Good morning, and thank you for joining us today for Select Medical Holdings Corporation's earnings conference call to discuss the second quarter 2019 results and the company's business outlook.

Speaking today are 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 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 operating 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. At this time, I will turn the conference call over to Mr. Robert Ortenzio. You may begin, sir..

Thank you, Operator. Good morning, everyone. Thanks for joining us for Select Medical Second Quarter Earnings Call for 2019. We were pleased with the overall performance in the quarter of meeting our internal expectations and achieving revenue and adjusted EBITDA growth in all four of our operating segments.

Before I outline our operational metrics, I want to provide you with some summary comments and updates since we presented last quarter.

As you are aware, we preannounced earnings ranges for the second quarter results for both net operating revenues and adjusted EBITDA on July 18 in connection with plans to launch a refinancing of some of the company's debt. We completed that financing yesterday, and I'll let Marty Jackson provide the details in his comments.

We also made a change in how we report what we have often referred to as pass-through revenue and expense this quarter. We provided employee leasing services to several of our nonconsolidating joint ventures as an administrative function where we lease employees to those JVs at costs essentially reporting was a zero margin.

In the second quarter, we included those revenues and expenses with our other activities and no longer report them as part of operating segments, which we believe improve the transparency of our segment revenues and margins. We have also changed prior comparative results to reflect this change as well.

Overall, our net revenue for the second quarter increased 5% to $1.36 billion in the quarter compared to $1.3 billion last year. Net revenue in our critical illness recovery hospital segment in the second quarter increased 4.2% to $461 million compared to $442 million at the same quarter last year.

The increase is attributable to both increase in patient volumes and revenue per patient day. Patient day increased 2.6% to the same quarter last year with almost 263,000 patient days in the second quarter. Occupancy in our critical illness recovery hospital segment was 69% in the second quarter this year compared to 68% in the same quarter last year.

Net revenue per patient day increased 1.7% to $1,739 per patient day in the second quarter compared to $1,710 per patient day in the same quarter last year. Net revenue in our rehabilitation hospital segment in the second quarter increased 10.8% to $160 million compared to $145 million in the same quarter last year.

Patient days increased 11.8% to over 86,000 days compared to 77,000 days in the same quarter last year. Net revenue per patient day increased 1.7% to $1,635 per day in the second quarter compared to $1,608 per day in the same quarter last year.

Net revenue in our outpatient rehab segment in the second quarter increased 3.1% to $262 million compared to $254 million in the same quarter last year. Patient visits increased 2.7% to 2.2 million visits in the second quarter compared to over 2.1 million visits in the same quarter last year.

Our net revenue per visit was $102 in the second quarter compared to $103 in the same quarter last year. Net revenue in our Concentra segment was relatively flat at $413 million in both the second quarter this year and last year.

For the second quarter, revenue from our centers was $375 million, and the balance of approximately $39 million was generated from on-site clinics, community-based outpatient clinics and other services. For the centers, patient visits increased 2.6% to just over 3.1 million visits compared to 3 million visits in the same quarter last year.

Our net revenue per visit was $121 in the second quarter compared to $125 per visit in the same quarter last year. The decline in net revenue per visit was primarily due to higher mix of employer services visits, which yield lower per visit rates.

Total company adjusted EBITDA for the second quarter increased 4.5% to $186.2 million compared to $178.2 million in the same quarter last year. Our consolidated adjusted EBITDA margin was 13.7% for both the second quarter this year and last year.

In our critical illness recovery hospital segment, adjusted EBITDA increased 5.6% to $64 million in the second quarter compared to $60.7 million in the same quarter last year. Adjusted EBITDA margin for the segment was 13.9% in the second quarter compared to 13.7% in the same quarter last year.

Our rehab hospital segment adjusted EBITDA increased 6.3% to $30 million in the second quarter compared to $28.2 million in the same quarter last year. Adjusted EBITDA margin for the rehabilitation hospital segment was 18.7% in the second quarter compared to 19.5% in the same quarter last year.

The increase in adjusted EBITDA was primarily attributable to an increase in volume at several of our existing hospitals. Our adjusted EBITDA and margin were negatively impacted by start-up losses, which were $6 million in the second quarter compared to $2.1 million in the same quarter last year.

