Select Medical Holdings Corp (SEM) 2013 Q1 法說會逐字稿

Good morning and thank you for joining us today for Select Medical Holdings Corporation's earnings conference call to discuss the first quarter 2013 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 future events or future financial performance of the Company, including without limitation statements regarding operational results, growth opportunities and other statements that refer to Select's plans, expectations, strategies, intentions and beliefs. These forward-looking statements are based on 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'll turn the conference over to Robert Ortenzio.

Thank you, operator. Good morning, everyone. Thanks for joining us for Select Medical's first quarter earnings conference call.

(technical difficulty) our reported earnings per fully diluted share were $0.24 in the first quarter compared to $0.29 the same quarter last year. Our earnings per share in the first quarter of this year included a nonrecurring loss on early retirement of debt. Excluding this loss and its related tax effect, the adjusted net income per share was $0.25 for the quarter.

Net revenue for the first quarter was $750 million compared to $744 million in the same quarter last year. During the quarter we generated approximately 74% of our revenues from our Specialty Hospitals segment, which includes both our long-term acute care and inpatient rehab hospitals, and 26% from our Outpatient Rehabilitation segment, which includes both our outpatient clinics and our contract services.

Net revenue in our Specialty Hospitals for the first quarter increased slightly to $557.8 million compared to $553 million in the same quarter last year. This growth resulted primarily from increase in revenues that are generated from contracting labor services provided to our Baylor joint venture. Specialty Hospitals' net revenues per patient day increased 1.2% to $1543 in the first quarter compared to $1525 per patient day in the same quarter last year. This increase resulted primarily from an increase in our average non-Medicare net revenue per patient day. Our patient days declined slightly to just over 339,000 in the first quarter compared to 343,000 days in the same quarter last year. Our occupancy was flat at 73%.

Decline in patient days resulted from a decrease in our Medicare patient days. We generated approximately 84% of our Specialty Hospitals revenue from the long-term acute care hospitals and 16% from our inpatient rehabilitation hospitals during the first quarter.

Net revenue in our Outpatient Rehabilitation segment for the first quarter was $192.1 million compared to $190.9 million in the same quarter last year. Net revenue on our outpatient clinic-based business, including our owned and managed clinics increased 3% to $145.2 million compared to the same quarter last year.

For our own clinics, patient visits increased 0.9% to over 1.16 million visits compared to the same quarter last year. Our net revenue per visit was $105 in the first quarter compared to $103 in the same quarter last year.

Net revenue in our contract services business in the first quarter declined 6% to $46.9 million compared to the same quarter last year. The primary reason for the decline was related to contract terminations. During the first quarter we generated approximately 76% of our outpatient revenue from our owned and manage clinics and 24% from contract services.

The overall adjusted EBITDA for the first quarter was $100.1 million compared to $109.1 million in the same quarter last year with overall adjusted EBITDA margins of 13.3% for the first quarter compared to 14.7% margins for the same quarter last year.

Specialty Hospitals adjusted EBITDA for the first quarter was $93.3 million compared to $100 million in the same quarter last year. The primary reason for the decline in the adjusted EBITDA in our Specialty Hospitals was due to inflationary labor cost increases without a corresponding increase in revenues. Adjusted EBITDA margins for the Specialty Hospitals segment were 16.7% compared to 18.1% in the same quarter last year.

Outpatient Rehab adjusted EBITDA for the first quarter increased slightly to $22.8 million compared to $22.5 million in the same quarter last year. Adjusted EBITDA margins for the Outpatient segment were 11.9% in the first quarter compared to 11.8% in the same quarter last year.

For the outpatient clinic portion of our business, adjusted EBITDA increased 3.3% to $19.4 million compared to $18.7 million in the same quarter last year. Adjusted EBITDA margins for our outpatient clinics were 13.3% for both the first quarter of this year and last year. For our contract services, adjusted EBITDA was $3.5 million and margins were 7.4% in the first quarter compared to $3.7 million of adjusted EBITDA margins of 7.5% same quarter last year.

