Select Medical Holdings Corp

NYSE:SEM

Earnings Call Analysis

Select Medical Posts Strong Q3 Earnings

Select Medical Holdings Corporation reported a solid third quarter in 2023, reflecting the company's ability to improve labor costs and expand its reach through strategic ventures and acquisitions. Notably, labor costs within the Critical Illness division were reduced for the sixth consecutive quarter with RN agency usage dropping to 15%, below pre-pandemic levels. The company's revenue and adjusted EBITDA outstripped the prior year, growing by 6% and 27% respectively. All operating divisions reported higher revenues and EBITDA, with the critical illness recovery hospital division making marked strides, achieving a 7% increase in net revenue and a 320% surge in adjusted EBITDA. Start-up losses for new hospital ventures totaled $5 million for the quarter, and new expansions and joint ventures are in the pipeline for Chicago, Orlando North, Indiana, Florida, and New Jersey. The company's outpatient rehab division experienced an 11% hike in patient volumes, and plans are set for more clinic openings in Q4 2023 and throughout 2024.

Strong Quarter with Consistent Growth and Labor Improvement

Select Medical's Q3 2023 was marked by sustained improvement across all divisions. Revenue increased by 6% and adjusted EBITDA by an impressive 27% compared to the previous year. Even when facing a headwind from the prior year's $8.1 million in CARES Act grant income, the company achieved an adjusted EBITDA of $193.8 million. This efficiency is reflected in an improved EBITDA margin, up from 9.8% to 11.6%. Strategic executive management promotions were announced, setting the stage for long-term success.

Critical Illness Recovery Division Turnaround

The Critical Illness Recovery Hospital Division stands out with a 7% hike in net revenue and a staggering 320% increase in adjusted EBITDA. This is, in part, due to a 10% cut in salary, wages, and benefit ratios. Further bolstering this performance was a 30% reduction in nursing agency utilization and a 9% decrease in nursing agency rates from the previous year. Additionally, although the RN agency costs and utilization are down, there was a marginal 1% increase in the agency rate. These figures underscore a powerful quarter for the division, which is also investing in future growth with upcoming hospital expansions and partnerships.

Outlook on Investments and Joint Ventures

Select Medical is expanding its geographical footprint, with joint ventures and acquisitions such as a 36-bed inpatient rehab hospital in Fort Wayne, Indiana, and more planned openings through 2025. These moves not only extend the company's care capabilities but also lay the groundwork for increased revenue streams in the future. The pipeline for growth is robust, with new acquisitions like three occupational medicine practices and several de novo clinics already delivering positive impacts.

Financials and Capital Allocation

Q3 saw gains reflected in equity and earnings from unconsolidated subsidiaries at $11.6 million, alongside a $12.6 million net income attributable to non-controlling interest. Despite an uptick in interest expense due to rate increases, the company's refinancing activities resulted in a favorable term loan and revolving credit extension. Select Medical's committed approach to capital deployment is illustrated by its dividend declaration, conservative approach to stock repurchases, and a careful balance in debt reduction and development opportunities.

2023 Business Outlook and Guidance

Select Medical is holding steady with its 2023 outlook, projecting revenue between $6.55 and $6.7 billion, and adjusted EBITDA estimates between $795 million and $825 million. Diluted earnings per share are expected to fall between $1.77 and $1.94, with adjusted earnings per share, excluding early retirement of debt, ranging from $1.85 to $2.02. Capital expenditures are anticipated to be $190 million to $210 million, aiming for a strong close to the year while maintaining growth momentum.

Earnings Call Transcript 2023-Q3

[Operator]

Good morning, and thank you for joining us today for Select Medical Holdings Corporation's earnings conference call to discuss the third quarter 2023 results in the company's business outlook. Speaking today are the company's Executive Chairman and Co-Founder, Robert Ortenzio; and the company's Senior Executive Vice President of Strategic Finance and Operations, Martin Jackson. Management will give you an overview of the quarter and then open the call for questions.

Before we get started, we would like to remind you that this conference call may contain forward-looking statements regarding future events or the future financial performance of the company, including, without limitation, statements regarding operating results, growth opportunities and other statements that refer to Select Medical's plans, expectations, strategies, intentions and beliefs. These forward-looking statements are based on the information available to management of Select Medical today, and the company assumes no obligation to update these statements as circumstances change.

