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

Speaking today are the company's Executive Chairman and Co-Founder, Robert Ortenzio; and the company's Executive Vice President and Chief Financial Officer, Martin Jackson. Management will give you an overview of the quarter and then 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 the 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 the time, I will turn the conference call over to Mr. Robert Ortenzio..

Thank you, Operator. Good morning, everyone, and thanks for joining us for Select Medical's Third Quarter Earnings Conference Call for 2019. Let me start out by saying Q3 was a very good quarter for us with 3 of our 4 business segments exceeding prior year adjusted EBITDA by double-digit growth, and our fourth business segment grew EBITDA by over 7%.

We experienced nice growth in terms of patient admissions in our specialty hospital business with critical illness recovery hospitals growing at almost 5% and inpatient rehabilitation hospitals growing at over 19%. Our outpatient rehabilitation clinic visits grew by more than 8% and Concentra visits grew by over 5%.

We also saw nice growth in our pricing. We completed two significant refinancing transactions during the quarter both at Select and Concentra, which Marty will provide some color in his remarks. We also opened a new nonconsolidating joint venture rehabilitation hospital in the quarter, affiliated with several partners in New Orleans, Louisiana.

Overall, our net revenue for the third quarter increased 9.9% to $1.39 billion in the quarter compared to $1.27 billion last year. Net revenue in our critical illness recovery hospital segment in the third quarter increased 10.2% to $463 million compared to $420 million in the same quarter last year.

The increase is attributable to both an increase in patient volumes and revenue per patient day. Patient days increased 5.8% compared to the same quarter last year, with 258,000 patient days in the third quarter.

Occupancy in our critical illness recovery hospital segment was 67% in the third quarter this year compared to 65% in the same quarter last year. Net revenue per patient day increased 4% to $1,773 per patient day in the third quarter compared to $1,705 per patient day in the same quarter last year.

Net revenue in our rehabilitation hospital segment in the third quarter increased 19.9% to $173 million compared to $145 million in the same quarter last year. Patient days increased 12.9% to over 89,000 days compared to 79,000 days in the same quarter last year.

The increase in patient days was related to new hospitals that recently opened as well as a 4% increase in our existing hospitals. Net revenue per patient day increased 9% to $1,724 per day in the third quarter compared to $1,582 per day in the same quarter last year.

Net revenue in our outpatient rehab segment in the third quarter increased 8.2% to $265 million compared to $245 million in the same quarter last year. Patient visits increased 8.1% to 2.2 million visits in the quarter compared to 2 million visits in the same quarter last year.

Net revenue per visit was $103 in both the third quarter of this year and last year. Net revenue in our Concentra segment increased 4.3% to $422 million in the third quarter compared to $404 million in the same quarter last year.

For the third quarter, revenue from our centers was $381 million and the balance of approximately $41 million was generated from on-site clinics, community-based outpatient clinics and other services.

For the centers, patient visits increased 5.6% to over 3.1 million visits compared to a little less than 3 million visits in the same quarter last year. Our net revenue per visit was $120 in the third quarter compared to $124 per visit in the same quarter last year.

The decline in net revenue per visit was primarily due to a higher mix of employer service visits, including drug screens, which yield lower per-visit rates. Total company adjusted EBITDA for the third quarter increased 6.6% to $182.7 million compared to $156.6 million in the same quarter last year.

Our consolidated EBITDA margin was 13.1% in the third quarter compared to 12.4% in the same quarter last year. In our critical Illness recovery hospital segment, adjusted EBITDA increased 7.4% to $57.2 million in the third quarter compared to $53.3 million in the same quarter last year.

Adjusted EBITDA margin for the segment was 12.4% in the third quarter compared to 12.7% in the same quarter last year. The decline in adjusted EBITDA margin is related to our newly acquired hospitals operating at lower margins than our existing hospitals.

Our rehabilitation hospital segment adjusted EBITDA increased 45.1% to $36.8 million in the third quarter compared to $25.3 million in the same quarter last year. Adjusted EBITDA margin for the rehabilitation hospital segment was 21.2% in the third quarter compared to 17.5% in the same quarter last year.

The increase in adjusted EBITDA and margin was primarily attributable to an increase in volume at our existing hospitals. Outpatient rehab adjusted EBITDA increased 16% to $40 million in the third quarter compared to $34.5 million in the same quarter last year.

Adjusted EBITDA margin for the outpatient segment was 15.1% in the third quarter compared to 14.1% in the same quarter last year. Adjusted EBITDA margin in the quarter increased as a result of increased volumes as well as other cost reduction initiatives implemented in the quarter.