I also want to provide a couple of updates since our fourth-quarter earnings in February. In conjunction with our earnings release yesterday, the Company announced that our Board of Directors declared a quarterly cash dividend of $0.10 per share at its meeting on May 1. The Company continues to look for opportunities to increase shareholder value, this dividend being the latest.

As many of you are aware, CMS issued the proposed fiscal 2014 LTAC regulations last Friday. The proposed rule included an update to the standard federal rate which, if implemented as proposed, would amount to a net increase in the standard federal rate of 0.55% effective October 1, 2013. The preamble to the proposed rule also indicated CMS intends to allow the regulatory moratorium on what we have historically referred to as the 25% rule, to lapse in fiscal year 2014. The 25% rule -- if the 25% rule is implemented as proposed, our LTACs will begin to be subject to the rule for the respective cost reporting periods beginning on or after October 1, 2013.

Because each of our LTACs has a unique Medicare cost reporting period that commence on various dates throughout the year, the effects of the rule would be phased in over time and we would not realize the full impact of lowering reimbursement until 2015.

Yesterday after the market closed, CMS published a proposed fiscal year 2014 inpatient rehab rule update. The proposed rule includes a net market basket increase at a standard payment rate of 1.8%. CMS also proposed in the rules update the list of codes used to comply with provisions of the 60% test which we will be further evaluating.

At this point I'll turn it over to Marty Jackson for additional financial highlights for the quarter before we open it up for questions.

Thanks, Bob. Good morning, everyone. For the first quarter, our operating expenses, which include our cost of services, general and administrative costs and bad debt expense, increased 2.4% to $651.6 million compared to the same quarter last year. As a percentage of our net revenue, operating expenses for the quarter were 86.9% compared to 85.5% in the same quarter last year.

Cost of services increased 2.2% to $624.9 million for the first quarter compared to the same quarter last year. As a percent of net revenue, cost of services was 83.3% for the first quarter. This compares to 82.2% in the same quarter last year. The primary reason for the 110 basis point increase in our cost of services was inflationary labor cost increases in our Specialty Hospitals, which we were not able to offset with revenue growth.

G&A expense was $17.4 million in the first quarter, which as a percentage of revenue was 2.3%. This compares to $14.2 million or 1.9% of revenue in the same quarter last year. Our G&A expenses during the first quarter of last year were favorably impacted by a gain on the sale of a building. Excluding the gain, G&A would have been 2.3% of revenue for the same quarter last year.

Bad debt as a percent of net revenue was 1.3% for the first quarter. This compares to 1.4% for the same quarter last year.

As Bob mentioned, total adjusted EBITDA was $100.1 million for the first quarter and adjusted EBITDA margins were 13.3%. This compares to adjusted EBITDA of $109.1 million, 14.7% adjusted EBITDA margins in the same quarter last year. The primary reason for the decline in adjusted EBITDA and margins were due to the increase in the Specialty Hospitals labor costs and the increase in G&A, as I mentioned previously.

Depreciation and amortization expense was $15.8 million in the first quarter. This compares to depreciation and amortization expense of $16.2 million in the same quarter last year.

We incurred a loss on early retirement of debt of $1.5 million due to the refinancing activities that occurred in the first quarter. On February 20, we entered into an incremental $300 million term loan and used the proceeds to redeem all of the outstanding 7.625% senior subordinated notes, which were due 2015, and all of our senior sub rate notes, also due in 2015. Both note issuances were redeemed on March 22.

We generated $1.1 million in equity in earnings during the first quarter. This compares to $2.5 million in the same quarter last year. The decline in the first quarter compared to the same quarter last year was the result of a decrease in the earnings contributed from the Baylor JV and losses incurred in start-up companies where we own a minority interest.

Interest expense was $23.5 million in the first quarter. This was down from the $23.9 million in the same quarter last year. The reduction in interest expense for the quarter is primarily related to lower interest rates on the portions of the debt that we refinanced during the third quarter of last year.