At this time, I will turn the conference call over to Mr. Robert Ortenzio.

[Robert Ortenzio, executive]

Thank you, operator. Good morning, everyone. Welcome to Select Medical's earnings call for the third quarter of 2023. We have a lot to be positive about as Q3 was another strong quarter. We continue to sustain our improvement in labor costs within the Critical Illness division. Q3 was the sixth sequential quarter that we have seen a reduction in agency expenses. RN agency usage dropped to our target percentage of 15%, which is lower than our prepandemic levels.

We also announced promotions within our executive management team that I believe will position the organization for continued long-term success. All 4 of our operating divisions exceeded prior year revenue and EBITDA. Overall, revenue grew 6% and adjusted EBITDA grew by 27% compared to prior year Q3. We received $8.1 million of CARES Act grant income in the prior year, which was a headwind heading into Q3 when comparing current to prior year performance. For the quarter, total company adjusted EBITDA was $193.8 million compared to $153.1 million in the prior year. Our consolidated adjusted EBITDA margin was 11.6% for Q3 compared to 9.8% in the prior year.

Our critical illness recovery hospital division experienced the most significant increase in performance compared to prior year, with a 7% increase in net revenue, a 320% increase in adjusted EBITDA along with a 10% reduction in their salary, wages and benefit to revenue ratio. Consistent with prior quarters, Marty Jackson will provide additional detail regarding this division's continued progress with labor within his commentary. Critical illness incurred $5 million of start-up losses related to new hospitals this quarter compared to $707,000 in the same quarter prior year.

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. We also have hospital expansions in the work that are expected to be completed in 2025, including Orlando North, which will include a 48-bed rehab distinct unit. There is also a strong pipeline of additional opportunities for growth that are under consideration.

On the inpatient rehab development front, on September 1, we entered into a joint venture with CHS and purchased a majority interest in a 36-bed inpatient rehab hospital in Fort Wayne, Indiana.

We've reached agreement with our joint venture partner at University of Florida Health Shands to open a 48-bed inpatient rehab hospital in Jacksonville, Florida, projected to open in Q3 of 2024, where we will have a majority interest. We are also planning to open a fourth inpatient rehab hospital, 32 beds with our joint venture partner, the Cleveland Clinic that is projected to open in the first half of 2025. 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 in either 2025, 2026.

The pipeline for growth is strong, and we anticipate strong performance throughout the remainder of the year. Concentra continued their exceptional performance exceeding prior year revenue, EBITDA and patient volume. During the quarter, Concentra continued to make progress on various ongoing transactions and bolster its pipeline for future acquisitions and de novos. Concentra acquired 3 occupational medicine practices with 2 located in Delaware and 1 in Northeast Maryland that closed on October 13. In addition to acquisition efforts, 3 de novos in Northrop, Virginia; Columbus, Ohio and Fort Myers, Florida opened in October 2023. We have 3 signed leases for de novos slated to open in 2024. There is a strong pipeline of acquisitions and other de novos that we continue to evaluate.

This quarter, our outpatient rehab division also surpassed prior year revenue, EBITDA and patient volumes. The division added 16 clinics this quarter via acquisitions and de novos. The pipeline for additional growth remains strong with 22 executed leases for de novo clinics of which 11 are scheduled to open in Q4 of 2023, with the remainder to be open in 2024. There are also many additional opportunities for acquisitions in de novos development 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 increases of 7% in net revenue and 320% of adjusted EBITDA for another successful quarter. While our occupancy was down from last year at 64%, down from 67%, an increase in our case mix index and a decrease in threshold days contributed to an increase in our revenue per patient day. Our adjusted EBITDA margin was 8.2% for the quarter compared to 2.1% in the prior year Q3. Our positive reductions in labor contributed to the significant improvement in EBITDA margin with a 10% reduction in our salary, wage and benefit to revenue ratio. Nursing agency rates decreased 9% and nursing agency utilization decreased 30% when compared to prior year Q3. Orientation hours decreased 4% compared to prior year Q3, but increased 19% compared to Q2 2023 as we continue to add full-time nurses.

