Select Medical Holdings Corp (SEM) 2011 Q3 法說會逐字稿

Good morning and thank you for joining us today for Select Medical Holdings Corporation earnings conference call to discuss the third quarter 2011 results and the Company's business outlook. Speaking today are the Company's CEO, Robert Ortenzio, and the Company's Executive Vice President and Chief Financial Officer, Martin Jackson. Management will give an overview of the quarter highlights 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 the 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'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 Robert Ortenzio. You have the floor, sir.

Good morning everyone and thank you for joining us for Select Medical Holdings third quarter conference call for 2011. For our prepared remarks, I'll provide some overall highlights for the Company and our operating divisions and then ask Marty Jackson, our CFO to go over some additional financial details before we open the call up for questions.

Our reported earnings per fully diluted share were $0.17 in the third quarter compared to earnings per share in the third quarter of last year of $0.05.

Net revenue for the third quarter increased 18% to $694.1 million compared to the same quarter last year. We generated approximately 75% of our revenues from our specialty hospital segment which includes both our long-term acute care and in-patient rehab hospitals, and 25% from our outpatient rehabilitation segment, which includes both our outpatient clinics and our contract services operations.

Specialty hospital net revenue for the third quarter increased 24.1% to $521.1 million compared to the same quarter last year. The primary driver behind the increase was the contribution from the hospitals acquired in the Regency acquisition which contributed $84.1 million of net revenue in the quarter.

The balance of the increase came primarily from improved patient volumes and our other specialty hospitals during the quarter. During the third quarter approximately 85% of our specialty hospital revenue came from our long-term acute care hospitals and 15% from our in-patient rehabilitation facilities.

We experienced a significant improvement in our specialty hospital volumes in the third quarter as patient days increased 21% compared to the prior year to 333,322 days in the quarter. The primary driver of this increase was the contribution of the Regency hospitals.

Excluding the effects of Regency, our hospital patient days increased 8% compared to the same quarter last year. Overall occupancy rates were 71% in the third quarter compared to 65% in the same quarter last year.

Net revenue per patient day in our specialty hospitals decreased slightly to $1,474 per day in the third quarter compared to $1,478 per day in the same quarter last year. This slight decrease in our net revenue per patient day resulted from a decline in our average non-Medicare net revenue per patient day. This decline is attributable to lower, non-Medicare per patient day rate realized at the rehabilitation hospital we acquired through a hospital exchange in January 2011.

Net revenue in our outpatient rehabilitation segment for the third quarter increased to $173 million compared to $168.4 million in the same quarter last year. During the third quarter approximately 79% of our outpatient revenue came from our outpatient clinics and 21% from our contract services.

Overall clinic-based revenues including our managed clinics increased 2.5 -- 2.4% and our contract services revenue increased 3.9% compared to the same quarter last year.

For our owned clinics, patient visits declined 3.9% compared to the same quarter last year and net revenue per visit increased 2% to $103 per visit compared to the same quarter last year. The primary driver behind our visit decline was due to the transition of our Dallas outpatient clinics into the non-consolidating Baylor joint venture as well as the effects of both hurricanes Irene and Lee in some of our markets.

Overall adjusted EBITDA for the third quarter increased 45.6% to $86.5 million compared to $59.4 million in the same quarter last year. Overall, adjusted EBITDA margins were 12.5% for the third quarter compared to 10.1% for the same quarter last year.

The primary reasons for the increase in margins include decreases in our relative, general and administrative expenses, which had 110 basis point positive impact on overall margins in the third quarter compared to the same quarter last year, improvement in our cost of services as patients -- as percent of revenue in our specialty hospital segment compared to the same quarter last year, and the effect of Regency hospitals which had a 30 basis point effect on overall margins in the quarter.

Specialty hospital adjusted EBITDA for the third quarter increased 40% to $81.6 million compared to $58.3 million in the same quarter last year. The hospitals acquired in the Regency acquisition contributed $12.7 million of this increase. The increase in the remainder of specialty hospitals was primarily the result of the increase in patient volumes I previously mentioned as well as lower operating costs in those hospitals.

Adjusted EBITDA margins for the same specialty hospital segment increased 180 basis points to 15.7% compared to 13.9% in the same quarter last year.

Outpatient rehabilitation adjusted EBITDA for the third quarter declined 4.4% to $19.4 million compared to $20.3 million in the same quarter last year. Adjusted EBITDA margins for the outpatient segment declined by 90 basis points to 11.2% compared to 12.1% in the same quarter last year.