The Company reported income tax expense of $21.9 million in the first quarter. The effective tax rate for the year was 37.3%. This compares to the effective tax rate of 39.3% in the first quarter of last year.

Net income attributable to Select Medical Holdings was $34.4 million in the first quarter and fully diluted earnings per share of $0.24. Excluding the loss on early retirement of debt and its related tax effect, fully diluted earnings per share were $0.25 in the first quarter. This compares to $0.29 in the same quarter last year.

We ended the quarter with $1.49 billion of debt outstanding and $4.5 million of cash on the balance sheet. Our debt balances at the end of the quarter included $1.39 billion in term loans, which is net of original issue discounts, $90 million in revolving loans outstanding with the balance of $9.8 million consisting of other miscellaneous debt.

As we mentioned in our press release, the Company intends to initiate a $500 million senior unsecured note offering and use the proceeds to prepay a portion of our existing term loans. The completion of any such offering is dependent on and subject to the current market conditions, among other factors.

Operating activities used $12 million of cash flow in the first quarter, which resulted primarily from increases in our accounts receivable. Days sales outstanding, or DSO, was 51 days at March 31, 2013. This compares to 45 days at December 31, 2012. The increase in DSO is primarily due to the timing of Medicare PIP payments received for services provided at our Specialty Hospitals.

Investing activities used $24 million of cash flow for the first quarter. The use of cash included $14 million for the purchase of property and equipment and $10 million related to an investment in a non-consolidating start-up company where we own a minority interest.

Financing activities provided $300,000 of cash for the first quarter. The provision of cash in the quarter resulted primarily from refinancing activities in the quarter which were offset by $10 million in share repurchases. During the first quarter we repurchased to little over 1.1 million shares at a total cost of $10 million. Under the share repurchase program, we have spent a total of $173.6 million of the $350 million authorized and have repurchased 23.6 million shares.

I will conclude my comments by outlining the financial guidance for calendar year 2013 that we provided in our earnings release. This includes net revenue in the range of $2.925 billion to $3.025 billion, adjusted EBITDA in the range of $375 million to $390 million, fully-diluted income per common share to be in the range of $0.86 to $0.93 and adjusted income per common share, which excludes the loss of early retirement of debt recorded in the first quarter as it relates to related tax effects, to be in the range of $0.87 to $0.94.

Our current business outlook includes the estimated financial impact from sequestration cuts that became effective April 1, 2013. We estimate the negative impact to net revenue and adjusted EBITDA from the sequestration cuts to be between $20 million and $25 million. Additionally, our previously provided business outlook includes and continues to include the adverse financial impact of the NPPR changes for the outpatient services that became effective April 1, 2013. We estimate the negative impact to net revenue and adjusted EBITDA for the NPPR changes to be between $5 million and $10 million annually for our Outpatient Rehabilitation segment. We have also assumed a 40% effective tax rate for the remainder of 2013 when we prepared our business outlook.

This concludes our prepared remarks and at this time we would like to turn it back over to the operator to open the call for questions.

(Operator instructions) A.J. Rice, UBS.

First off, maybe just to follow up on your comments on the IPPS rule, I know that doesn't -- that sort phases in over time, like you said, based on your cost reporting period. Is there any way to quantify any impact that you are reflecting of the guidance for this year, if there is any? And then long-term in 2015 and beyond when it is up and running, what the aggregate impact would be?

A.J., there is. I want to point out that these are estimates. Because the calculations that that are used, and they are constantly changing, we really focus on the first year and then we have tried to give an estimate for 2014 and 2015. But in 2013 we think it will be less than $1 million.

Okay.

And longer-term.

Yes, I mean, longer term, if you take a look at 2014, when you take a look at all of our hospitals and some mitigation strategies and some of the operation cost expenses that we can reduce, we are probably in that $5 million to $10 million for 2014.

Okay.

The other thing, A.,J., I want to point out is the rules, as you know, is proposed. This is one of the reasons why we often hesitate to make a lot of comment on proposed rules because they can change between the proposed and through the comment period to the final rule. So if you assume that the final rule is put in place and the 25% rule as it is proposed stays, then Marty has given some comments in some guidance on that.

