Q2 2023 Select Medical Holdings Corp Earnings Call
Participants
Martin F. Jackson; Executive VP & CFO; Select Medical Holdings Corporation
Robert A. Ortenzio; Co-Founder & Executive Chairman; Select Medical Holdings Corporation
Benjamin Hendrix; Assistant VP; RBC Capital Markets, Research Division
Justin D. Bowers; Research Associate; Deutsche Bank AG, Research Division
Kevin Mark Fischbeck; MD in Equity Research; BofA Securities, Research Division
Unidentified Analyst
Presentation
Operator
Good morning, and 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, and then the call will open for questions.
Before we started, we would like to remind you that this conference may contain forward-looking statements regarding future events or future financial performance of the company, including, without limitation, statements regarding operation 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.
I would now like to turn the conference over to Mr. Robert Ortenzio. Please go ahead, sir.
Robert A. Ortenzio
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 4 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 July 19 in connection with plans to launch a refinancing of some of the company's debt. We completed our refinancing on July 31, and Marty Jackson will provide on further details in his commentary.
So I wanted to highlight that on August 1, U.S. News and World Report released its annual Best Hospitals list. I'm pleased to share with you that our Kessler Institute for Rehabilitation Hospital and 6 of our partnered inpatient rehab hospitals are ranked among the nation's best for 2023, 2024. #3, Kessler Institute for Rehabilitation; #21, California Rehab Institute; #22, Baylor Scott & White Institute for Rehabilitation in Dallas; #34, Ohio Health Rehabilitation Hospital in Columbus. #38, Cleveland Clinic Rehabilitation Hospital; #46, TriHealth Rehabilitation Hospital in Cincinnati; and #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 Ohio Health. 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 4 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 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 8-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% to 57%, along with a $43 million reduction in agency expenses compared to same quarter prior year.
Consistent with last quarter, Marty 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 3 more openings this past quarter. In May, we opened 2 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 recovery hospital for 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 remains strong with a 36-bed inpatient rehab hospital in Fort Wayne, Indiana, expected to close in Q3 with our joint venture partner, CHS. Also, 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 '26. 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 2 transactions. The acquisition of Holland Medi Center in Michigan included a stand-alone 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 One Source Occupational Medicine, a transaction that resulted in a fold-in of the practice into our nearby clinic located in Tulsa, Oklahoma. Concentra has 4 signed leases for new de novo locations that are expected to open in Q4 2023. Additionally, there's a strong pipeline of acquisition and 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 Atlanta Care in our South Jersey market, contributing 13 clinics where we are the managing partner and majority owner. The vision added 8 clinics this quarter via acquisitions and de novos. The pipeline for additional growth remained 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 prior -- 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 outlined in the proposed rule of 55,8055,860. 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 October 1. Final rule includes a 3.7% increase to standard payment amount, which is higher than the 3.3% included in the proposed rule. High-cost outline threshold increased $2,103 which was slightly less than the $2,836 decrease in the proposed rule. The CMG relative weight and average length of stay values were also updated in the final rule.
Concentra experienced an increase in 6% in net revenue driven by a 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 same 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 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 going to turn it over to Marty Jackson for some additional financial details before we open the call up for questions.
Martin F. Jackson
Great. Thank you, Bob. Good morning, everyone. Consistent with the prior 3 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 remains 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 3 quarters. We experienced slight fluctuations in our agency rates and costs as the quarter progressed, with the rate fluctuation from April to June at 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 sequentially to Q1 '23 of 24%, and the hours remained relatively consistent during the quarter at an average of 40,000 hours per month. Overall, our SWB to 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 of prior year. Net income attributable to noncontrolling interest 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 of 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 6.25% senior notes and $77.1 million of other miscellaneous debt. We ended the quarter with net leverage of our senior secured credit agreement of 5.06x. As of June 30, we had close to $250 million of availability on our revolver.
