Select Medical Holdings Corporation (SEM) Q1 2022 Earnings Report, Transcript and Summary

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.

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 2 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 the life for the communities in which we live and we 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 4 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 a 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've 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 of our average daily census of 43. Our case mix index remained consistent with 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 the decrease in our census compared to prior year for the quarter. Our census in April, however, was right in line with 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 is our expectations 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 prior year include $17.9 million, related to the positive outcome of litigation with CMS. Excluding this item, the EBITDA margin would've 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 prior year and by 4% from Q4 2021. Additionally, the utilization of our agency nurses increased by 36% from prior year Q1 that 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 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 prior year at 84%, revenue per patient day increased $90 from $1,853 to $1,943. The EBITDA margin for the 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 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 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, experienced a slight increase in net revenue from Q1, while EBITDA increased significantly by $7.5 million. Centers patient volume increased by 11.5%, it was offset by an expected decline 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 for visit of $125 remain consistent with prior year, as our employer services mix increase which has a lower level in 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% of 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 continue to increase within our centers. In Q1, Concentra acquired one new center in Gary, Indiana and have executed leases for 2 de Novo clinics. There is a very attractive pipeline, potential de novos and smaller acquisitions and we continue to expect strong volumes in this segment. Turning to our outpatient division, 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 prior year with a decrease in margin to 9.8% from 10.4% in prior year 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 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 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 prior year. As previously stated and noted in our press release, our Board of Directors has declared 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.

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 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 JVs. Net income attribute to non-controlling interest with $6.8 million, this compares to $26.7 million in the same quarter prior year. The decrease is partially due to the re-purchasing 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 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 Medicare Advantage’s to be repaid. Since April of last year, we have returned over $312 million of the Medicare Advantage’s. 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 about, 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 3 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 is stabilized and is 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.

Your first question comes to line with Justin Bowers from Deutsche Bank.

Just wanted to make sure I understood some of the -- a lot of the development activity -- for LTACs, it sounds like there's two more hospitals expected to be acquired this quarter and then four developed by the -- four developments by the end of this year or into 2023. So six total, I think you called out. And then on Concentra or -- sorry, outpatient then, 40 more de novos through year end. And can you give us a sense of how do you expect those to phase in if I understood all that correctly?

Justin, it's Bob. On the critical illness side, I think what you're seeing is something that we talked about a couple quarters ago, when -- through the pandemic, I think there was an increasing recognition of the value that long-term acute care hospitals or our critical illness recovery hospitals play in the continuum of care of decompressing ICUs. And I think, the recognition of that, and with a little bit of delay has seen more requests and developments. There's a couple things that I think are noteworthy about the critical illness development is they are in the main hospital within a hospital. And then unlike the history of the company where we literally did most -- all of our joint ventures on the inpatient rehab side, the critical illness projects in the main are now joint ventured as well. So I think that is -- what we've been saying is a recognition of the importance of that segment and the overall continuum. So those hospitals are being developed on our HIHs. We do have two hospital acquisition in one of our markets with markets, which is Youngstown, Ohio. And we did sign that and expect that to close. And one of those is in HIH and one is a free standing, and we are already have a presence in that market. So that's a further consolidation of that market. On the inpatient rehab side, we will continue to selectively do large, primarily freestanding hospitals, usually from the ground up with large partners. And we recently had one open with the Banner Hospital. And we'll continue to do those probably at the same cadence and pace as you've seen over the last couple years. Turning to the outpatient rehab division, I think again, a couple quarters ago, Marty and I talked about our renewed focus on growing that division. And we said that we would do it selectively in small acquisitions and in de novos. We are in a lot of markets. We have over 1800 clinics, so that 40 de novo clinics really represents us expanding primarily in markets that we're already in, where we know the markets very well. It's a better use of capitals to sign a lease and open a new outpatient center then to acquire something. And then where we can do smaller-sized outpatient acquisitions, we'll do that. And then finally, on Concentra, while they have a -- we only showed, we only commented on 1 de novo and I think an acquisition, their pipeline is really robust. And while that will be lumpy in terms of the announced de novo or acquisitions, I think by the time year-end, you'll see that they've grown significantly through acquisition and de novo. So I hope that gives you kind of a good sense. And Marty, I don't know if there's anything you want to add to that.

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

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?

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.

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

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 4Q. 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.

Michael, this is Marty Jackson. 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 2 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.

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?