Excluding the start-up losses in both periods, margins would've improved 150 basis points in the second quarter year-over-year. Outpatient rehab adjusted EBITDA increased 1.5% to $42.6 million in the second quarter compared to $41.9 million in the same quarter last year.

Adjusted EBITDA margin for the outpatient segment was 16.3% in the second quarter compared to 16.5% in the second quarter last year. Adjusted EBITDA in the quarter increased relatively as a result of newly acquired and developed clinics.

Concentra adjusted EBITDA increased 4.8% to $76.1 million for the second quarter compared to $72.6 million in the same quarter last year. Adjusted EBITDA margin was 18.4% in the second quarter compared to 17.6% in the same quarter last year.

The increase in adjusted EBITDA and margin was a result of us achieving operating cost synergies across our combined Concentra and U.S. HealthWorks businesses. Earnings per fully diluted share was $0.33 for the second quarter compared to $0.35 for the same quarter last year.

Adjusted earnings per fully diluted share excluding nonoperating gains and the related tax effects was $0.31 in the second quarter of last year. During the second quarter, we acquired three new critical illness recovery hospitals in Florida, and we opened a new rehabilitation hospital in partnership with Dignity Health in Nevada.

We're also under construction on two of our planned three new rehabilitation hospitals in partnership with Banner Health in Arizona. On July 31, CMS posted an advanced copy of the final rule for patient rehabilitation hospitals for fiscal year 2020. The final rule calls for a 2.9% market vested increase subject to other adjustments.

The final rule was in line with the proposed rule that came out in April and includes refinements to the CMGs. We are still evaluating impact on our hospitals but overall see these changes as positive for our portfolio of hospitals.

Finally, we announced earlier this week that we've appointed Daniel Thomas to the Board of Directors of Select, and Dan will also serve on the Board's Audit Committee. Dan is also an active member of the Board of Directors of Concentra and brings over 30 years of health care experience to our Board, and we are pleased to have him on board.

I'll now turn it over to Marty Jackson for some additional financial details before opening the call up for questions..

Thanks, Bob. Good morning, everyone. For the second quarter, our operating expenses, which include our cost of services and general and administrative expenses, were $1.18 billion. As a percent of net revenue, operating expenses were 86.8% in both the second quarter of this year and last year.

Cost of services were $1.15 billion for the second quarter compared to $1.09 billion in the same quarter last year. As a percent of net revenue, cost of services were 84.5% for both the second quarter of this year and last year. G&A expense was $31.3 million the second quarter. This compares to $29.2 million in the same quarter last year.

G&A as a percent of net revenue was 2.3% in both the second quarter of this year and last year. As Bob mentioned, total adjusted EBITDA was $186.2 million, and adjusted EBITDA margins was 13.7% for the second quarter as compared to total adjusted EBITDA of $178.2 million and adjusted EBITDA margins of 13.7% in the same quarter last year.

Total revenue and expense related to the labor pass-through was $64.5 million in the second quarter this year. That compares to $42.2 million in the same quarter last year.

Excluding the impact of labor pass-through, overall adjusted EBITDA margins would've improved 20 basis points in the second quarter this year compared to the same quarter last year. Depreciation and amortization was $55 million in the second quarter. This compares to $51.7 million in the same quarter last year.

This increase was primarily attributable to our critical illness recovery hospitals as the certificate of need regulations in Florida were appealed, which cost approximately $2.1 million of unamortized intangible assets to be fully expensed in the quarter.

We generated $7.4 million in equity and earnings of unconsolidated subsidiaries during the second quarter. This compares to $4.8 million in the same quarter last year.

The increase in equity and earnings was attributable to the growth of nonconsolidating subsidiaries as a result of the sale of outpatient rehabilitation clinics to these nonconsolidating subsidiaries over the last 12 months. Interest expense was $51.5 million in the second quarter. This compares to $50.2 million in the same quarter last year.

We recorded income tax expense of $20.8 million for the quarter. This compares to $21.1 million in the same quarter last year. The effective tax rate in both periods was 25.8%. Net income attributable to Select Medical Holdings was $44.8 million in the second quarter, and fully diluted earnings per share was $0.33.

At the end of the quarter, we had $3.4 billion of debt outstanding and $124 million of cash on the balance sheet.