As Bob previously noted, we completed a refinancing transaction on July 31 this year. We amended and extended our $2.1 billion Term Loan B secured 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 2 years and will mature on March 6, 2027, with an early springing maturity of 90 days prior to the senior notes maturity triggering more than $300 million of senior notes remains outstanding at May 15, 2026. The refinancing term loan is priced at SOFR+300 bps with a step down of 25 basis points if our net leverage ratio falls below 4x. The revolver has been priced at SOFR+250, with a stack down of 25 basis points and net leverage ratio falls below 4x.
It is 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 6.25% 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 of '23 compared to 53 days, June 30, 2022, and 54 days as of March 31, '23.
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, '23, 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 to $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 to $1.94. Select Medical expects adjusted earnings per share to be in the range of $1.86 to $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 '23.
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.
Question and Answer Session
Operator
(Operator Instructions) Our first question comes from the line of Justin Bowers with Deutsche Bank.
Justin D. Bowers
Bob, just wanted to clarify one thing on the LTACs. Is that -- is the next de novo or JV coming online in 2024? Or is there anything left in the rest of the year this year?
Robert A. Ortenzio
Just Rush is the one that we have that would be next based on deals that we've announced. So anything else that we would do that would be before that, we've not announced yet.
Justin D. Bowers
Got it. And then just on outpatient sort of given the landscape over the last year or so, is the plan for you guys to sort of stay the course with your the JV approach and sort of building around your existing? Or is there any appetite to do something with greater scale?
Robert A. Ortenzio
I would say at this point, there is no appetite to do anything on a broader scale. 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 onto our many joint venture agreements that are growing pretty rapidly. So I would say to you that we are probably not in the market for a bigger transaction in the outpatient space.
Justin D. Bowers
Okay. And Marty, healthy free cash flow generation in the first half, especially in 2Q. How are you guys thinking about CapEx in the second half? And then just given the attractive spread in T-Bills versus the rate cap, -- how should we think about the deleveraging going forward through September '24. Is that just more of a function of the EBITDA growth? Or is there going to be some paydown to along the way?
Martin F. Jackson
Yes, Justin... With regards to -- I mean, Bob had talked about the use of free cash flow. We anticipate that we will continue to see the dollars on our revolver come down, and that should be going into '24 by the end of '24, that should completely be eliminated any cash -- any borrowings on that revolver. So no, we will continue to pay down debt. So you can expect to see leverage come down not only from increased EBITDA but also reduction of that.
Operator
Question comes from the line of Ben Hendrix with RBC Capital Markets.
Benjamin Hendrix
Just a follow-up question on your LTAC plan or role comments. We're definitely glad to see that outlier threshold come down from the proposal. But 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?
Martin F. Jackson
Yes, Ben, there's no doubt that, that increase in the high-cost outlier number, we'll have -- we will certainly have some headwinds there, but there are certainly ways to mitigate that, and that's what we're focused on right now.
Benjamin Hendrix
Okay. And then just overall, the rate increase, 3.5% or thereabouts, how does that translate, you think, for Select Medical specifically kind of given your case mix and...
Robert A. Ortenzio
Ben, could you clarify that question when you say how does it --
Benjamin Hendrix
Just how the rate update, if you expect it to be any different for Select than the 3.5% finalized?
Martin F. Jackson
No, we anticipate it will be in that neighborhood for us. You can expect to see increases for our Medicare dollars increased by that percent. I think that's a good number to use in your model.
I think you'll see better increases on the commercial side. I think we've been in that negotiated rates, we've been in that 5-plus percent range. But with Medicare, I think it's 3.5%, and Ben I think there's a deduct of about 0.2% for efficiency improvements.
Robert A. Ortenzio
And as usual, Ben, these LTAC, 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 have the high-cost outlier threshold, which has an impact. You have the rate increase, 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. So post the rule and going into next year, we'll be taking a look at all of those to adjust all the levers that we have at our disposal to make sure that we can get some growth out of the segment.
