Select Medical Holdings Corporation

Good morning, and thank you for joining us today for Select Medical Holdings Corporation's Earnings Conference Call to discuss the second quarter 2022 results and the company's business outlook. Speaking today are the company's Executive Chairman and Co-Founder, Robert Otenzio, 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 over to Mr. Robert Ortenzio.

Thank you, operator. Good morning, everyone. Thanks for joining us for Select Medical's earnings call for the second quarter of 2022. The past two and a half years have presented numerous challenges for our company and our colleagues. As we're hopefully in the back end of the more extreme impacts of the pandemic, our focus has been on recruiting, retention, and valuing the accomplishments of our employees. This quarter, we have started to experience progress as a result of our efforts, which has led to an upturn in hiring key clinical positions, namely RNs. The investment in full-time staff has resulted in an increase in orientation and education costs for our new hires. We anticipate these costs will return to approximate historical trend once our utilization of agency reaches a normalized level. We have gained traction and have seen a decline as the second quarter progressed both in reduced agency rates and utilization. The past nine months' labor costs, particularly in our critical illness recovery hospital division, have created many headwinds, but we are cautiously optimistic we will continue to see improvements which will result in stability and predictability of our clinical labor by the end of the year. Marty Jackson will provide some more granular data supporting our optimism on the direction of our clinical labor expenses in his comments. In other news, I'm pleased to share with you that U.S. News & World Report has released its annual best hospitals list. One of our wholly owned and three of our partner inpatient rehabilitation hospitals are ranked among the nation's best for 2022-2023. They are at number four, Kessler Institute for Rehabilitation, number 14, Baylor Scott & White Institute for Rehabilitation in Dallas, number 26, Emory Rehabilitation in Atlanta, and number 31, Ohio Health Rehabilitation Hospital in Columbus, Ohio. This marks the 30th consecutive year that the Kessler Institute has been named among the nation's best hospitals for rehabilitation, and the second year in a row for Baylor, Scott & White, Dallas, Emory, and Ohio Health. For my comments today, I am continuing with the format that was introduced in the first quarter, which provides 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 the highlights in my remarks. Overall, we experienced revenue growth in the quarter with an increase of 1.3%, over prior year while continuing to navigate through labor challenges. For the quarter, total company adjusted EBITDA was $181 million compared to $342 million in the prior year. Our consolidated adjusted EBITDA margin was 11.4% for Q2 compared to 21.9% in the prior year. CARES Act grant income was recognized in Q2 of this year as well as Q2 of prior year. This quarter, we recognized $15.1 million of grant income versus $98 million in prior year Q2. Excluding grant income, adjusted EBITDA for this quarter would have been $165.9 million with a 10.5% margin compared with $244 million with a 15.6% margin last year. Excluding the decrease in CARES income, the most significant contributor to the decrease in Q2 adjusted EBITDA of a prior year was the salary, wage, and benefit increase in the critical illness division. While Q2 was the first quarter to show reduction in agency expense, as I previously mentioned, retention efforts and new hires in the RN and CNA positions contributed to an increase in costs. salary increases, orientation, education, and incentive bonuses are necessary steps in the efforts to replace the higher agency cost nurses with employed staff. We are starting to see positive results in hiring full-time nurses and expect this trend to continue into Q4 of this year. Now I'll provide some data points as commentary on each of our operating divisions. Our Critical Illness Recovery Hospital Division's revenue, patient days, and net revenue per patient day slightly increased compared to Q2 of prior year. Occupancy decreased to 67% from 69% compared to the same quarter prior year. Many of our referring short-term acute care hospitals still experience lower volumes within their ICUs compared to prior year, specifically VENT patients, which contributed to our decrease in occupancy. We expect that when ICU volumes in our referring hospitals increase, we will continue to see these patients within our hospitals. Adjusted EBITDA margin for the critical illness was 4% for the quarter compared to 13% in the prior year as our salary wage and benefit to revenue ratio increased by 14%. The SWB to revenue ratio improved slightly from Q1 and we have seen improvement every month within the second quarter. Salary increases RN orientation, education, along with incentive and sign-on bonuses were the main drivers for the increase in labor. Education and orientation hours for RNs increased by 67% over prior year, while overall bonus expense increased 51%. In Q2, we saw a substantial drop in nursing agency rates from Q1, but remained slightly higher than prior year Q2. In Q2, we expanded our footprint in the Youngstown, Ohio market with a two hospital acquisition. One existing hospital was closed and consolidated with one of the acquired locations. We have also signed agreements with joint venture partners to open four hospitals located in Jackson, Tennessee, Tucson, Arizona, Alexandria, Virginia, and Venice, Florida, all expected to