Our debt balance at the end of the quarter included $1 billion in Select term loans, $195 million in Select revolving loans, $710 million in Select 6 3/8% senior notes, $1.1 billion in Concentra first lien term loans, $240 million in Concentra second lien term loans, $39 million in unamortized discounts, premiums and debt issuance cost to reduce the overall balance sheet debt liability, and we had $81 million of other miscellaneous debt.

As Bob mentioned, we completed a refinancing transaction yesterday, which included the issuance of $550 million of new seven year senior notes at a coupon of 6.25% and a new $500 million incremental term loan, which is on the same terms as our existing term loan.

We tend to use the net proceeds from the new debt to redeem our existing $710 million 6 3/8% senior notes and pay out the balance of our revolving loans. Operating activities provided $91.2 million of cash flow in the second quarter. The provision of operating cash flow for the quarter is primarily driven by cash income.

Our days sales outstanding, or DSO, was 53 days as of June 30, 2019. This compares to 53 days at March 31, 2019, and 51 days at December 31, 2018. Investing activities used $144.7 million of cash in the second quarter.

The use of cash was related to $40.2 million in purchases of property and equipment and $104.5 million of acquisition and investment activity during the quarter. Financing activities provided $29.7 million of cash in the second quarter.

We had net borrowings of $35 million on Select's revolving loans and $12.4 million in net proceeds related to noncontrolling interest in the quarter. We also spent $13.1 million to repurchase approximately 900,000 shares of our common stock as part of our $500 million authorized share repurchase program.

Additionally, in our earnings press release, we reaffirmed our business outlook for calendar year 2019 we provided earlier this year. We expect net revenue to be in the range of $5.2 billion to $5.4 billion. Adjusted EBITDA is expected to be in the range of $660 million to $700 million.

Fully diluted earnings per share is expected to be in the range of $1 to $1.16 and adjusted earnings per share to be in the $0.97 to $1.13, which excludes the nonoperating gain and its related tax effects. This outlook does not include any impact from the recently completed refinancing transactions. This concludes our prepared remarks.

And at this time, we'd like to turn it back to the operator to open up the call for questions..

[Operator Instructions]. Your first question comes from the line of Frank Morgan with RBC Capital Markets..

I was hoping we could start with the guidance of -- obviously, there's -- you're coming in at a seasonally weaker quarter. And I'm just curious if you could give us any general commentary around kind of the contribution in the second half of the year considering third quarter is typically seasonally the weakest.

But also just on the de novos, it looks like -- I think you originally guided at $6 million to $8 million of start-up losses for the year. And it looks like you had over two last quarter a bigger number this quarter. So just wondering how that plays in as well..

Yes. Frank, this is Marty. With regard to the start-up losses, we would anticipate that two of our hospitals will start to have positive gains. We'll actually have positive EBITDA and in particularly the fourth quarter.

So in essence, you can -- when we take a look at the $6 million to $8 million we were talking about, we're taking a look at the full year. So we would anticipate that, as I said, fourth quarter, we should have some positive EBITDA..

Got you. And then....

That will be [indiscernible]..

Got you. So it sounds like it's going to be a much bigger fourth quarter than third quarter.

Is that a fair assessment?.

Well, the fourth quarter is typically much better than the third quarter. Yes..

Okay.

But especially with this dip on the development side?.

That's correct..

Okay. I know you have had some activity in Florida in the past with the CONs.

I'm just curious is this change in Florida of CON loss, is that having any kind of impact on what you do and how you approach Florida? In any case, we have net-net?.

Well, yes. Well, I don't think we can project any financial impact right now. But with the CON going away, Frank, we're looking at all of our Florida assets to determine what their position is in the market and where there's any expansion opportunities or vulnerabilities. But net-net, we think that regulatory changes in Florida will be good for us..

Okay. Maybe one more. I think you mentioned at the very end about your guidance, and I don't think it contemplated the financing.

But when you start thinking about use of proceeds, I know you've got your Welsh Carson as your option next year, but just any high-level commentary about how we should think about this refinancing and how it positions you for use of proceeds?.

Yes. Frank, the expectation is part of the financing we did was really contemplating what was going on with the put with regards to our private equity partners for Concentra. As you know in the first quarter, the first put comes if they so choose to do it. So yes, that is part of the contemplation that we have when we did the refi..

