Select Medical Holdings Corp. Q3 FY2024 earnings call

Management Statement and Operational Highlights

• Concentra IPO: Successfully completed Concentra's initial public offering. Select Medical owns 81.74% of Concentra's stock and expects to distribute remaining interest by end of year contingent on IPO lockup waiver.
• Hospital Developments: In September, opened a 48-bed inpatient rehab hospital in Jacksonville, Florida. Announced new projects including acquisition of a 50-bed hospital in Oklahoma City (closing in December), opening a 54-bed rehab hospital in Temple, Texas early next year, and planning to open a 68-bed facility in Jersey City in late 2026. On track to open multiple hospitals with partners in 2025 and 2026, aiming to add 569 additional beds through 2026.
• Consolidated Performance: Consolidated adjusted EBITDA grew 6% to $205.5 million with margin 11.7% (11.6% prior year Q3). Revenue grew 6% compared to prior year Q3. EPS $0.43 per share (prior year Q3 $0.38 per share).
• Capital Allocation: Board declared a cash dividend of $0.125 payable on November 26, 2024. Did not repurchase shares under board authorized share repurchase program; will evaluate stock repurchases, debt reduction, and development opportunities.

Segment Performance

• Hospital Divisions:
  • Inpatient Rehab Division: Revenue increased 14% and adjusted EBITDA increased 12% compared to Q3 prior year. Incurred $3.7 million in startup losses. Average daily census increased 4%, rate per patient day increased 6%. Occupancy 82%, adjusted EBITDA margin 21.3% (21.7% prior year). Same store adjusted EBITDA margin 23.4%.
  • Critical Illness Recovery Hospital Division: Revenue increased 3% and adjusted EBITDA increased 9% compared to same quarter prior year. Incurred $2.5 million in startup losses. Occupancy and average daily census increased 1%, rate per patient day increased 2%. Adjusted EBITDA margin 8.7% (8.2% prior year). Salary, wages and benefit to revenue ratio decreased 0.3 percentage points. Nursing agency rates stabilized, utilization decreased, orientation hours decreased 13%, sign on and incentive bonus dollars decreased 18%.
• Concentra: Net revenue and adjusted EBITDA increased 3% each compared to prior year same quarter. Revenue increase driven by 4% rate increase from workers' comp state fee schedule increases. Workers' comp volume increased 2%, employer-based visits decreased 4%. Adjusted EBITDA margin 20.7% (20.9% prior year).
• Outpatient Rehab Division: Revenue increased 7% with patient volumes increasing 6% and net revenue per visit increasing from $100 prior year Q3 to $101 Q3 of this year. Adjusted EBITDA increased 7% and margin increased from 9% to 9.1%.

Guidance

• Updated 2024 outlook:
  • Revenue expected to be in the range of $6.95 billion to $7.15 billion.
  • Adjusted EBITDA expected to be in the range of $865 million to $885 million.
  • Fully diluted earnings per share expected to be in the range of $2.01 to $2.12.
  • Adjusted earnings per share expected to be in the range of $2.09 to $2.20.
  • Capital expenditures expected to be in the range of $200 million to $250 million.

Risks

• IPO Lockup: Uncertainty regarding receiving the waiver of the IPO lockup based on market conditions which could affect the distribution of Concentra's remaining interest to shareholders.
• Labor Force Impact: For Concentra, demand for employer-based visits has normalized as the labor force has stabilized, but changes in the labor market could impact future volumes.
• LTAC Thresholds: Challenges with threshold levels in the LTAC business which could affect capital deployment and growth in that segment.

Question and Answer

Q: First to Bob, our deepest condolences for Rocco's passing. And the second question, I guess for Marty, I just wanted to get some more comments on LTAC occupancy trends. I think we may have misconstrued some seasonal occupancy trends as staffing related. Maybe you could provide just some more detail and kind of what you're seeing from an occupancy standpoint in that segment versus your targets and if there's any outlier threshold influence there.

A: Ben, the occupancy rate for this past quarter, we were actually pretty pleased with it. It was higher than prior-year same quarter. And it really is seasonality of the third quarter. So it really didn't have anything to do with staffing issues. It's really just a function of the quarter. Our operators have done a very good job managing through the high cost outlier. So we really haven't seen too much of an impact there.

Q: When I look at pro forma net leverage post spin, I arrive around a number of about 3x, maybe a little lower than that. The company is going to generate substantial amount of free cash flow, even after all the development projects that you laid out. Any thoughts or preferences on capital deployment, given what we know now, and is there sort of an optimal leverage range for the company or would you sort of even take that down to two or that level?