Nursing sign-on incentive bonuses, dollar decreased 49% from prior year Q3, but remained consistent with prior sequential quarter. Our inpatient rehab hospital division experienced an 8% increase in net revenue and adjusted EBITDA. Patient volumes increased 3% and our rate per patient day increased by 5%. Our occupancy was 84% compared to 85% prior year. The adjusted EBITDA margin for inpatient rehab was 22% for Q3, which was consistent with prior year. Concentra experienced an increase of 7% in net revenue, driven primarily by rate. Our work comp net revenue per visit increased 3% and our employer services rates increased by 7%.

Concentra's adjusted EBITDA increased by 10% with margin increasing to 20.9% for the quarter compared to 20.2% in the same quarter last year. Our outpatient rehab division experienced an increase in 2% in net revenue with patient volumes increasing by 11%, offset by a decrease in rate from $103 net revenue per visit to $100 net revenue per visit. The volume increase offset by rate decrease when compared to prior year was consistent with what we saw in Q2.

Organizational initiatives focusing on improving clinical productivity via patient access contribute to additional volume where the decline rate was due to a decline in outpatient Medicare fee schedule, payer mix and variable discounts. The outpatient division's adjusted EBITDA increased by 3% compared to prior year while the EBITDA margin remained consistent at 9%. Earnings per fully diluted share were $0.38 for the third quarter compared to $0.21 per share in the same quarter prior year. Adjusted earnings per fully diluted share were $0.46. Adjusted earnings per share excludes the loss on early retirement of debt and its related cost and tax effects.

In regards to our allocation and deployment of capital, our Board of Directors declared a cash dividend of $0.125, payable on November 28, 2023, shareholders of record as of the close of business on November 15, 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 prepared remarks.

With that, I'll turn it over to Marty Jackson for some additional financial details before we open the call up for questions.

[Martin Jackson, executive]

Great. Thank you, Bob, and good morning, everyone. Consistent with the past year, I would like to provide additional details with the progress we continue to make regarding labor costs within the critical illness recovery hospital division. This past quarter, we had a sequential reduction from Q2 to Q3 in our RN agency costs and utilization, but had a slight increase in the RN agency rate. The reductions we realized were 17% in RN agency costs, having $22.1 million versus $18.4 million this quarter and a drop in RN utilization from 18% to 15%. The agency rate increased by only 1% from $77 to $78, and we experienced very little change in the rate throughout Q3. RN agency utilization during the quarter inched down from 15.6% in July, 15.5% in August and 15.1% in September and the related costs were $6.2 million in July, $6.3 million in August and $5.8 million in September.

Nursing sign-on and incentive bonus dollars remained consistent with Q2 at $7.8 million, while we had a 19% increase in orientation hours, 143,000 hours compared to 120,000 in hours with the fluctuation during the quarter from 44,000 hours in July, 51,000 in August and 48,000 in September.

Moving on to our financials. In Q3, equity and earnings of unconsolidated subsidiaries were $11.6 million. This compares to $8.1 million in the same quarter last year. This increase in earnings was the result of increased in earnings in a few of our unconsolidated joint ventures. Net income attributable to noncontrolling interest was $12.6 million compared to $11 million in the same quarter prior year. And again, this increase was primarily due to the improved performance of our consolidated joint ventures.

Interest expense was $50.3 million in the second quarter. This compares to $45.2 million in the same quarter prior year. The increase in interest expense was primarily attributable to an increase in the interest rates compared to Q3 of 2022. At the end of the quarter, we had $3.7 billion of debt outstanding and $77.4 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 and 6.25% senior notes and $75.8 million of other miscellaneous debt. We ended the quarter with net leverage for our senior secured credit agreement of 4.85x. As of September 30, we had $374 million of availability on our revolving loans.

As we reported on the last call, we completed a refinancing transaction in the third quarter. We amended and extended our $2.1 billion senior secured term loans, along with increasing our revolving credit facility by $120 million from $650 million to $770 million. Both the term loan and the revolver has been extended 2 years and will mature on March 6, 2027, with an early springing maturity of 90 days prior to the senior notes maturity triggered that more than $300 million of senior notes remains outstanding on May 15, 2026. The refinanced term loan is priced at SOFR+ 3% with a step down of 25 basis points if our net leverage ratio falls below 4x.

