Select Medical(SEM) - 2023 Q4 - Annual Report

PART I Business Select Medical Holdings Corporation is a major US operator of specialized post-acute care facilities across four key segments - As of December 31, 2023, the company operated 107 critical illness recovery hospitals, 33 rehabilitation hospitals, 1,933 outpatient rehabilitation clinics, and 544 occupational health centers across 46 states and the District of Columbia[20] - On January 3, 2024, the company announced its intention to separate the Concentra business into a new, publicly traded company by the end of fiscal year 2024[68][332] 2023 Revenue by Business Segment | Segment | Revenue Percentage | | :--- | :--- | | Critical Illness Recovery Hospital | ~35% | | Rehabilitation Hospital | ~15% | | Outpatient Rehabilitation | ~18% | | Concentra | ~28% | Business Segments The company's operations are managed through four distinct segments: Critical Illness Recovery, Rehabilitation, Outpatient Rehabilitation, and Concentra - The Critical Illness Recovery Hospital segment primarily serves highly acute patients, with an average length of stay of 31 days in 2023[24][25] - The Rehabilitation Hospital segment serves patients with conditions like brain/spinal cord injuries and strokes, with an average length of stay of 14 days in 2023[39] - The Outpatient Rehabilitation segment derives approximately 82% of its revenue from commercial payors, including workers' compensation programs[56] - The Concentra segment is the largest provider of occupational health services in the U.S, with approximately 60% of its 2023 revenue from workers' compensation payers[64][67] Facility Count by Segment (as of Dec 31, 2023) | Segment | Number of Facilities | States of Operation | | :--- | :--- | :--- | | Critical Illness Recovery Hospitals | 107 | 28 | | Rehabilitation Hospitals | 33 | 13 | | Outpatient Rehabilitation Clinics | 1,933 | 39 + D.C. | | Concentra Occupational Health Centers | 544 | 41 | Competitive Strengths and Strategy The company's strategy centers on specialized care, cost control through centralization, and growth via acquisitions and joint ventures - Key strategies include focusing on specialized inpatient services, providing high-quality care, controlling operating costs through centralization, increasing commercial patient volume, and pursuing opportunistic acquisitions and joint ventures[31][45][58][69] - The company leverages its significant scale to centralize administrative functions like accounting, finance, payroll, legal, and HR, which improves efficiency[37][50][78] - A core strategy for the rehabilitation hospital segment is pursuing joint ventures with large healthcare systems, where Select Medical typically serves as the manager[52] Sources of Revenue The company's revenue is derived from a diverse mix of payors, led by commercial insurance, Medicare, and workers' compensation Revenue by Payor Source (2021-2023) | Payor Source | 2021 | 2022 | 2023 | | :--- | :--- | :--- | :--- | | Medicare | 22.9% | 22.9% | 22.3% | | Commercial insurance | 36.2% | 36.0% | 36.1% | | Workers' Compensation | 19.0% | 19.6% | 20.0% | | Private and other | 20.4% | 19.8% | 19.4% | | Medicaid | 1.5% | 1.7% | 2.2% | Human Capital Management The company focuses on talent acquisition, employee development, diversity, and wellness for its large, predominantly non-union workforce - The company employed approximately 54,600 people as of December 31, 2023, including about 38,400 full-time and 16,200 part-time/per-diem employees[87] - The company focuses on talent acquisition through employee referral programs, sign-on bonuses, and partnerships with nursing and therapy schools[92] - A diversity task force is established to oversee affirmative action planning and provide strategic recommendations for a diverse and inclusive workplace[96] - The company has implemented an Employee Assistance Program (EAP) for mental health services and formed a task force to address workplace violence[99][100] Government Regulations The company operates in a heavily regulated healthcare industry, subject to complex laws governing licensure, reimbursement, and fraud - The healthcare industry is subject to complex laws at federal, state, and local levels, covering areas like facility licensure, reimbursement standards, fraud and abuse, and health information privacy (HIPAA)[107] - The Stark Law prohibits physician self-referrals for designated health services to entities where they have a financial relationship, unless an exception applies[166][171] - The federal anti-kickback statute prohibits offering or receiving remuneration to induce patient referrals covered by federal healthcare