continue to add full-time nurses. Nursing sign-on and incentive bonus dollars decreased 35% from prior-year Q2, and 25% from the prior sequential quarter.
Our adjusted EBITDA margin was 11.4% for the quarter, compared to 3.7% in the prior year Q2. Our positive reductions in labor contributed to the improvement in our EBITDA margin. On the regulatory front this week, CMS issued the final LTAC rules for fiscal year 2024, which will be effective October 1 of this year. The final rule includes a 3.6% increase in the federal base rate, which is higher than the proposed rule. The high cost outlier threshold increased by $21,355, which was much lower than the increased outline in the proposed rule of $55,805, $55,805, $55,860. The MS LTAC DRG relative weight and expected length of stays were also updated in the final rule.
Our Inpatient Rehab Hospital Division experienced a 5% increase in net revenue, with patient volumes increasing 1% and our rate per patient day by 4%. Occupancy was 84%, compared to 86% prior year. The adjusted EBITDA margin for inpatient rehab was 23% for Q2, compared to 21.8% in the prior year. Last week, CMS also issued the final inpatient rehab rules for fiscal 2024, which were effective 1 October. Final rule includes a 3.7% increase to standard payment amount, which is higher than the 3.3% included in the proposed rule. The high cost outlier threshold increased $2,103, which was slightly less than the $2,836 decrease in the proposed rule.
The CMG relative weights and average length of stay values were also updated in the final rule. Concentra experienced an increase in 6% in net revenue, driven by 2% increase in volume and a 6% increase in rate. Our work comp net revenue per visit increased by 2%, and our employer services rate increased by 9%. Concentra's adjusted EBITDA margin was 21.5% for the quarter, compared to 21% in the same quarter prior year. Our outpatient rehab division experienced an increase of 6% in net revenue, patient volumes increasing by 11%, offset by a decrease in rate from 103 net revenue per visit to 100 net revenue per visit compared to quarter prior year.
The increase in volume compared to prior year was spread amongst multiple markets and was partially attributed to organizational initiatives focusing on improving clinical productivity via patient access. The decline in rate was due to a decline in outpatient Medicare fee schedule, full implementation of Medicare sequestration, payer mix, and variable discounts when compared to prior year. The outpatient division's EBITDA declined slightly by $751,000 compared to prior year, while their EBITDA margin was 10.8% this quarter versus 11.7% same quarter prior year. Earnings per fully diluted share were $0.61 for the second quarter, compared to $0.43 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 September 1, 2023, to shareholders of record as of the close of business on August 15, 2023. This past quarter, we did not repurchase shares under our board authorized share repurchase program. We'll continue to evaluate stock repurchases, reduction of debt, and development opportunities. This concludes my remarks. With that, I'm gonna turn it over to Martin Jackson for some additional financial details before we open the call up for questions.
Martin Jackson (EVP and CFO)
Great. Thank you, Rob. Good morning, everyone. Consistent with the prior three quarters, I'd like to provide some additional details with the progress we continue to make regarding labor costs with Critical Illness Recovery Hospital division. This past quarter, we had a sequential reduction from Q1 to Q2 in our total RN agency costs and our RN agency rates, while utilization of agency remained consistent. The reductions we realized were 7% in the RN agency costs and 7% in the agency RN hourly rate, from $83 down to $77. Our utilization of agency remained at 18% for the past three quarters.
We experienced slight fluctuations in our agency rates and costs as the quarter progressed, with the rate fluctuation from April to June of 1%, from $79 down to $78, and RN agency costs of $7.9 million in April, $7.4 million in May, and $6.7 million in June. Agency utilization was 19% in April and May. This dropped to 17% in June. Other areas where we saw improvement compared to the sequential quarters were reductions of 25% in nursing sign-on and incentive bonuses, while our hospital administrative SWB remained relatively consistent with Q1. This quarter, we had an increase of orientation hours compared to sequential, compared sequentially to Q1 2023 of 24%, and the hours remained relatively consistent during the quarter, at an average of 40,000 hours per month.
Overall, our SWB, the net revenue ratio, increased slightly from Q1 to 56.7%, up from 56.3%, which is remaining within the targeted rate that we previously had communicated. Moving on to our financials. In Q2, equity and earnings of unconsolidated subsidiaries were $10.5 million. This compares to $6.2 million in the same quarter prior year. Net income attributable to non-controlling interests was $13.6 million, compared to $11.1 million in the same quarter last year. Interest expense was $49 million in the second quarter. This compares to $41.1 million in the same quarter prior year. The increase in interest expense was primarily attributable to an increase in the interest rates compared to Q2 of 2022.