The revolver has been priced at SOFR+ 2.5% with a step down to 25 basis points if our net leverage, again, falls below 4x. It's important to note that the 1% SOFR interest rate cap on $2 billion of our term loans will remain in place through September 30, 2024, our $1.2 billion in senior -- in 6.25% senior notes matures August 15, 2026.

During Q3, we recognized $14.7 million of loss on the early retirement of debt as a result of the amendment to the credit agreement. For the third quarter, operating activities provided $116 million in cash flow. Our day sales outstanding or DSO was 52 days at September 30, '23 compared to 53 days at September 30 of '22 and 52 days in June 30 of '23. Investing activities used $63 million of cash in the third quarter. This includes $50.2 million in purchases of property and equipment and $12.8 million in acquisition and investment activity.

Financing activities used $77 million of cash in the third quarter. We had $25.1 million in net payments and distributions to noncontrolling interests, $16.5 million in net payments on our term loans as a result of the refinancing, $16 million in dividends on our common stock, $9.5 million in share repurchases and $5 million in net payments on our revolving line of credit. As stated previously, we did not repurchase any shares under our Board authorization repurchase program this quarter. The Board has approved a 2-year extension of the share repurchase program, which will now remain in effect until December 31, 2025, unless further extended or earlier terminated by the Board.

We maintain our business outlook for 2023 with expected revenue to be in the range of $6.55 billion to $6.7 billion, expected adjusted EBITDA in the range of $795 million to $825 million and fully diluted earnings per share to be in the range of $1.77 to $1.94. Select Medical expects adjusted earnings per share, which was revised to exclude the actual tax effect at loss on early retirement of debt to be in the range of $1.85 to $2.02. Adjusted earnings per share, excluding the loss on retirement of debt and its related cost and tax effect. Capital expenditures are expected to be in the range of $190 million to $210 million for 2023.

This concludes our prepared remarks. At this time, we'd like to turn it back over to the operator to open the call up for questions.

[Operator]

[Operator Instructions] Our first question comes from Justin Bowers with DB.

[Justin Bowers, analyst]

Bob, I may have missed this in the prepared remarks. But are there any additional LTAC? Is there additional LTAC capacity coming online the rest of this year or into 2024 and -- or any deals that you announced in the quarter?

[Robert Ortenzio, executive]

Well, we have Rush next year, which is the combined rehab and critical illness post-acute building, that will be next year. I don't know that we have any other critical illness openings next year that we've announced. I mean it's possible. Orlando will be 2025. But we typically don't announce those deals until they're signed. I mean it is possible that we could do a critical illness if it's a hospital within a hospital that we would sign between now and the end of the year and could be potentially in service next year, but we haven't announced any.

[Justin Bowers, analyst]

Got it. And then with respect to the guide in the rest of the year, what are some of the swing factors in the guide, the big swing factors as you look into 4Q?

[Martin Jackson, executive]

Yes, Justin, as you know, we provide guidance on an annual basis. And from that perspective, we're going to keep the guidance that we have provided. I know you guys do it on a quarterly basis. And we anticipated that we would have the quarter that we did in Q3 and for the balance of the year. We think the guidance that's out there on an annual basis is a good guide for the Street.

[Justin Bowers, analyst]

Okay. Got it. And then in terms of SWB and sort of the targets that you've laid out over the next several years returning to normalization with critical illness. Like how are you thinking about that? Any sort of updated thinking around what that trajectory may look like over the next couple of years? .

[Martin Jackson, executive]

Yes, Justin. I mean our expectation is that by the end of 2025, when all of the contracts, all of the payer contracts are renegotiated, we anticipate we should return to somewhere in the range of 52%, SWB as a percentage of revenue.

[Justin Bowers, analyst]

Okay. And would that sort of look like a linear sort of progression from now until then? Or is that a reasonable assumption?