When you say testing; Michael, are you talking about the testing for COVID? Which was really predominant in the first quarter of '21, but there was really nothing in -- no, there was really nothing in Q1 of '22. So it was really a function of the -- what we saw was basically a replacement of that testing by the 11.5% growth rate in volume in Q1 of '22.

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

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?

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?

I was just going to say, if you're starting to see improvement there, shouldn't that bode well for lessening your demand for the temporary staff? Or is that -- It doesn't sound like you're necessarily forecasting that over the near term.

You're absolutely right, A.J. We should see a decline in utilization of agency nursing. But remember, as we're onboarding the nurses, there's training that takes place for, typically, in that 4- to 6-week time frame. So we'll continue to utilize agencies during that period of time. And that's why I was suggesting that in -- probably in May and June we're going to start to see utilization of agency nurses go down.

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?

Well, to answer your second question, is 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 being able to have proven to be able 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.

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

Just to take a whack at the dead horse on labor a little bit -- one more time. What was the utilization ratio prior to the pandemic, the agency RN to total, your total workforce?

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.

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?

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.

I can't imagine that in this environment, in this general labor environment that we could say that, it would return to levels prepandemic. But on the other hand, I think we would say is, we don't need it to return to prepandemic. I mean, what we need is just to be able to move away from these agency levels that are just unsustainable. And I think that the message that you've heard from other companies that have released is the same thing. So yes, rates are up. Even comp is up. Comp is up for our mature staff. It's up for new hires. Which is understandable, and we can handle that on a go-forward basis. It's just the extreme of the agency rates that I don't think that there's many people in health care services that believes that those agency rates are sustainable. And we're seeing them come down. And so do they return completely to trend on agency? I think they could. But you're still going to have increase in -- minimum wage is up across the entire United States. I mean, salaries are up.

Bill, I think the way you should think about this is really take a look at SW&B as a percentage of revenue. And there's really 3 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. I mean, 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.

So that's how you kind of recapture that EBITDA margin even though you have permanently a -- structurally, obviously, everyone's got a higher labor cost structure. Okay. That's very helpful. And on Concentra, remind us how much the COVID comps are a factor for the growth comp for the balance of this year.

With regards to COVID comps, if you take a look at Q1 of '22, I mean, there's almost no COVID in that. I mean, the increase --

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.

I think the way to think about it is 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.

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

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 clearly there's a little bit of a lag on the government side of the equation.

Kevin, that's a very good point. I mean, 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 it's going to be, as I said, we probably won't see that for 18 months on Medicare.

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?

Well, in most of our contracts we have COLA adjustments.

Okay. So you see it relatively right away. And then it was helpful to kind of hear your impact on the Medicare -- your expectation of the rate update. Do you think it's going to be a higher number by the time that we get the final rule as CMS get a little more data coming in? Or is this more or less what we should be expecting for the final rule?

Kevin, you never know. I mean, the comment period. I mean, you've been around this business for a long time. So I mean, your guess is as good as ours.

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

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.

A lot of our LTAC volumes during the height of the pandemic was COVID, and we did treat probably well over 10,000 COVID patients in our critical illness. But in the main, the LTACs were used to decompress very busy ICUs in the acute care hospitals. So what we saw -- now in some of our markets, and it's hard to make a blanket statement across over 100 hospitals, but with all of the extreme pressure on acute care hospitals and as the pandemic and the incidence of COVID and the hospitalizations for COVID has gone down relatively dramatically, some of those hospitals are still gearing up on their, what I will call, return to traditional profile of their business, because their ICUs have been stressed, like all are. So the elective surgeries are less. They maybe have less volume in their ICUs, and that will translate into less volume for us. But I would say that was, I think we mentioned a 44% ADC. I mean, that is not going to continue. There is a lot of pent-up demand for acute services. ICUs are probably the single most underbedded segment of health care. And so there's going to be a lot of demand for ICUs on a go-forward basis. And as that demand and those ICUs fill up, there'll be more demand for our services and our critical illness recovery hospitals. And so that will happen. We were just trying to give a little bit of color on a reduction of the ADC. Now I would still say that there was a time when we would have said 71% occupancy was pretty good. We had 75% a year ago, which does reflect a little bit of COVID. So I can't say that I'm disappointed with a 71% ADC on our critical illness side, but it's been 75% and it can probably go higher from here as we see more demand.

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. And the pandemic actually accelerated the acute care hospital sending these critically complex patients to us. And 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.

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

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

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