programs[170] - Hospitals are required to provide clear and accessible pricing information online for items and services, including machine-readable files and consumer-friendly displays[184] Executive Officers of the Registrant The company is led by an experienced executive team, including its co-founders and long-tenured officers in the healthcare industry Key Executive Officers (as of Feb 22, 2024) | Name | Age | Position | | :--- | :--- | :--- | | Robert A. Ortenzio | 66 | Executive Chairman and Co-Founder | | Rocco A. Ortenzio | 91 | Vice Chairman and Co-Founder | | David S. Chernow | 66 | Chief Executive Officer | | Martin F. Jackson | 69 | Senior Executive Vice President, Strategic Finance and Operations | | Michael F. Malatesta | 54 | Executive Vice President and Chief Financial Officer | Risk Factors The company faces significant risks from Medicare reimbursement changes, labor costs, regulatory shifts, and its substantial indebtedness - Changes in Medicare reimbursement rates could significantly reduce revenue, as Medicare accounted for approximately 22% of revenue in 2023[216] - The company faces risks from labor shortages, increased employee turnover, and rising labor costs, which could decrease profitability[222] - A significant risk for LTCHs is the large increase in the high cost outlier fixed-loss amount for FY 2024, which could reduce Medicare payments[235] - The company's substantial indebtedness of approximately $3.66 billion requires dedicating significant cash flow to debt service, limiting funds for other purposes[292] - Credit facilities and bond indentures contain restrictive covenants, including a leverage ratio requirement, which if breached could result in default[293][294] Cybersecurity A comprehensive cybersecurity program, based on the NIST framework, is overseen by the Board and managed by an experienced team - The company's cybersecurity program is based on the National Institute of Standards and Technology (NIST) Cybersecurity Framework[304] - The Board of Directors provides oversight, receiving annual written reports and quarterly briefings on the cybersecurity program from the CIO and CISO[305] - Management, including a CIO and CISO with over 20 years of experience each, is responsible for assessing and managing cybersecurity risks[306] - The company has not experienced a material cybersecurity breach in the past three fiscal years but acknowledges future incidents are possible[308] Properties The company leases the majority of its facilities, including its corporate headquarters, while owning a small number of its hospitals and centers - The company leases the majority of its facilities, owning 21 of its 107 critical illness recovery hospitals and 9 of its 33 rehabilitation hospitals[310] Total Facilities by State (Top 5) | State | Total Facilities | | :--- | :--- | | Pennsylvania | 267 | | Texas | 213 | | California | 203 | | New Jersey | 201 | | Florida | 172 | Legal Proceedings The company is involved in various legal actions and governmental investigations arising in the ordinary course of business - The company is a party to various legal actions and governmental investigations in the ordinary course of business, with details in Note 20 of the financial statements[315] PART II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's stock trades on the NYSE, and it maintains a regular quarterly dividend and a significant stock repurchase program - The company's common stock is traded on the New York Stock Exchange under the symbol "SEM"[318] - The Board of Directors has authorized a stock repurchase program of up to $1.0 billion, effective until December 31, 2025, with $399.7 million remaining available[323][325] 2023 Quarterly Dividends | Declaration Date | Payment Date | Dividend Per Share | | :--- | :--- | :--- | | February 16, 2023 | March 15, 2023 | $0.125 | | May 3, 2023 | May 31, 2023 | $0.125 | | August 2, 2023 | September 1, 2023 | $0.125 | | November 2, 2023 | November 28, 2023 | $0.125 | Management's Discussion and Analysis of Financial Condition and Results of Operations In 2023, revenue and operating income grew significantly, driven by reduced contract labor costs and strong performance in the hospital segment - The significant improvement in 2023 financial performance was primarily due to decreased contract labor costs and increased revenue in the critical illness recovery hospital segment[385] - Cash flows from operating activities increased to $582.1 million in 2023 from $284.8 million in 2022, driven by higher operating income and changes in working capital[405] Financial Performance Summary (2022 vs. 2023) | Metric | 2022 | 2023 | % Change | | :--- | :--- | :--- | :--- | | Revenue | $6,333.5M | $6,664.1M | +5.2% | | Income from Operations | $403.3M | $554.9M | +37.6% | | Net Income | $198.0M | $299.7M | +51.4% | | Adjusted EBITDA | $646.9M | $807.4M | +24.8% | Results of Operations (2023 vs 2022) All segments reported revenue and Adjusted EBITDA growth, with the Critical Illness segment showing a dramatic surge in profitability - The Critical Illness Recovery Hospital segment's total contract labor costs decreased by approximately 62% in 2023 compared to 2022[392] - Interest expense increased to $198.6 million in 2023 from $169.1 million in 2022 due to higher average borrowings and rising variable interest rates[400] Segment Revenue and Adjusted EBITDA Growth (2023 vs 2022) | Segment | Revenue Growth | Adjusted EBITDA Growth | | :--- | :--- | :--- | | Critical Illness Recovery Hospital | 2.9% | 121.0% | | Rehabilitation Hospital | 6.9% | 12.0% | | Outpatient Rehabilitation | 5.7% | 9.8% | | Concentra | 6.6% | 8.1% | Liquidity and Capital Resources The company maintains sufficient liquidity through cash flows and borrowing capacity to meet its debt, lease, and capital expenditure needs - The company's leverage ratio was 4.54 to 1.00 as of December 31, 2023, compliant with the credit agreement covenant of less than 7.00 to 1.00[416] - A mandatory prepayment of $79.1 million based on 50% of excess cash flow for 2023 is required and expected to be paid in Q1 2024[593] Liquidity Position (as of Dec 31, 2023) | Item | Amount (in millions) | | :--- | :--- | | Cash and cash equivalents | $84.0 | | Availability under revolving facility | $434.2 | | Total Indebtedness | $3,658.0 | Quantitative and Qualitative Disclosures About Market Risk The company's primary market risk is interest rate exposure from its variable-rate debt, which is partially mitigated by an interest rate cap - The company is exposed to interest rate risk from its variable-rate debt, which includes a $2.09 billion term loan and $280.0 million of revolving borrowings as of year-end 2023[429][430] - An interest rate cap agreement mitigates risk by limiting the Term SOFR rate to 1.0% on $2.0 billion of term loan principal through September 30, 2024[431] - A 0.25% change in market interest rates would affect annual interest expense by approximately $2.2 million, factoring in the expiration of the interest rate cap[432] Controls and Procedures Management concluded that the company's disclosure controls and internal control over financial reporting were effective as of year-end 2023 - The principal executive and financial officers concluded that the company's disclosure controls and procedures were effective as of December 31, 2023[435] - No material changes were identified in the company's internal control over financial reporting during the fourth quarter of 2023[436] - Management's assessment concluded that internal control over financial reporting was effective as of December 31, 2023, based on the COSO framework[441] PART III This section incorporates information by reference from the company's 2024 definitive proxy statement regarding directors, compensation, and governance PART IV This section contains the audited consolidated financial statements, notes, schedules, and a list of all exhibits filed with the report Exhibits and Financial Statement Schedules This section provides an index to the audited financial statements and lists all exhibits filed as part of the 10-K report - This section contains the Index to Financial Statements and a list of all exhibits filed with the Form 10-K[455] - The independent registered public accounting firm, PricewaterhouseCoopers LLP, issued an unqualified opinion on the financial statements and internal controls[474] - A critical audit matter identified by the auditor was the valuation of patient accounts receivable, due to significant management judgment involved[480][482] Notes to Consolidated Financial Statements The notes provide detailed disclosures on accounting policies, segment results, debt, legal contingencies, and the impact of the CARES Act - As of December 31, 2023, total goodwill was $3.51 billion, with the largest amounts allocated to the Critical Illness Recovery Hospital and Concentra units[570] - Total long-term debt as of December 31, 2023, was $3.66 billion, consisting primarily of senior notes and credit facilities[583] - The company is involved in several government investigations, including matters related to billing at its Oklahoma City hospital and physical therapy services[645][646][647] - All Medicare advance payments received under the CARES Act have been fully recouped by CMS as of year-end 2023[653][654]