At the end of the quarter, we had $3.8 billion of debt outstanding and $101.2 million of cash on the balance sheet. Our debt balance at the end of the quarter included $2.1 billion in term loans, $345 million in revolving loans, $1.2 billion in our 6.250% Senior Notes, and $77.1 million of other miscellaneous debt. We ended the quarter with net leverage of our senior secured credit agreement of 5.06 times. As of June 30th, we had close to $250 million of availability on our revolver. As Rob previously noted, we completed a refinancing transaction on 31 July this year.
We amended and extended our $2.1 billion Term Loan B, secured on loan with, along with increasing our senior secured revolving credit facility, $60 million from $650 million up to $710 million. Both the term loan and the revolver have been extended two years and will mature on March 6, 2027, with an early springing maturity of 90 days prior to the Senior Notes maturity, triggering if more than $300 million of Senior Notes remains outstanding at May 15, 2026. The refinancing term loan is priced at SOFR plus 300 basis points, with a step down of 25 basis points if our net leverage ratio falls below four times.
The revolver has been priced at SOFR plus 250, with a step down of 25 basis points if net leverage ratio falls below 4 times. It's important to note that the 1% SOFR interest rate cap on the $2 billion of our term loans will remain in place through September 30, 2024. Our $1.2 billion of 6.250% Senior Notes still mature on August 15, 2026. For the second quarter, operating activities provided close to $235 million in cash flow. Our day sales outstanding, or DSO, was 52 days at June 30, 2023, compared to 53 days, June 30, 2022, and 54 days as of March 31, 2023. Investing activities used $66.8 million of cash in the second quarter.
This includes $59.5 million in purchases of property and equipment and $7.3 million in acquisition and investment activity. Financing activities used $150.6 million of cash for the second quarter. We had $115 million in net payments on our revolving line of credit, $14.3 million of net payments on other debt, and $15.9 million in dividends on our common stock. As stated previously, we did not repurchase any shares under our board authorized repurchase program this quarter. The program remains in effect until December 31, 2023, unless further extended or earlier terminated by the board.
We are adjusting our business outlook for 2023, with expected revenue to be in the range of $6.55 billion-$6.7 billion, expected adjusted EBITDA in the range of $795 million to $825 million, and a fully diluted earnings per share to be in the range of $1.77-$1.94. Select Medical expects adjusted earnings per share to be in the range of $1.86-$2.03. Adjusted earnings per share excludes the loss of early retirement of debt and its related costs and tax effects. Capital expenditures are expected to be in the range of $190 million to $210 million for 2023. This concludes our prepared remarks, and at this time, we'd like to turn it back over to the operator to open the call up for questions.
Operator (participant)
Thank you. As a reminder, to ask your question, you'll need to press star one, one on your telephone. To withdraw your question, please press star one, one again. Please wait for your name to be announced. Please stand by while we compile the Q&A roster. One moment for our first question, please. Our first question comes from the line of Justin Bowers with Deutsche Bank. Your line is now open.
Justin Bowers (Equity Research Analyst)
Hi, good morning, everyone. Rob, just wanted to clarify one thing on the, on the LTACs, is that is the next, you know, de novo, or JV coming online in, in 2024, or is there anything left in the rest of the year, this year?
Robert Ortenzio (Executive Chairman and Co-Founder)
just, just Rush is the one that's, that we have.
Justin Bowers (Equity Research Analyst)
Okay.
Robert Ortenzio (Executive Chairman and Co-Founder)
That's, would be next, based on deals that we've announced. You know, anything else that we would that we would do that would be before that, we've not, we've not announced yet.
Justin Bowers (Equity Research Analyst)
Got it. Then just on outpatient, you know, sort of given the landscape over the last, you know, year or so, is the plan for you guys to sort of stay the course with your, you know, the JV approach and sort of building around your existings, or is there any appetite to do something, you know, with greater scale?
Robert Ortenzio (Executive Chairman and Co-Founder)
I would say at this point, there, there is no appetite to do anything on a broader scale. We, we feel really good about our opportunities for creation of value by adding incrementally in markets where we have a presence, and also snapping outpatient on to our many joint venture agreements that are, are growing pretty rapidly. I would say to you that we are probably not in the market for a bigger transaction in the outpatient space.
Justin Bowers (Equity Research Analyst)
Okay, thanks. Martin, healthy free cash flow generation in the first half, especially in Q2. How are you guys thinking about CapEx in the second half? Then just given the attractive spread in T-bills versus the rate cap, how should we think about the deleveraging going forward through 24 September? Is that just more of a function of, you know, the EBITDA growth, or is there, is there gonna be some paydown, too, along the way?