For our clinic portion of this segment, adjusted EBITDA was up $1.1 million to seven point -- to $17 million and adjusted EBITDA margins were up 50 basis points to 12.5% in the quarter compared to the same quarter last year. The increase was primarily due to an increase in our net revenue per visit and lower bad debt expense.

For our contract services, adjusted EBITDA declined $2 million to $2.4 million for the third quarter and margins were 6.6%, down from the 12.5% margins in the same quarter last year. The decline in contract services margin was a result of higher labor costs associated with both regulatory changes and newer contracts added in 2011.

Before I turn the call over to Marty Jackson, I want to provide a couple of other updates. On the legislative front, as most of you know in August six US senators introduced bipartisan legislation that would implement certification criteria for LTAC hospitals. The legislation would better define what types of facilities qualify to be LTAC hospitals and which patients should be admitted to them. The underlying policies of this legislation were developed by the American Hospital Association.

Select supports the legislation and the efforts to have the Medicare program adopt clearer LTAC standards. It is still early in the life of the legislative proposal so it would not be worthwhile to speculate on the bill's chances of adoption or to comment on some of its specific provisions since it's very likely they will be changed numerous times.

From a business point of view, let me say that if the bill was passed and implemented, it would be a positive development since it would help clarify the distinct role that LTAC hospitals play in the continuum of care.

In addition, yesterday our board of directors extended our previously announced $150 million share repurchase program through March of 2013. The program was previously set to expire in January 2012. The other terms of the program remain unchanged. Through September 30, 2011, the Company has spent $75.8 million of the authorized program.

At this time I'll turn it over to Marty Jackson to cover some additional financial highlights for the quarter.

Thanks Bob. Our operating expenses, which include our cost of service, general and administrative costs and bad debt expense, in the third quarter increased 15% to $608.5 million compared to the same quarter last year. As a percentage of our net revenue, operating expenses for the quarter were 87.7% compared to 90% in the same quarter last year.

Cost of services increased 16.7% to $581.8 million for the third quarter compared to the same quarter last year. The principal reason for the increase is additional costs associated with the Regency hospitals. As a percentage of net revenue, cost of services was 83.8% for the third quarter. This compares to 84.8% in the same quarter last year. This decline in cost of services was attributable to our specialty hospital segment.

G&A was $15 million in the third quarter which as a percentage of net revenue was 2.2%. This compares to $19.2 million and 3.3% of net revenue for the same quarter last year.

During the third quarter 2010, our G&A cost included approximately $2.1 million in expenses related to the transition and closing of the Regency corporate office. We also incurred $4.8 million in incremental employee health care costs in the third quarter, resulting from an increase in claims affecting our self-insured health program. These increases were offset by a $1.8 million reduction in incentive compensation for executive officers in 2010.

Bad debt as a percentage of net revenue was 1.7% for the third quarter which represents a 20 basis point decrease from the same quarter last year. We continue to expect bad debt expense to run under 2% for the remainder of the year.

Overall we experienced a one-day decline in days sales outstanding or DSO to 52 days for the quarter. This compares to 53 days at June 30, 2011. The decline in DSO in the quarter was primarily the result of the timing of our periodic interim payments from Medicare for our specialty hospitals.

As Bob mentioned, total adjusted EBITDA was $86.5 million for the third quarter and adjusted EBITDA margins were 12.5%. This compares to adjusted EBITDA of $59.4 million and 10.1% adjusted EBITDA margins in the same quarter of last year.

Depreciation and amortization expense was $17.5 million in the third quarter. This compares to $17 million for the same quarter last year.

Net interest expense was $24 million in the third quarter. This is down -- this is actually down from $27.7 million in the same quarter last year. The reduction in interest expense is primarily related to the lower interest rates on the portion of our debt refinance during the second quarter this year.

The Company recorded income tax expense of $19.3 million in the third quarter, which represents an effective tax rate of 42.3%. This compares to an effective tax rate in the same quarter last year of 39.1%. The increase in our effective tax rate has resulted from a difference between the tax accounting basis and the financial accounting basis associated with the hospital exchange transaction we completed on January 1 of this year.

Net income attributable to Select Medical Holdings was $25.6 million in the third quarter and as Bob mentioned, fully diluted earnings per share were $0.17.

We ended the quarter with $1.41 billion of debt outstanding and $10.2 million of cash on the balance sheet. This compares to $1.43 billion of debt and $13.6 million of cash at the end of last quarter.