Benjamin Hendrix
Got you. And just quickly, finally, do you expect to the high-cost outlier to drive any industry disruption that could create a consolidation opportunity for you guys?
Robert A. Ortenzio
I do not.
Operator
The next question comes from the line of Kevin Fischbeck with Bank of America.
Kevin Mark Fischbeck
All right. Great. 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 that IRF rule?
Robert A. Ortenzio
Yes. I mean I think that we are pretty satisfied with the LTAC rule and -- or the rehab rule. And I think we've got a little bit of a tailwind on the final rule there as we're looking forward to Q4 and into next year, Kevin.
Kevin Mark Fischbeck
Okay. And then obviously, a lot of progress on SWB. I wanted to get a sense from you guys where you thought you were in that progress. We all love baseball analogies. So like what inning are we on the improvement there? Is there much to go still from here? Or is this the right way to think about SWB heading into 2024?
Martin F. Jackson
Yes, Kevin. I think throughout the balance of the year, we'll be in that 55% to 57% range. Now we see that dropping down in '24 and '25. And the reason being -- remember, we're not just focused on the cost here. I mean, would be as a percentage of revenue, has a revenue component to it. So our commercial contracts are basically 3 years. The terms on those are 3 years. So we'll be negotiating increases in those we're done about 1/3 of our contracts now. So we'll be negotiating in '24, '25 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 '25. And our focus is really to get it back to that historical rate of 52%.
Kevin Mark Fischbeck
Okay. That's great. So when we think about that improvement, though, you're saying that the improvement is less about further declines in bill rates or utilization per se, and it's more about getting the top line growth to kind of match inflation?
Robert A. Ortenzio
That's correct.
Kevin Mark Fischbeck
Okay. Great. And then maybe just last question. On the outpatient side, the rates being down, is that something that we should be modeling going into 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 the payer mix is kind of in there is the reason to believe that rates next year will be better than rates this year?
Martin F. Jackson
Yes, there is. We anticipate that going into next year, we think it's going to rebound back to at least being that $102, $103 range.
Kevin Mark Fischbeck
What's driving that?
Martin F. Jackson
Again, contracts. -- and improvements in some other -- in our -- in the CBO area.
Operator
Our next question comes from the line of A.J. Rice with Credit Suisse Financial.
Unidentified Analyst
This is [NJ] on for A.J. So I wanted to ask about the larger volume trends 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?
Martin F. Jackson
Yes, could you repeat that?
Robert A. Ortenzio
Yes, you're not coming through very clearly.
Unidentified Analyst
Yes, 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 A. Ortenzio
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 -- if you characterize as the post-pay. I mean the business on the demand side in IRF and outpatient is very, very good. I mean for a company like ours or others, I mean it's just a question of navigating your local market and your competition and your rate negotiations. But I don't think in either of those businesses, it's necessarily -- there's no systemic volume issue.
Martin F. Jackson
Yes. 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 A. Ortenzio
And there's lots of things that can affect it in local markets. For example, staffing challenges that large systems continue to have can oftentimes or sometimes affect their surgical volumes. And if surgical volumes, particularly on the orthopedic side, are impacted in a local market, we're going to -- we're going to certainly see some pull-through negative on that. But overall, when we look nationally, we see a turn to a pretty strong business. Did that answer your question?
Unidentified Analyst
Yes. Got it. 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 acuity mix step down as well. Why is the pricing going up? And how does the back half of the year shape out...?
Robert A. Ortenzio
Well, I can tell you one thing on the acuity mix 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 or the case mix index reduction that we commented on as being any kind of systemic signal reduction in acuity of our patients. In fact, we continue to see increased acuity in our critical illness hospitals. So I mean I think that will continue to remain strong. And as you know, there is some seasonality in our business.
Martin F. Jackson
Yes. I think the other thing is, as you know, we're paid on a DRG. So 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 rate.
Operator
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 A. Ortenzio
Closing remarks. Thanks, everybody, for joining us, and we look forward to updating you again next quarter.
Operator
This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.