A: I think that I hate to say that the answer has kind of always been similar from Marty on capital deployment. We do kind of pride ourselves on our history of being opportunistic on our deployment. We are fortunate to have lots of opportunities in the development area, as you saw from my comments on some deals that we have, and there's others behind that. I would describe our development pipeline as quite robust right now. And then there is obviously the opportunity to de-leverage through free cash flow or have stock buybacks. All options are on the table, as we like to always have them. I will say that we have worked hard to drive our leverage down to 3 times, and we've gotten some uplift from the rating agencies, as you've seen. We're pleased with that and we would like very much and it's a priority to maintain that. So I think a 3 times leverage is very good for us, very positive, allows us to keep all of our options open. And I think as we go forward as a smaller company without Concentra, we want to maintain that flexibility. So I would say – that's a long answer to say 3 times is really where we want to be and we want to try to maintain that and then we want to be opportunistic in terms of where we allocate our free cash flow.

Q: Just quick clarifications. On LTAC development, it sounds like there's – at least through 2026, there's one program that you have or project that you have line of sight on. Is that right? 26 additional beds.

A: Well, there are other opportunities. We've only listed one. We find, as that business is evolving with the threshold levels making that business even tougher, our operators are navigating. We have a very big platform. We are finding that a lot of our new LTAC development projects are bleeding into our partnerships, our existing ones and our new ones. As we continue to perform very well with our partners on inpatient and outpatient rehab, LTAC has become a part of that model, which we like. We will also do some de novos. But it is not a place where we won't spend capital, but as we look across our business segments and on the hospitals, bigger opportunities for capital deployment on rehab. And then also some on outpatient, although that's relatively modest. On the LTAC side, we would like to grow, but we're not looking to have really large capital deployment in that area. So another way of saying is we like the hospital within a hospital model, which is less capital intensive, so we will look for those opportunities. So the LTAC will continue to be a growth segment for us. But with our platform, we can be a little bit more judicious on our capital and find opportunities where we can grow in the LTAC space without a lot of capital and then continue to allocate that primarily right now because of the opportunities on the inpatient rehab side.

Q: Just quick one on the IRF rates, I think in the 2Q call, you talked about 2% for the federal funds base rate, and then the final rule said basically like 3% market basket net of productivity. Can you just square those two for us, at least on the Medicare side? Is the right way to think about sort of like, the base rates is 3%.

A: Justin, this is Marty. We think it is in that 3% range.

Q: I had one question on LTAC. Noticing one fewer hospital listed as of the last quarter, was there a removal or something from the portfolio?

A: Hold on just for a second, Bill. I think we saw a reduction from a year ago. Yeah, we're looking right now. Yeah, you're right. We did close one in Ohio. Just underperforming? Yeah, it was a consolidation, Bill.

Q: Marty, while I've got you, what are you thinking about as far as additional progress you can make on SWB as a percent of revenue? Is there more wood to chop?

A: Yeah, we think that there is, Bill. The numbers that we provide for, our targets are really annual. We think we'll probably end this year in that 57% range. As you know, we started off very well in the first quarter in that 54%, 55% range. And so, next year, we think we can see that come down. And there's really two points that are going to drive that. One is the commercial contracts. We continue to have some success on the negotiation of our commercial contracts. If we can obtain what we've done in the past year, be in that mid-range single digit increases, that will certainly help that number come down. The second one is volume increases. Volume increases has a big impact on the ability to drive that number down. And the hope is that, given the CMS mandate, that Medicare Advantage, follow traditional Medicare patient criteria, that we'll see improvements in the pre-authorization admission approval rates of Medicare Advantage. So if that occurs, that SW&B as a percentage of revenue will continue to drop.

Q: Looking at outpatient rehab and the progress you're making steadily here, kind of what are the keys for the next sort of step up? I know that it's a business that you've run in the mid-teens margin area in the past. I'm not sure what's on the planner for progress forward from here.

A: Bill, one of the major movers for us is our clinical efficiency. Clinical efficiency being the number of patients a therapist can see in a day. And we've really kind of focused over the past year in using technology to help us do that. We've got a very significant release that's occurring at the end of the year, and we think that that will be a game changer. That will be a big help for us. So we anticipate we'll see some nice improvement in the margins come next year.

Q: This is Christian Porter on for Joanna. Our question was about outpatient rehab. So margins came in much better than our estimate and we just wanted to know if you could talk about your efforts to improve efficiency. One of your peers saw higher contract labor costs in Q2. And we were wondering if you were seeing any of that and just trends around volume, staffing, and pricing.

A: There's a couple of questions that you put there. I think what we saw was, the first one I'll focus on is really taking a look at supplemental staffing, the agency staffing. We've seen that decline sequentially, and so that certainly helped the margin. I think we talked with the prior caller, with Bill, on what we're doing on the technology side through our systems to help enhance our clinical efficiency. So, both of those, we think will – one has helped in just recently, we think the technology will certainly help in the future.