Our balance sheet debt at the end of the third quarter included $167.3 million of HoldCo senior floating rate notes, $345 million 7-5/8 senior subnotes, $839.8 million of term loans outstanding and $50 million in revolver loans outstanding with the balance of $5.6 million consisting of other miscellaneous debt.

Operating activities provided $60.4 million of cash flow for the quarter compared to $51.5 million in the same quarter last year. The provision of operating cash flow was primarily the result of cash earnings and increases in accounts payable and income and deferred taxes, offset in part by decreases in accrued expenses associated primarily with accrued interest during the quarter.

Operating activities provided $143.9 million of cash flow year to date compared to $110.3 million for the same period last year. The provision of operating cash flow was primarily the result of cash earnings and increases in accounts payable and income and deferred taxes, offset in part by increases in accounts receivable and decreases in accrued expenses associated primarily with accrued interest during the period.

Investing activities used $8.4 million of cash flow in the third quarter for purchases of property and equipment. Year to date investing activities used $35.8 million of cash, including $32.1 million for the purchase of property and equipment and $13.5 million investment in business, offset in part by proceeds from the sale of assets of $7.9 million and $1.9 million in proceeds from acquisition activity related to the final working capital settlement for Regency.

Financing activities used $55.4 million of cash for the third quarter. The use of cash consists of $28.4 million for repurchases of common stock under our share repurchase program, $15 million in net repayments under our revolving credit facility, $6.3 million for the repayment of bank overdrafts, $2.4 million in net other debt payments, $2.1 million of amortization payments on our term loan and $1.2 million in distributions to non-controlling interests.

During the third quarter we repurchased 4,239,972 shares of our common stock in the open market for a total cost of $28.4 million. The Company has spent a total of $75.8 million of our $150 million authorization to repurchase 11,555,447 shares through September 30 of 2011.

We are updating our prior business outlook for calendar year 2011. We currently expect net revenue for the full year of 2011 to be in the range of $2.76 billion to $2.8 billion, and adjusted EBITDA for the full year to be in the range of $375 million to $390 million.

We now expect fully diluted income for common share to be in the range of $0.62 to $0.68 a share on an adjusted basis, excluding the loss on early retirement of debt and its tax effect from the refinancing completed in the second quarter. We expect fully diluted income per common share in the range of $0.75 to $0.81.

This concludes our prepared remarks and we'd like to ask the operator to open up the call for questions.

(Operator Instructions) Frank Morgan with RBC Capital Markets.

Good morning. A couple of question here, just any additional color or commentary you can provide around the strong volume growth, what's really driving that, as well as also the reasons for the softness on the acuity side and maybe just some commentary on how sustainable you think these trends are, or anything that you may think would change going forward.

And then also just maybe talk a little bit about the breakout in the margins, particularly with the ramp up from Regency. And any share repurchases since the end of the quarter, thanks.

Sure, Frank. We can tell you that since the end of last year our operators have had a renewed focus on increasing census. And I think that is really what we are attributing the growth in census to. I mean, they've done a great job with that.

What -- do you think the growth in -- but what about on the acuity side? What do you see there that's -- well, you've seen the soft -- is it just the fact that you're doing such a good job on the volume side that maybe you are pulling in some lower acuity or do you think there's some underlying trend from what we're seeing in the acute care hospitals?

We've spent some time talking to our operators about that and their comments are very similar to what you're hearing in the acute care hospitals, that they're seeing acuity down.

Okay. And then any commentary on kind of the same store versus the Regency, where Regency margins are in the quarter, and then share buybacks since September 30? Thanks.

With regards to the Regency margins, you know at the beginning of the year we talked about the margins being in the 13 -- we anticipated for this year Regency margins would be in that 13% range and we're actually on a year to date basis a little bit higher than that. We're happy with where Regency is right now.

We anticipate that as we go into 2012 we will see them gravitate towards our Select or Legacy LTAC margins. So we think that's terrific.

And yes, we continue to repurchase shares. We are continuing to repurchase shares in this quarter.

Okay, thanks.

A.J. Rice with Susquehanna.

Thanks. Hello everybody. A couple of questions if I might. So we have a step up in the equity and earnings of unconsolidated subsidiaries. I guess that's principally driven by the Baylor JV, a nice sequential increase. A, can you give us a little flavor for how that JV is progressing? And also, is the rate you show this quarter something that's sustainable going forward?

A.J., yes. We're actually -- the JVs are a little bit ahead of where we anticipated they would be. We're very pleased with where they are and we do believe that that type of rate is sustainable.