[Robert Ortenzio, executive]

Yes. I mean I can't tell you that I specifically know when the contracts will be renegotiated. I'm not so sure that the -- if we've got 2/3 left in the last 2 years, whether those are linear or not. But I think when you get to the end of '25, you can assume that our expectation is we'll be in the 52% range.

[Operator]

Our next question comes from Ben Hendrix with RBC Capital Markets.

[Michael Murray, analyst]

This is Michael Murray on for Ben. Just focusing on LTAC, the sequential decline in EBITDA is steeper than what we were modeling, agency labor continued to improve. The occupancy decline 400 bps sequentially, which seems larger than the typical sequential decline that you would see even pre-pandemic. Can you shed some light on some of the inner workings there. What drove the lower occupancy leverage?

[Robert Ortenzio, executive]

Yes. I think one of the things you really have to do is you've got to take a look and add back that $5 million of startup losses. So if you take a look at those margins, if you added that back, you had basically a 90 basis point improvement in the margins, right?

[Michael Murray, analyst]

Are you talking sequentially?

[Robert Ortenzio, executive]

Well, you realize that when you take a look at historically for us, I mean, if you compare Q3 of '22, sequentially is really irrelevant because of the seasonality in the business. So what you really have to do is take a look at it on a same quarter year-over-year basis. I mean, we normally have a dip in occupancy rate in Q3.

[Michael Murray, analyst]

Yes, the 400 bps sequential decline, even that seems at a higher magnitude than even pre-pandemic levels. So what we're driving -- what drove the lower occupancy levels. .

[Robert Ortenzio, executive]

Yes. I think that we'll have to -- I think what we're going to have to do is talk off-line on this, and we'll go through the details. I'm not sure that we fully understand that there's a [differentiator] you're saying. Next question.

[Operator]

Our next question comes from William Sutherland with The Benchmark Company.

[William Sutherland, analyst]

Well, guys, I was wondering the -- you've had some good progress in outpatient with -- despite the rate headwind. What are -- do you have some like goalposts out there that you think you can move the productivity and margins to for outpatients? I'm just trying to get a sense of kind of where that business can run now. And maybe you have some color or some insight on where you think rates are heading in the following year.

[Martin Jackson, executive]

So Bill, I'm assuming you've got 2 questions there. One is improving the clinical productivity, and we do see some continued improvement in that area. And then with regards to rates, I think our expectation is we're going to see an increase of probably over the next year somewhere in that 2% range.

[William Sutherland, analyst]

Okay. So that will be a nice switch, and then you'll be doing your commercial -- I mean, your commercial is going to be, I assume, the same positive trend, that you've been able to negotiate?

[Martin Jackson, executive]

Yes, commercial. Commercial should be higher than that 2% that I mentioned, Bill, but then we have the offset with regards to Medicare.

[William Sutherland, analyst]

Right. So 2% is the blended, Marty is what you're saying?

[Martin Jackson, executive]

That's correct.

[William Sutherland, analyst]

Okay. Are you all in the course of just improving the whole network of clinics at pruning as you add like when you talk about the adds each quarter, those -- that's not net adds, is it?

[Martin Jackson, executive]

Yes, that would be net adds.

[William Sutherland, analyst]

Okay. That's good enough there. And then on Concentra, I know this business sort of been -- just up a hair year-over-year and quarter-on-quarter. I just wanted to understand kind of what's going on behind that number a little bit better?

[Martin Jackson, executive]

Yes. What we saw, though, is we saw a change in the mix. So we saw employer service volume down a bit, but workers' comp up. So that had a nice impact on the rate.

[William Sutherland, analyst]

Is that just something that's kind of occurring this year? Or is there a longer tail to that, do you think? .

[Martin Jackson, executive]

I think that we saw a significant increase in prior period due to additional employment. And so as that becomes more normalized, and I think that's what you saw in this particular quarter or this particular year-end actually.

[Operator]

That concludes the question-and-answer session. I'd like to turn the call back over to Robert Ortenzio for closing remarks.

[Robert Ortenzio, executive]

Thank you, operator. No closing remarks. Thanks for your participation, and we look forward to updating you next quarter.

[Operator]

Thank you for your participation. This does conclude the program, and you may now disconnect. Everyone, have a great day.