Your next question comes from the line of Peter Costa with Wells Fargo Securities..

A couple of questions for me. The first one is on the -- your IRFs for 2020. You said you expect them to be positive for you.

Do you mean just positive year-over-year? Or do you mean the CMGs are more positive for you than the market pass-through rate increase?.

Yes. We mean positive year-over-year, Pete..

Okay.

So the CMGs, are they -- do you think will be a little bit negative for you but not tremendously negative?.

No. We do not anticipate they'll be negative for us..

Okay. And then the other question I have is on the Concentra business. If you talk to employers, more and more seem to be talking about work sites and things like that. And your mix suggests that you're seeing more use from employers.

Is that an accelerating phenomenon at this point in time that you do in fact see that? And so should we be thinking about the rate pressure that you're seeing from mix continuing? And then will it ultimately result in a faster top line?.

Yes. What we have done is there is -- in our employer services, which really saw an increase in visits has to do with drug testing. And we believe that, that really resulted because we actually charged a little bit less on the drug testing. And there's a lot of price elasticity with that. So in essence, we saw it drop there in our pricing.

We saw it increase. Our expectation ultimately is, Pete, we will see some pull-through from those employers into the workers' comp space. So that was really what was driving that thought process of reducing the price, the drug pricing..

Okay. So that's sort of a separate phenomenon than what I'm talking about.

So are you seeing more work site usage? Are more employers asking work site usage at this point? Or is it really more stable now? It's just the way it's been for a number of years?.

I'd have to say it's stable..

Your next question comes from the line of Kevin Fischbeck with Bank of America..

I wanted to I guess do another question on Concentra. This is the kind of the first quarter that we're seeing kind of a normal comparison here to U.S. HealthWorks in there.

Can you talk a bit about kind of what you expect the revenue growth in this segment to be going forward? And obviously, you get some nice synergies here boosting the margins this quarter.

But what kind of revenue growth do you think you need to kind of maintain margins or improve margins going forward?.

Yes. Kevin, I think you can expect to see on a same-store basis maybe 1% to 2% revenue growth on Concentra. And that is really what we expect to see that basically volume flat or a little bit up and then the balance coming from pricing..

Okay.

And is that kind of enough to maintain margins once you get through all the synergy tailwinds?.

We have said early on we thought the margin would be in the -- early on meaning what? Two years ago. We thought the margins were going to be in the 15% range -- 15% to 16% range. The operators have done a terrific job. This quarter, we're at 18.4%. Probably in that 17% on an annualized basis is probably a good number in total.

Remember the fourth quarter -- the first three quarters are in that ballpark or a little bit higher. The fourth quarter has always been a little bit lower in that 10% to 12% range..

Okay. And can you just remind me how much more in synergies do you still expect from U.S.

HealthWorks? Or are we done with that now?.

Yes. No, we're not done with that. I think you'll see full run rate, probably the $38 million that we talked about by the fourth quarter of this year. And then you'll see the full $38 million come next year..

Okay.

So how close are you to that $38 million now?.

We're pretty close. I mean it's probably maybe $5 million to $6 million away..

Okay. And then just on the critical hospitals, yes, you guys bought some hospitals. It was the first time in a little while that we've seen kind of net adds to this hospital side.

So what will the opportunity there be that you may actually see adding more hospitals as part of the growth story there?.

We do see some possibility for growth. As you know with the full implementation of the criteria, the industry has been kind of resetting itself on the number of hospitals. And as that fully shakes out, we do think that there'll be opportunities for de novo growth in the hospital. It will be rare for us to see acquisitions.

I mean the promised acquisition out of bankruptcy was unexpected but a good deal for us.

But I think that with all the partners that we have throughout the country that may have originated with inpatient rehab and then moving to outpatient rehab, we see some potential opportunities to add critical illness recovery hospitals on a de novo basis in some of those markets.

So I think over the coming years, you will see us get back on the growth of a couple new ones per year..

Your next question comes from the line of A.J. Rice with Crédit Suisse..

When we look at the -- or critical access business or critical care business as well as of the IRFs, it looks like payer mix has dipped down, Medicare dipped down a little bit and others -- other payers are picked up. I think you were -- been running about 53% in patient days in the LTAC business and you're sort of at 50 this quarter.