Okay. And then another line, net income attributable to non-controlling interest, that actually stepped down from what you'd been reporting in the first and second quarter. Is that just seasonality or is there anything else behind that?

No, there's a -- that is -- there's a number of small JVs that we have and a couple of those hospitals did not perform nearly as well as we thought they would or they could. And consequently, we think that's just a little blip right now and we anticipate that we will get back on track there.

Okay. And then finally just maybe a broader question. Obviously you guys don't have a lot of exposure. You've got some exposure to the IRF market. But certainly in talking about JVs going forward as well as even acquisitions, that's been something you guys have said you have an interest in. In the last three months there's -- I mean, the administration's proposed revisiting the 75% roll, some other less well defined potential changes.

Does that give you pause in investing in that area right now? Or maybe give us your thoughts on, A, the proposals, and, B, whether you step back and assess -- reassess for a little while until you get clarity on what's going to happen there.

A.J., it's Bob. I don't think that it changes our focus or outlook on growing that segment of the business. As you know, that's a business that we know very well and like just about any segment of healthcare, you're going to have some ups and downs on the Medicare payment policy proposals. And I think it's important to try to sort out which of those are actually going to happen and which are just being thrown out.

We take all of them seriously but what tends to happen is these things ripple through into valuations. The uncertainty just as people who view our stock, we view acquisitions the same way and as uncertainty goes up on the future then, I think it has to find its way into valuations.

But we are certainly undeterred on our focus on the rehab -- our rehab strategy both in-patient and outpatient.

Okay, all right. Thanks a lot.

Sure, A.J. Thank you.

Kevin Fischbeck with Bank of America Merrill Lynch.

Okay, thank you. The -- you mentioned that you're continuing to buy shares back in Q4. Can you just give a little bit of an update on your capital deployment strategy and kind of how you view share repurchases in the context of all the opportunities, and then maybe an update on kind of new JV opportunities?

Sure. As far as share repurchase, Kevin, the focus is really to continue to purchase shares when the price is right. And consequently, as you've seen, we've done a lot of that in Q3 and to the extent that the price continues to be where it is, we'll continue to purchase.

(Multiple speakers). Sure, Kevin, as far as the JV strategy, we continue to work it. We have a pipeline of projects that are solid. As I've said in the past, it's difficult to predict when we would be able to get those signed just because we tend to work with large institutions and systems and it is difficult to predict the speed at which they will move.

But I will tell you that our success that we've had in our existing joint ventures with SSM in St. Louis, Baylor in Dallas or Penn State University, have all been such that we remain [consistently] committed to that strategy and we think we're very well positioned to get those. And I think that a lot of the things that are going on with healthcare reform lead that to continue to be viewed as a very good strategy for us, so we're continuing to work it.

Okay, and then in the comments you mentioned that the outpatient rehab margins were impacted by changes in response to some of the regulatory changes that have been going on. Were those fully reflected in the numbers in the quarter or do you check on (inaudible) down in Q4 based upon what's continuing to happen there on the rehab side?

In essence you're talking about concurrent therapy, I'm assuming, Kevin.

Yes.

Yes. We anticipate that there was impact in the third quarter on that. There will continue to be impact in the fourth quarter.

Do the group therapy changes impact you meaningfully in Q4?

I think the group therapy will impact us. I don't think it'll be meaningful.

Okay. And then just you mentioned before kind of a refocus on getting volume growth this year and the number, I guess 71% occupancy is a good number here. How much farther do you feel like that number can go from here?

I would expect to see occupancy 71%, 72%, 73%. I don't see it growing much more than that, at least in the next year.

Okay, great. Thanks.

Gary Lieberman with Wells Fargo Securities.

Good morning. This is Ryan on for Gary. I guess going back to Regency, you mentioned you're comfortable with your -- with how margins have been going so far. I calculate, I guess, year to date you guys -- Regency's generated about $36 million of EBITDA and a 13% margin target was the equivalent of like $45 million. Do you care to maybe update what you think you might be able to generate from the Regency, as far as absolute EBITDA?

As far as the end of the year?

Yes.

I think probably $44 million to $45 million is probably appropriate.

Okay. Okay, and then I guess on the last quarter's call on the outpatient clinics, you gave an idea of how much -- how many of the visit decline was associated with the Dallas conversion to Baylor. Any sense of how many visits this quarter?

We, in essence, transferred over 19 clinics and I think we were looking at somewhere in the neighborhood of 28 -- 27,000 to 28,000 visits associated with that.