Concentra adjusted EBITDA increased 13% to $17.7 million for the third quarter compared to $68.8 million in the same quarter last year. Adjusted EBITDA margin was 18.4% in the third quarter compared to 17% in the same quarter last year.

The increase in adjusted EBITDA margin was primarily the result of us achieving operating cost synergies across our combined Concentra and U.S. HealthWorks business. Earnings per fully diluted share was $0.23 for the third quarter compared to $0.24 in the same quarter last year.

Adjusted earnings per fully diluted share, which excludes the loss on early retirement of debt and related costs and their tax was $0.33 in the third quarter. During the third quarter last year, adjusted earnings per fully diluted share, excluding gain on sale of businesses-related tax effects was $0.23.

At this point, I'll turn the call over to Marty Jackson for some additional financial details before we open the call for questions..

$1.53 billion in Select term loans, $550 million in Select 6.25% senior notes, $1.24 billion in Concentra first lien term loans, $45 million in unamortized discounts premiums and debt issuance costs that reduced the overall balance sheet debt liability and we had $76 million of other miscellaneous debt.

Operating activities provided $133.7 million of cash flow in the third quarter. The provision of operating cash flow for the quarter is primarily driven by cash income and an increase in accrued expenses. Our days sales outstanding, or DSO, was 53 days at September 30, 2019. This compares to 53 days at June 30, 2019, and 51 days at December 31, 2018.

Investing activities used $43.2 million of cash in the third quarter. The use of cash was related to $34.7 million in the purchases of property and equipment and $8.5 million of net acquisition and investment activities during the quarter. Financing activities used $78.6 million of cash in the third quarter.

We had net term loan and senior note borrowings of $180.5 million. This is offset by $195 million in repayments on the revolving loans related to the refinancing activities we just talked about. We also had $27.3 million reduction in bank over debt as excess cash balances offset outstanding checks.

In addition, we used $23.7 million to repurchase stock during the quarter, net payments of other debt of $4.9 million and $8.3 million in net distributions to noncontrolling interest in the quarter.

We purchased 1.26 million shares under the company's authorized repurchase program at an average price of $15.87, which includes transaction costs during the third quarter. Additionally, in our earnings press release, we updated our business outlook for the calendar year 2019.

We now expect net revenue to be in the range of $5.375 billion to $5.425 billion, adjusted EBITDA to be in the range of $685 million to $700 million, fully diluted earnings per share to be in the range of $1 to $1.06 and adjusted earnings per share of $1.07 to $1.13, which excludes the loss on early retirement of debt and its related costs and the gain on sale of businesses and the related tax effects.

This concludes our prepared remarks. And at this time, we'd like to open up the call. So operator, if you can please do so..

[Operator Instructions]. Our first question comes from Frank Morgan with RBC Capital Markets..

I wanted to talk a little bit about the strong rate growth across the segments. I know on the LTAC side, I believe there's probably a decline in some of the [indiscernible] days that you've had in the past.

But just any other thing that you can call out about the rate growth there, any kind of change in mix or acuity that might have driven that? And then the same thing on the rehab hospital side, IRF rates up really strong there.

Any color around that? And we've heard others talk about the growth in Medicare Advantage in their overall business mix in the IRF business, so are you seeing that? And how do those rates compare? We've been hearing that the -- that those case rates -- the discounts to fee-for-service have been declining, but just any color on that as well?.

Yes. Frank, the pricing on the LTAC side, we saw a bump up in -- on the Medicaid side. We saw a decent increase in rates there. So that was predominantly one of the items. Actually, that was predominantly the reason why we saw the rate increases there. On the -- the next question you had, I think, was on the....

On the IRF side, strong rate growth there..

Yes. I think a good portion of that has to do, in particular, with California rehab. We see some very nice increase rates there. And that's one of the predominant drivers for that increase.

And as we see more of our new start-ups coming on board, that increase will probably mitigate because we're not going to see the same type of rates increase like we do in the California hospitals..

Got you.

And maybe on that point, if you would just kind of remind us of the rollout maybe over the next year, which quarters you have additional development coming online? And then back to that one of the earlier questions that you didn't catch was the -- how much growth are you seeing in Medicare Advantage in the rehab hospital business? Is that a -- how big a part of the mix is that and how do those rates compare? And are you paying day rates or case rates? And how does that compare fee-for-service?.

Sure. Let me answer the -- your last question first, and that is Medicare Advantage. We are seeing Medicare Advantage increase across the specialty hospital -- across both LTACs and outpatient rehab hospitals. And how does that compare? Most of the Medicare Advantage rates piggyback off of traditional Medicare. So we're not seeing case rates.