And I guess the IRFs step down from 54 to 50.

Is that Medicare Advantage? Or is there conversions or is -- what do you see in there that is making those tweaks in payer mix?.

Yes. A.J., it is primarily Medicare Advantage because Medicare Advantage is the payers are commercial. We include that in our commercial. So in essence, what you're basically seeing is patients moving from -- or joining Medicare and Medicare Advantage category..

Okay.

And is that -- are you sort of neutral to that? Or do you -- is there any difference in profitability and payer rates or whatever between those two?.

There used to be, A.J., some differences. But for the most part of -- in particular, on the critical illness recovery hospitals. For the most part, most of the payers are now piggybacking off of traditional Medicare DRG payments. On the inpatient rehab side, it depends on the geography you're located in.

Some locations you're better on -- you've got better profitability on Medicare Advantage, and there are some regions where that's not the case..

Okay. And I don't know if -- I didn't hear you comment in your prepared remarks on what you're seeing on the labor side specifically turnover rates. I don't know what productivity measure or however and wage updates.

Any -- across your different buckets of the types of employees, are you seeing easing versus last year where it was sort of tight? Or are you seeing pressure points elsewhere? Any comments on that?.

Yes. With regards to labor, it's primarily on the nursing side. And we have not seen any relief over the same period last year. I mean it's always -- it's pretty consistent I think with regards to turnover and increases in overall rates..

What would you describe your average rates at?.

It's in that 3% range increase is what we're seeing..

Okay. All right. And then just last for me and sort of a technical one. With the refinancing, it looks like sort of awash on the ongoing interest expense.

But I did wonder is there any redundant cost that we should factor in while you were making the transition in the third quarter with this? Did you have any double carry of interest or anything in a month?.

Yes. There'll be double carry for the -- for a one month period of time. And it will have a slight negative impact on EPS, but it's within the band that we provided..

I was going to say that it's still within the guidance..

That's right..

Your next question comes from the line of Bill Sutherland with The Benchmark Company..

So I was just going to focus a little bit on outpatient rehab because I noticed the net revenue per visit was off here. It just had been very steady for several quarters.

Anything notable about that?.

Yes. It really just -- we were $1 off. Actually, it was $0.67, Bill. And in that respect, that really had the impact of a little bit of compression on the margin..

Okay. And then all my other operational things have been asked. I missed it actually in the JV you announced earlier in the quarter with Alternate Solutions.

Maybe can you just give us a little color on how that's going to work and what the financial impact might look like in the future?.

Yes. We did -- what we have found since we have developed such a -- I think a strong network of joint venture partners and had expanded our post-acute offerings from not only inpatient rehab to outpatient rehab, day rehab and in some cases, our critical illness recovery hospitals.

Some of our partners were requesting that perhaps that we would -- can snap onto the joint venture a home care offering. So our -- we established a partnership with Alternate Solutions. And what our plan is that -- is to bring their expertise to some of our local markets where we'll do joint ventures in the local market.

And what it does for us is it doesn't require us to have a nationwide home care platform. But we have the expertise and experienced operator that can bring it to our local joint ventures where we need the service that's being requested by our partners..

Are you going to be somewhat integrated in terms of systems being able to pass through the requisitions? Or are how you're going to handle it?.

Well, the systems for home care are rep cycle, and a lot of the other ones are different. So we would not be -- but it is the anticipation that the services will be integrated in the market. I can't tell you that the systems platforms will be integrated.

But the services will be integrated through the local market with the other post-acute services that the joint venture provides..

And then how do you reflect -- I mean how does this get reflected in your financial statements, Bob?.

It will be a nonconsolidating entity, so below the line, Bill..

Okay. It will? All right..

Yes..

And actually one follow-up on Concentra. Marty, you referred to same-store outlook feeling like it was 1% to 2%.

Would there be expansion, either employer or clinic on top of that, do you think?.

Yes, there absolutely would be. We continue to make acquisitions on 1 or 2 centers. And as you know, we're opportunistic when we do that. So -- very attractive prices. But yes, we anticipate there will be some of that..

At this time, I'm showing no further questions. I'd like to turn it back over to management for closing remarks..

No closing remarks. Thanks for joining us. We look forward to updating you next quarter..

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Good day..