open in 2023. On the regulatory front, This week, CMS issued final LTCH rules for fiscal 2023, effective October 1st of this year. The final rule includes a 3.8% increase in the federal base rate, which is higher than the 2.8% increase outlined in the proposed rule. The high cost outlier threshold increased by 16.7%, which was lower than the proposed rule. The MS LTCH DRG relative weight and expected length of stays were also updated in the final rule. Turning to inpatient rehab, our inpatient rehabilitation hospital division experienced an increase of 7.6% in net revenues, with patient volumes increasing by 4%. Occupancy increased to 86% compared to prior year, which was 85%. Revenue per patient day increased $79 from $1,849 to $1,928. The adjusted EBITDA margin for the inpatient rehab was 21.8% for Q2 compared to 23.9% in the prior year. The decline in inpatient rehab adjusted 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 inpatient rehab hospitals increased by 4% from prior year Q2, but improved by 3% from Q1 2022. Nursing agency usage levels increased from prior year, but we have seen improvement compared to the first quarter of this year, along with improvement each month throughout the second quarter. The agency rates for RNs in the rehab division decreased by 4% from prior year and 21% from Q1. The increase in agency compared to prior year was predominantly in our California and North Jersey markets. In regards to development, we have signed an agreement with a joint venture partner to open a rehabilitation distinct part unit in our Venice, Florida Critical Illness Recovery Hospital, which is expected to open in 2023. There are numerous opportunities in the pipeline currently being evaluated. Last week, CMS also issued the final inpatient rehab rules for the fiscal 2023, effective October 1st. The final rule includes a 3.7% increase in the standard payment amount, which is higher than the 2.7% included in the proposed rule. In addition, the high cost outlier threshold increased by 32%, which is lower than the proposed rule. The CMG relative weights and average length of stay values were also updated with the final rule. Turning to Concentra. Concentra continues to outperform and exceed plan, although when comparing this quarter to prior years, revenue declined by $15 million as a result of the significant demand for COVID-related testing and evaluations in the second quarter of 2021. Last year, These services generated $55 million in revenue and $22 million in adjusted EBITDA compared to $8 million in revenue and $3 million in adjusted EBITDA in Q2 of this year. The revenue decline was less than expected as the exceptional performance in the centers mitigated the COVID testing revenue reduction. Center patient volume increased by 6% and concentric overall net revenue per visit increased by 2% to $127. Our adjusted EBITDA margin for Concentra was 21% for Q2 compared to 30% in the prior year. The results in Q2 of prior year included $32.3 million of CARES grant income. Excluding the grant income, the adjusted EBITDA margin would have been 23% in Q2 2021 versus 21% this quarter. Consentra experienced a 1% improvement in their salary, wage, and benefit-to-revenue ratio from prior year Q2 and remained consistent with Q1. The reduction in adjusted EBITDA margin from prior year was primarily a result of increased lab and medical supply costs in addition to travel expense returning to normal. In Q2, Consentra acquired two centers located in Chesapeake and Newport News, Virginia, which is an attractive new market for the company. They have also signed four leases for de novo clinics that are expected to open by year end. There continues to be a healthy pipeline of potential acquisition de novo opportunities that are under consideration. Turning to outpatient, our outpatient rehabilitation division experienced a 2% Increase in net revenues with patient volumes also increasing 2% compared to same quarter prior year. Net revenue per visit increased to $103 from $102 prior year in spite of a 3% decline in Medicare reimbursement. Adjusted EBITDA decreased compared to prior year with a decrease in margin to 11.7% from 16.3%. The decline in adjusted EBITDA margin is primarily due to an increase in salary, wage, and benefit to revenue ratio compared to same quarter prior year. In the second quarter, outpatient division experienced a 5% increase in salary, wage, and benefit to revenue ratio compared to prior year, but improved by 1.5% from Q1 2022, which represents an improvement for the last two quarters. Other operating expense to revenue ratio increased by 9% over prior year Q2, mainly due to marketing and travel costs returning to pre-pandemic levels. In Q2, we expanded our clinic count by 19 centers via acquisition and de novo growth. Looking forward to the remainder of the year, we have leases executed for 26 de novo clinics. Finally, earnings for fully diluted share were 43 cents for the second quarter compared to $1.22 per share in the same quarter prior year. Our earnings were positively affected by CARES grant income recognized in the second quarter of both this year and last. In regards to our allocation and deployment of capital, our board of directors declared a cash dividend of 12.5 cents payable on September 2, 2022, to shareholders of record at the close of business on August 16, 2022. This quarter, we bought back 5,438,939 shares of stock at an average price of $23.16. We will continue to be opportunistic and evaluate stock repurchases, reduction of debt, and development opportunities. This concludes my remarks, and I'll turn it over to Marty Jackson for some additional financial details before we open the call up for questions.