Martin Jackson (EVP and CFO)
Yeah, Justin, with regards to I mean, Rob had talked about the use of free cash flow. We anticipate that we will continue to see the dollars on our revolver come down. That should be, you know, going into 2024, you know, by the end of 2024, that should completely be eliminated, any cash, any, any borrowings on that revolver. No, we will continue to pay down debt. You can expect to see leverage come down, not only from increased EBITDA, but also reduction of debt.
Justin Bowers (Equity Research Analyst)
Okay, understood. Yep, I'll hop back in queue. Thank you.
Operator (participant)
Thank you. One moment for our next question, please. question comes from the line of Ben Hendrix with RBC Capital Markets. Your line is now open.
Ben Hendrix (VP)
Thank you very much. Just a follow-up question on your LTCH final rule comments. We're definitely glad to see that outlier threshold come down from the proposal, but it still seems like a pretty significant hike. How are you thinking about the financial impact of that to your critical illness segment from 3Q to 4Q and then into next year? Thank you.
Martin Jackson (EVP and CFO)
Yeah, Ben, there, there's no doubt that that increase in the high cost outlier number will have, we will certainly have some, some headwinds there. There are certainly ways to, to mitigate that, and that's what we're focused on right now.
Ben Hendrix (VP)
Okay. Then just overall, the, the, the rate increase, 3.5% or thereabouts, how does that translate, do you think, for Select Medical, specifically, kind of given your case mix and thanks?
Martin Jackson (EVP and CFO)
Ben, could you clarify that question when you say, how does?
Ben Hendrix (VP)
Yes.
Martin Jackson (EVP and CFO)
I mean, we have a
Ben Hendrix (VP)
Just how the rate update, if you expect it to be any different for Select than the 3.5% finalized?
Martin Jackson (EVP and CFO)
No, we, we anticipate it will be in that neighborhood for us. You know, you can expect to see, you know, increases for our Medicare, you know, dollars increase by that %. I think that's a good, a good number to use in your model.
Robert Ortenzio (Executive Chairman and Co-Founder)
Yeah, I think
Martin Jackson (EVP and CFO)
I think you'll see, you know, better increases on the commercial side. You know, I think we've been in that negotiated rates. We've been in that 5%+ range. With Medicare, I think it's, I think it's 3.5, Ben, and then I think there's a, a deduct of about 0.2% for efficiency improvements.
Robert Ortenzio (Executive Chairman and Co-Founder)
As usual, Ben, these LTCH, because it's a complicated business, there's. In these final rules, the aftermath of the final rules, there's a lot of give and takes in this. You know, you have the high cost outlier threshold, which has an impact. You have the rate increase, and then you have our mix of business, the case mix index, and our percentage of respiratory cases and pulmonary. All of these have an effect on the business. You know, we're, you know, post the rule and going into next year, we'll be taking a look at all of those to, you know, adjust all the levers that we have at our disposal to make sure that we can get some growth out of the segment.
Ben Hendrix (VP)
Got you. Thank you. Just, just quickly, finally, do you expect this, the high cost outlier to, to drive any industry disruption that could create a consolidation opportunity for you guys?
Robert Ortenzio (Executive Chairman and Co-Founder)
I do not.
Ben Hendrix (VP)
Okay. Thank you.
Operator (participant)
Thank you. One moment for our next question. The next question comes from the line of Kevin Fischbeck with Bank of America. Your line is now open.
Kevin Fischbeck (Managing Director and Senior Equity Research Analyst)
All right. Great, thanks. Maybe just to stay on Medicare rates, do you have a similar comment on IRFs? What do you think the kind of net rate to you guys will be on the IRF rule?
Robert Ortenzio (Executive Chairman and Co-Founder)
Yeah, I mean, I think that we're pretty satisfied with the, with the LTCH rule and or the, the rehab rule, and I think we've got a little bit of a tailwind on the final rule there as, as we're looking forward to Q4 and in the next year, Kevin.
Kevin Fischbeck (Managing Director and Senior Equity Research Analyst)
Okay. Then, obviously, a lot of progress on SWB. Wanted to get a sense from you guys where you thought you were in that, in that progress. We all love baseball analogies, so, like, what inning are we on the improvement there? Is there, is there much to go still from here, or is this the right way to think about, you know, SWB, heading into 2024?
Martin Jackson (EVP and CFO)
Yeah, Kevin. You know, I think throughout the balance of the year, we'll be in that 55%-57% range. Now we see that dropping down in 2024 and 2025. The reason being, remember, we're not just focused on the costs here. I mean, SWB, as a percentage of revenue, has a, a revenue component to it. Our commercial contracts are basically three years. The terms on those are three years, so we'll be negotiating increases in those. You know, we're done about a third of our contracts now, so we'll be negotiating in 2024 or 2025 for the, for the balance of the contracts. We anticipate as we do that, we get decent increases there. We would expect to see SWB, as a percentage of revenue, continue to come down through 2025. You know, our, our, our focus is really to get it back to that historical rate of 52%.