You also know in that proposed rule that CMS telegraphed that they are looking at revisiting patient facility criteria maybe in a year from now. That was in the narrative. So you could also speculate that if patient facility criteria was in the proposed rule a year from now and that became effective in the final rule, whether the 25% rule would be a permanent part of that or whether criteria would eliminate the need for the 25% rule, which was pretty much what CMS telegraphed last year at this time in their proposed rule, where they said they were looking at policies that would make the 25% rule not necessary. So I just point that out to suggest that there are a fair number of moving parts here and a lot of this assistance and a lot of this is estimates and a lot of it is speculation of what the regulation will be.

That actually leads to my second question. I was going to ask you about the fact that last year they didn't seem to couple the two together, the criteria and the 25% rule. And this year, they seemed to decouple them. Do you read anything into that?

And then second, I know you guys and the industry has legislative efforts underway. Any update on the status of those to get the criteria bills through the Congress?

Well, to your first point, I think it is factually correct that last year's proposed rule, they seemed to couple other policy initiatives with the elimination of the 25% rule, and in this proposed rule they seemed to de-couple those. I don't know that that represents two separate policy lines -- and, again, this is speculation -- but it could be that their policy recommendations for further criteria were not ready for prime time or not ready to be proposed, but they just wanted to go ahead and let the 25% rule, which was already baked and already pretty much articulated going back as far as 2004, to just go ahead and let that go into effect. But I suspect that there's going to be a lot of comments on that by providers and others during the comment period of the proposed rule. So we may not have heard the end of that.

Alright. And then the Congressional issues, anything new to report there?

No, I don't have much new. As I think most people on the call know that follow the Company, the industry has been pushing for patient facility criteria. It did show up in a Roberts-Nelson bill. There has been a lot of work done by the American Hospital Association. The only way for me to characterize is that work is ongoing. Speaking for Select, we continue to work with Washington to try to push along patient facility criteria. That is, we think, the best place for the industry to go.

CMS now seems to be back in the fray. They had suggested a couple years ago that they didn't think patient facility criteria was something they were going to work on and it was really left to the Congress. But now that CMS is reengaged in this, I think that that might be a positive. But now I think the way to look at it is probably both initiatives, both from CMS and on the hill, both initiatives ongoing. So for us we want to be participatory in both debates.

And then the prepared comments, you guys mentioned that there was some contract terminations in your contract services business. Was that something you initiated or maybe give us a little more background on those?

That's really just a common occurrence in that business, where you are constantly reevaluating the contracts and seeing how profitable they are. In this particular case, those are contracts to be terminated because of the lack of profitability.

Okay, I just was wondering, because it seemed like you called those and highlighted them.

And then I will just as the last question on capital priorities. You mentioned the dividend. You have done this refinancing. I don't know whether there's additional thoughts on further refinancings, but can you just comment on capital priorities for your cash flow at this point?

I'll make the first comment; I'll let Marty add some comments. If you look at the Company in the recent past, I think it's a good indication of what we would do in the future. We have made acquisitions. We have brought back stock. We have bought back bonds at certain points in time and we've paid dividends. And what we try to look at and -- is try to be opportunistic. I think the Board, the recent evidence shows the Board's confidence in the cash flow of the Company, and I think you can also assume that it reflects management's not highly confident that this is a good time to be making a lot of large acquisitions without capital. We are in a period of regulatory uncertainty. The 25% rule was something, if it is in the final rule, was something we didn't anticipate. So we will have to let that sort out through the industry as well as CMS work and Congress's work on patient criteria. So I don't think we see a lot of opportunities in the M&A area that we've seen in the past. And so we think that a small dividend as a percentage of overall free cash flow is probably a good thing to look at right now.

Okay, thanks a lot.

Gary Lieberman, Wells Fargo.