Okay. Okay, and then I guess as far as your capital structure, you guys are always looking at the 7-5/8. Where would you, I guess -- where would you rank that versus share repurchases as far as your use of your capital and balance sheet?

You know Ryan, when you take a look at the 7-5/8 currently, at least the last time we checked, trading right now at 93, 94, and to replace that right now just doesn't make a lot of sense to us, given it's a 2015 piece of paper. (Multiple speakers).

Okay. Thank you.

Okay.

Doug Simpson with Morgan Stanley.

Good morning everyone. Marty, could you talk a little bit about the G&A opportunity going forward? You guys have held the line on that and pulled the ratio down year over year obviously with the growth on the top line. Just any specific actions you see over the next six months where you can maybe target further efficiencies or how are you thinking about that opportunity?

Doug, with regards to G&A, I think the 2.2% is probably a good number.

Okay. Okay, any dramatic seasonality into Q4 preparing for the year ahead or not really?

Normally you see a little bit of a comeback on the in-patient side. You see -- on the outpatient side it's typically down a little bit as compared to the other quarters with the exception of Q3. And that's just because the number of days, the number of holidays that you have during that period of time.

Right, okay. And then on the outpatient side, I think you touched on it earlier about the weather, just thinking about the weather, the economy, anything you want to break out there or was it not really that meaningful in aggregate?

I think the -- well, the weather I think was immaterial.

Okay.

I think it was probably somewhere in the $1 million range so from that perspective I think that's rather immaterial. I think the -- our operators on the clinic side have continued to do an outstanding job. I think the volume relative to the points you mentioned, what's going on with the economy, higher copays, higher deductibles, I think they've done a great job there.

The clinic side, we've had -- with new business and with some of the regulatory changes, we have our work cut out for us.

Okay. Any change in some of the mom and pops out there in their thinking about their own futures and maybe an opportunity to gain a little bit of share there?

That would be maybe in a market to market but I couldn't say anything that is systemic across the country or in the markets that we're in, maybe one off here and there.

Okay. And then you touched earlier on the difference in the margin trends, sort of the ebb and flow between the Legacy and the Regency business. As you're doing your forecasting, how do you think about that ebb and flow among those two buckets? And should we expect them to sort of gravitate more towards I guess trends more similar with one another or are they just going to sort of do their own thing a little bit?

It's a good question. No, Doug, our expectation is that over the next 12 to 18 months you will see Regency basically gravitate towards our Legacy specialty hospital margins, up in that 17% to 18% range.

Okay. Great. Thanks.

Thank you.

Whit Mayo with Robert W. Baird.

Thanks. Good morning, just a couple of questions. Just, you guys have seen some -- I think had an impact on some FI changes in the past, maybe impacted some of your payments. Just maybe if you could comment on that and sort of how the AR's looking. Are any of those pressures getting better or are they just insignificant at this point?

At this point in time, Whit, we think we're back to normal. FI, we had an FI change, I think it was two quarters ago, but everything has been going smoothly since then.

Okay. Marty, do you have the ending share count for the quarter? Not the average.

Yes, we do here, Whit. It was a 100 --

That's October.

I can give you October's. 148,108,130 shares.

Thanks. And maybe going back to last year, you had the little charge capture snafu with Regency, just maybe update us there, just any implications as you go through your cost report settlement period this year and sort of what that means going forward.

No, I think from -- last year at this time with Regency, remember we owned it for a month. So if you take a look at what we've been able to do this year and if you take a look at the margins, I think on a quarterly basis we were at 16% in the first quarter, 10.8% in the second quarter and this particular quarter I think we were about 13.9% to 14%.

There is still some variation that we're seeing but I think as -- over the next 12 to 18 months you should see the same types of EBITDA margins and consistency that you've seen in our Legacy business.

Okay, and maybe just one last one. I can't recall but I thought you were building an ERF with SSM that was supposed to open sometime soon. Is that still on schedule? I just -- I can't recall or find (multiple speakers)

Yes, it is tracking. Yes, it's a new rehab hospital on the campus of the SSM DePaul hospital and we expect that to open in the first quarter.

Okay. Perfect. Oh, can you remind me how many beds that is again?

60 to 70 beds, I think.

Okay, all right. Great. Thanks Bob.

Sure.

Ladies and gentlemen that will conclude the question and answer portion of our call. I'd now like to turn the presentation back over to Mr. Ortenzio for closing remarks.

I just thank all of you for joining us and we look forward to updating you at year end.

Ladies and gentlemen that will conclude our conference call for today. Thank you for your participation. You may now disconnect and have a wonderful day.