Thanks, Bob. Good morning, everyone. I would like to follow up on several of Bob's opening comments regarding our clinical labor costs. As he mentioned, we've seen a significant sequential reduction in Q1 of 22 to Q2 of 22 in agency rates, utilization, and total agency expenses. The reductions we realized during this period were 22 percent for rates, with the average rate for Q1 of $143 an hour dropping to $111 for Q2, a 13 percent reduction in utilization moving from 37.5 percent in Q1 to 32.5 percent in Q2, and a 37 percent reduction in agency expense from $89.4 million in Q1 to $56.4 million in Q2. Even more encouraging are the reductions of these categories within the second quarter. We saw a reduction from April to June of 23% on rate, from an average rate of $123 in April to $95 in June, drop of 29% in utilization, from 38.2% in April to 26.9% in June, and a drop of 48% for overall agency expense from $24.4 million in April to $12.8 million in June. We have seen this trend continue for the month of July with a 5% reduction in rate to $90 an hour, 10% utilization reduction to 24.1%, and a 13% reduction in total agency expense to $11.1 million. Bob also mentioned our efforts on the hiring of full-time nurses. We have seen a very nice increase in the number of full-time nurses hired this past quarter, growing by more than 54 percent sequentially from quarter one to quarter two. These new hires typically participate in seven to eight weeks of orientation and training prior to treating patients. During this time, we will continue to utilize agency, but we see a pathway to continue to the continued reduction of agency throughout the balance of the year with these newly hired RNs. Another key performance indicator we focus on is salaries, wages, and benefits as a percentage of revenue. Our historical trend prior to the pandemic ran at a rate of 51% to 52%. During the pandemic, there was a significant increase in demand from health systems for nurses regardless of the cost. We saw agency rates increase from historical rates of $72 to $78 an hour up to, in some cases, $220 an hour in certain geographical locations. Given this new macroeconomic environment we saw for the first three quarters of 2021, this KPI increased to 56%. This rate increased dramatically Q4 of 21 in the first two quarters of this year, ranging from 64% to 66%. We believe, given our discussion above, this rate will come down nicely over the next two quarters as new hires replace agency nurses and the agency rates continue their downward trend. Our target for the end of the year is to be in the range of 55% to 57% with a clear path of returning to a more normalized range closer to our historical rate throughout 2023. Moving over to our financials, in Q2, equity and earnings of unconsolidated subsidiaries were $6.2 million. compares to $11.8 million in the same quarter prior year. The decrease is a result of lower earnings in our minority-owned inpatient rehab hospitals and outpatient clinics. The new Banner East Hospital opened in April and incurred losses within the quarter related to startup costs. A few other joint ventures experienced lower earnings caused by unfavorable shifts in payer mix, which resulted in reductions to our net revenue rate. Net income attributable to non-controlling interest was $11.1 million. This compares to $31.3 million in the same quarter prior year. The decrease is primarily due to the repurchase of membership interest and concentra in Q4 of 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 primarily as a result of the elevated nurse agency costs compared to quarter two of 2021. Interest expense was $41.1 million in the second quarter. This compares to $33.9 million in the same quarter prior year. The increase in interest expense was primarily attributable to an increase in one-month LIBOR rates compared to Q2 of 2021, as well as borrowings made under our revolving credit facility. At the end of the quarter, we had $3.8 billion of debt outstanding and $94.7 million of cash on the balance sheet. Our debt balance at the end of the quarter included $2.1 billion in term loans, $350 million in revolving loans, $1.2 billion in six and a quarter senior notes, and $88.4 million of other miscellaneous debt. We ended the quarter with net leverage for our senior secured credit agreement of 5.44 times. As of June 30th, we had $243 million remaining availability on our revolving loans. For the second quarter, operating activities provided $186.1 million in cash flow, of which $14.4 million was recouped in the quarter related to the repayment of Medicare advances. At the end of June, there is $6.5 million remaining of the Medicare advances to be repaid. Our day sales outstanding, our DSO, was 53 days at June 30th, 2022. This compares to 53 days at March 31, 2022, and 52 days at the end of 2021. Investing activities used $58.8 million of cash in the second quarter. This includes $46.3 million in purchase of property and equipment, and $17.8 million in acquisition and investment activity during the quarter. We also generated $5.3 million in proceeds from the sale of assets in the quarter. Financing activities used $149.1 million of cash for the second quarter. This was primarily due to common share repurchases, totaling $126 million. As Bob indicated, we acquired a little bit north of 5.4 million shares. Also included dividends on our common stock of $16.1 million. We have the capacity to purchase an additional $407 million worth of shares under this program, which remains in effect until December 31st, 2023, unless further extended or earlier terminated by the Board. We are reaffirming our revenue outlook for the year and expect revenue to be in the range of $6.25 billion to $6.4 billion in 2022. We are also reaffirming our previously issued three-year compounded annual growth rate target for revenue to be in the range of 4% to 6%. We still expect capital expenditures to be in the range of $180 to $200 million for the year. And as stated last quarter, we will readdress our business outlook and target growth rates for adjusted EBITDA and earnings per share when we believe the labor market has stabilized and is predictable. This concludes our prepared remarks, and at this time, we would like to turn it back over to the operator to open up the call for questions.