We're not seeing per diems. It's basically -- it's predominantly, as I said, just doing the same reimbursement that we see on traditional Medicare..

And I think, Frank, the other thing about that is Medicare Advantage, obviously, unlike Medicare fee-for-service is going to have some variation geographically around the country. We have -- those rates are not standard, and so we'll see different things in different parts of the country with different hospitals..

And our next question comes from Peter Costa with Wells Fargo..

Congratulations on the quarter. Nice job, guys. My question is more on the balance sheet and interest expense. Marty, you've been kind of busy on the balance sheet there.

Can you tell us, where do you think interest expense is going to settle out for the rest of the year? And then can you talk about the puts and the timing on when that's going to happen if that's going to happen?.

Sure, Pete. As far as -- let me take a look at the -- or let me provide you with information on what we would anticipate on an apples-to-apples comparison. The refi that occurred at Concentra will have a significant impact on an overall basis just because the elimination of that second lien.

That annual interest on a -- number on a pretax basis should be somewhere in the $15 million to $16 million range. What we've seen is on the Select refinancing, we've basically took out the 6 3/8% notes, put in place $550 million of 6 1/4% so there's not that much of a difference there.

There was another, I think, close to $200 million that was -- that went to our first lien so there's a little bit of a spread there. But we added additional -- or a nominal dollar amount, taking into consideration the put payments that we had coming up in first, second quarter of 2020.

So there's really not that much of a savings on the Select refinancing..

Okay.

And then in the quarter itself, you had the $3.6 million of just transitional costs, so that's gone, right?.

That's correct. Yes, that's right. If you take a look at -- I think the overall tax -- the nominal tax amount was about $54 million, and that should probably adjust somewhere in that $50 million, $51 million range..

Okay.

And then the puts will occur in the second quarter of next year if they occur?.

Yes. Based on the contract, it's -- the first put can start -- the mechanism that we have is basically on the second year anniversary of the U.S. HealthWorks transaction. Our joint venture partners can request evaluation to be done. And we anticipate that could take a couple of months to do that, and so it would probably be in the second quarter..

Okay. And then the last question. The drug screenings continued this quarter. I know there was some thought that those would lead to more business down the road.

Have you seen any of that happen so far in terms of the first drug screenings that you started to do?.

We have seen some additional pull-through of worker comp business because the employers have now come back to us with the drug screens. So the answer to that is, yes..

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

Actually, this is Joanna Gajuk filling in for Kevin today. So first question on your guidance, which now implies revenue actually will decline of about 5% quarter-over-quarter and EBITDA will be down almost $29 million or so sequentially.

I know that in the past, seasonality was such that the EBITDA was down sequentially in Q4 from Q3, but this year this guidance implies a more dramatic decline. So I just want to clarify, I mean, what's driving that..

Yes. You're -- Joanna, you're going to have to walk us through those numbers again because, I mean, the -- we don't see.

Could you say that again?.

So yes. The annual guidance for revenues, right, is for $5.4 billion and year-to-date, it's $4 billion. So it implies $1.3 billion for fourth quarter so sequentially, it's a decline -- a 5% decline Q4 from Q3. And I'm doing similar math on the adjusted EBITDA versus your midpoint of, call it, $693 million annual and year-to-date it's $539 million.

So that implies, call it, $154 million so midpoint for Q4, so that's down from $183 million at Q3..

It's actually going up, Joanna..

Okay. So I guess, maybe using the incorrect year-to-date. So what's the year-to-date EBITDA..

Year-over-year income..

Yes. I mean, what you've got to do is you've got to compare Q4 of '18 to Q4 of '19 and in both situations, it's going up..

Right. But I'm just looking at sequentially from Q3 of this year to Q4..

Yes. Joanne, we don't take a look at the business sequentially. Everyone knows that Concentra's business is down in Q4..

In seasonality?.

Yes..

Okay, right. So I just want to clarify that. Okay, good. And then I guess, also in terms of Q4, what does the guidance assume for the in-patient rehab final regulation implications for that business? Did the revisions to the case mix -- previously, you said it would be positive.

So is there a way to quantify this?.

There is not, no. We basically said that the impact is neutral to a little bit positive. And so I think what you would assume that it's pretty much the same..

Okay. And then the last question, so margins were pretty good in all the segments, I guess, [indiscernible] impacted somehow by the new hospitals.

So are you -- are these margins, I guess, that we saw this quarter for this segment, are these a good run rate? It seems like they were doing pretty good at the IRF segment and outpatient and also Concentra.