Kevin Fischbeck (Managing Director and Senior Equity Research Analyst)
Okay, that's great. So when we think about that improvement, though, you're, you're saying that the improvement is less about further declines in bill rates or, or utilization per se, and it's more about getting the, the top line growth to kind of match inflation?
Martin Jackson (EVP and CFO)
That's correct.
Kevin Fischbeck (Managing Director and Senior Equity Research Analyst)
Okay, great. Then, excuse me. Then maybe just last question. On, on the outpatient side, you know, the rates being down, you know, is that something that we should be modeling going into to next year? I guess there's still another rehab rate cut, at least proposed next year, or is there anything kind of unusual? You mentioned you mentioned payer mix is kind of in there. Is there a reason to believe that the rates next year will be better than, than rates this year?
Martin Jackson (EVP and CFO)
Yes, there is. We anticipate that, you know, going into next year, we think it's going to rebound back to at least be in that, $102-$103 range.
Kevin Fischbeck (Managing Director and Senior Equity Research Analyst)
What's driving that?
Martin Jackson (EVP and CFO)
again, contracts and improvements in some other in our, in the CBO area.
Kevin Fischbeck (Managing Director and Senior Equity Research Analyst)
Okay. All right, perfect. Thank you.
Operator (participant)
Thank you. One moment for our next question. Our next question comes from the line of AJ Rice with Credit Suisse Financial. Your line is now open.
Speaker 6
Hi, good morning. This is NJ on for AJ. I wanted to ask about the larger volume trend that we're seeing. Your volumes, especially in IRFs and outpatient rehab, are very strong. Do you see this as mostly deferred care flowing through the system, or do you see this more as more sustainable volume? Thank you.
Martin Jackson (EVP and CFO)
Yeah, could you repeat that question?
Robert Ortenzio (Executive Chairman and Co-Founder)
Yeah, you're not, yeah, you're not coming through very clearly.
Speaker 6
Yeah, I was asking about whether the volume that you're seeing on IRFs as well as outpatient rehab, is it more the deferred care flowing through the system after the pandemic, or is it more sustainable volume?
Robert Ortenzio (Executive Chairman and Co-Founder)
I think the business on the, if I'm understanding your question, I think the business in the IRFs and the outpatient is very sustainable in this post, if you're, if you characterize it as post-pandemic growth. I mean, the business on the demand side in IRF and outpatient is very good. I mean, you know, for a company like ours or others, I mean, it's just a question of navigating your, your local market and your competition and your rate negotiations. It's I don't think in either of those businesses, it's necessarily. There's no systemic volume issue.
Martin Jackson (EVP and CFO)
Yeah, we, we don't really think that it's a function of pent-up demand due to the pandemic. We think it's really, we think we'll continue to see increases like this.
Robert Ortenzio (Executive Chairman and Co-Founder)
There's lots of things that can affect it in, in local markets. For example, staffing challenges that large systems continue to have can oftentimes or sometimes affect their surgical volumes. If surgical volumes, particularly on the orthopedic side, are impacted in a local market, we're going to certainly see some pull-through negative on that. Overall, when we look nationally, we see, you know, a return to a pretty strong, pretty strong business. Does that answer your question?
Speaker 6
Yes, got it. Thanks. Maybe one more on LTAC pricing. I think revenue per patient day was up 4.5%, and sequestration should be a headwind, and it seems like the acuity mix stepped down as well. Why is the pricing going up? How does the back half of the year shake out?
Robert Ortenzio (Executive Chairman and Co-Founder)
Well, I can tell you one thing on the acuity mix in the, in the, in the winter months, when we tend to see more pulmonary, the acuity mix will go up. I don't think you should look at the acuity, the case mix index reduction that we, we commented on as being any kind of systemic, signal or reduction in acuity of our patients. In fact, we, we continue to see increased acuity in our critical illness hospital. So, I mean, I think, I think that will continue to remain strong. As you know, there is some seasonality in our business.
Martin Jackson (EVP and CFO)
Yeah I think the other thing is, as you know, we're paid on a DRG. To the extent that the length of stay goes down, which it did, during the quarter, that's going to have a positive impact on the, the rate.
Speaker 6
Thank you.
Operator (participant)
Thank you. I am currently showing no further questions at this time. I'd like to hand the conference back over to Mr. Robert Ortenzio for closing remarks.
Robert Ortenzio (Executive Chairman and Co-Founder)
Closing remarks. Thanks, everybody, for joining us, and look forward to updating again next quarter.
Operator (participant)
This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.