This is Ryan Halsted on for Gary. I guess, starting with the regulatory, you mentioned the ERF rule. I was curious if you have any thoughts on what was in the proposed rule, specifically the revisions to the codes.

You know, we don't. That came out last night when the market closed as we were getting ready for the conference call. So we haven't spent a lot of time analyzing, so it wouldn't be fair for us to give any narrative on that at this point until we've had a chance to dig into it a little bit.

I think the only comment we would make there, Ryan, is the rate looks relatively good.

Sure. Okay, and then, as far as your guidance for sequestration it looks like you added more of a range now from where you originally anticipated the impact. Any thoughts on what you are seeing that might have changed?

Could you be more specific on your question?

You are highly sequestration could impact you by $20 million to $25 million. I believe in the past, you said just $20 million. Is there something additional that you think might be impacting you guys?

No. What we have done -- I think when we provided the $20 million number originally, there was no description from CMS as to the mechanics of how it was going to work. Now that CMS has come out with the mechanics and said, no, it's not going to be applied against the base rate but it's going to be applied against all of the Medicare revenue less the deductibles and co-pays, we were able to fine-tune that.

Okay, and then -- so you mentioned, to A.J.'s question about potential offsetting cost initiatives, I was just curious if you guys had contemplated something more formal, considering a lot of your peers have implemented the formal cost-cutting initiatives. Is that something you guys are looking into?

Yes, I would characterize it as something that we are looking at and we are always looking at. And as these cuts become more visible and with the 25% rule, we will take a step back and take a look at where we are and we will institute -- we will formalize some of the things that we have been looking at. The cost-cutting is certainly something that we can initiate.

Okay, and then, lastly, you indicated maybe a little bit of a slowdown on the M&A front. Does that include inpatient rehab JVs or any sort of update on your pipeline there?

No, that doesn't include the JVs. The JVs are less capital intensive and much longer lead time and there's fewer of those and they are not as sizeable. So we could do a couple of those per year that on the capital side really don't move the needle that much.

Yes, the pipeline is good. We are in active negotiation with a number and I am feeling a little bit more confident than I have in the past that we will probably get a couple this year.

Okay, and you think the pace of those might change or pick up?

I don't know. I don't want to say that the pace -- I would certainly like to see the pace pick up because I've been disappointed about the pace or the absence of signed deals in the recent past. So, yes, I would certainly like to see the pace pick up.

Okay, thank you.

Walter Branson, Regiment Capital.

So I had a couple of things. Obviously, volume was weak in the first quarter in this. Acute care hospitals have also been reported weak volumes, but also some of them have talked about a pickup in the second quarter so far. I wondered if you have any comments about how volume trends are looking in the second quarter.

And my second question is, you've been investing regularly in some of these start-ups, $10 million in the first quarter. I wonder if you could talk a little bit about what these start-ups are and what your expectations are as to what you will achieve from them.

I'll take the first part of that. No, we really don't make comments on value in future quarters. It's just not our practice. I suspect maybe there's some companies that do, but we really don't. They can vary from month to month. I wouldn't want to give you a comment on volumes early in the quarter and find them fall off. So we really don't make comments on volume.

In terms of investments, I will let Marty take a shot at that.

We have five investments, very small investments, minority interests, is a lot of the companies that are basically start-up and they are incurring costs. And, in essence, what we're doing is just taking the hit associated with that.

I don't think we're looking at any material new investments at any of those companies at the current time. They are really capitalized, and what you see is the losses from our minority interest.

Do you have any expectation of actually showing profits from those in the next year or two, or is it more long-term than that?

No, we certainly expect to see profitability in the next year or two.

We do, but those profits will not be material to us. I do think that these are more longer-term investments and could be characterized as strategic.

Okay, thank you.

Thank you for your questions. Having no further questions in queue, I would now like to turn the call back over to Robert Ortenzio for closing remarks.

We appreciate your participation on the conference call and we look forward to updating you next quarter.

Thank you for your participation in today's conference call, ladies and gentlemen. That now concludes your presentation. You may now disconnect. Have a good day.