So are these revenue good numbers? I mean, I guess there's some seasonality quarter-to-quarter, but any upside you're seeing into these margins you reported this quarter?.

No. I think if you go through each of our business segments, the LTAC margins were down a little bit. But as we mentioned on the call, that's predominantly because the new hospitals that we brought on board or the acquired hospitals that we brought on board, and their margins are single digits this time.

They'll grow into our margins, but those margins should be up. For inpatient rehab, inpatient rehab was up nicely, where it's over that 21% range. But you're going to see fluctuations in the inpatient rehab as we continue to add new hospitals on board. So I would think you could expect to see 19% to 20% margins.

On the outpatient at 15%, I think that's probably a pretty good rate. And then on Concentra rates, I think Concentra rates are on an annualized basis in that 17% range..

And our next question comes from Justin Bowers with Deutsche Bank..

A nice broad-based performance this quarter. So just going -- looking at a few of the segments. On the LTAC side, it looks like you guys added another hospital in the quarter.

And I'm just trying to get a sense of what the -- kind of like what the underlying growth was versus the contribution from the new ads, either on a volume or admission basis?.

Yes. Justin, we did add another hospital. That is a nonconsolidating hospital. So that will not come through the P&L, just under the equity line.

So that should answer your first question, right? And then the second one, what we've seen was a very nice increase on the inpatient rehab due to the new hospitals and the volume that was generated there, in particular, Shands and Dignity at Las Vegas..

Okay. Got it. And then just in terms of looking ahead, what are we thinking about in terms of the pace of just start-up losses? Is it going to be similar to kind of what we saw in 2018? Or are we looking at something a little more moderate in....

Yes. With regards to the startup losses, the next time we're going to see start-up losses, we'll probably see some start just a little bit in Q2.

And then in Q3 and Q4, we'll see some more, and not that's due to two banner hospitals coming on, okay?.

Yes. And then just in terms of the new hospitals and critical illness. What are we thinking in terms of the ramp to get those back up to the core margins.

Is that a 1 year, is that a two year kind of trajectory? Or how are you guys thinking about that?.

Yes. How we're thinking about it is, we would expect to see improvements in the two to three quarters..

Okay. Okay. And then just any thoughts on just outpatient rehab. Is there some seasonality to that as well? Or something like funky with the high deductible plans? I mean it was just -- the volume was impressive there..

Yes. There is seasonality with that business. And typically, it's down in the third quarter. So in the third and the fourth quarters, you typically see that volume down, but the operators did a terrific job. So it -- the margin was terrific. And we've talked to the operators, and they said they think that can continue..

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

I know you had good results across the board. Some of the companies have talked about how they did get a little bit of help from that extra business day.

Have you sort of sized how much of that was a factor in these volume numbers and performance?.

Yes. A.J., It was about $1.5 million to $2 million..

Okay.

That's across the entire company, pretty much?.

That's correct. Yes..

All right. And you mentioned that U.S. HealthWorks synergies was helpful.

Any update on exactly how much of that you've realized at this point? And do you have -- is there still more to come on that? Or are we at a sort of a run rate at this point?.

Through the third quarter, we've achieved most of the synergies. We think there's probably an additional $3 million to $4 million over the next quarter or 2..

Okay.

And when you think about the raise, $100 million in revenue guidance, about $12.5 million on EBITDA, is that mainly reflecting the outperformance in relative to your internal forecast on Q3 or maybe you made any adjustment to your Q4 assumption in that updated guidance?.

It's basically taken into consideration what occurred in Q3..

And our next question comes from Frank Morgan with RBC Capital Markets..

My follow-up question was actually asked, but I will center back. On California Research Institute, obviously, a big source of the rate growth there. But just maybe a little more color, like how much upside do you see left there? Where are the occupancies today? I know that's been a big project and has lots of capacity.

But maybe how much upside do you see left in that one?.

Well, there's some upside, Frank. The hospital is running very high occupancy. So our -- we will be very shortly, capacity constrained. So -- and then -- but I think there's other opportunities out there, and perhaps we can begin to develop some outpatient.

You know all the results from the inpatient of California Rehab Institute has really been the inpatient with modest amounts of outpatients.

So I would say, we have a little bit of incremental opportunity on inpatient census, and then we'll begin to look to use the market share that we've gained to, as we've done in other markets to, expand and snap-on, hopefully, some other services..

And I'm not showing any further questions at this time. I would now like to turn the call back to Mr. Ortenzio for any further remarks..

No further comments. Thanks, everybody, for joining us, and we'll look forward to updating you again next quarter..

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may all disconnect..