10-Q: Select Medical Reports Mixed Q2 Results Amid Segment Shifts and Regulatory Headwinds

Select Medical Holdings Corporation reported increased revenue and income from continuing operations for the second quarter and first half of 2025, driven by strong performance in its Rehabilitation and Outpatient segments, despite a decline in its Critical Illness Recovery Hospital segment and ongoing legal and regulatory uncertainties.

Summary

• Revenue for the three months ended June 30, 2025, increased by 4.5% to $1,339.6 million, up from $1,281.7 million in the prior year period.
• Income from continuing operations, net of tax, for the three months ended June 30, 2025, rose to $57.9 million, a 53.8% increase from $37.6 million in the same period last year.
• Earnings per common share from continuing operations for the three months ended June 30, 2025, were $0.32, compared to $0.17 in the prior year.
• Adjusted EBITDA for the three months ended June 30, 2025, was $125.4 million, a slight increase of 0.5% from $124.7 million in the comparable period.
• For the six months ended June 30, 2025, revenue increased by 3.4% to $2,692.8 million, up from $2,603.0 million.
• Income from continuing operations, net of tax, for the six months ended June 30, 2025, was $132.6 million, a 33.7% increase from $99.2 million in the prior year period.
• Earnings per common share from continuing operations for the six months ended June 30, 2025, were $0.76, up from $0.50 in the prior year.
• Adjusted EBITDA for the six months ended June 30, 2025, decreased by 4.7% to $276.9 million, from $290.5 million in the prior year period.
• The Critical Illness Recovery Hospital segment's revenue decreased by 0.6% for the quarter and 1.8% for the six months, with Adjusted EBITDA declining by 21.6% and 23.9% respectively, primarily due to lower Medicare rates and increased labor expenses.
• The Rehabilitation Hospital segment's revenue increased by 17.2% for the quarter and 16.4% for the six months, with Adjusted EBITDA increasing by 14.7% for both periods, driven by higher patient days and revenue per patient day.
• The Outpatient Rehabilitation segment's revenue increased by 3.8% for the quarter and 2.6% for the six months, with Adjusted EBITDA increasing by 6.1% and 2.0% respectively, attributed to higher patient visits.
• Cash provided by operating activities for the six months ended June 30, 2025, was $106.8 million, a decrease from $211.5 million in the prior year, largely due to the spin-off of Concentra.
• Repurchased 6,375,512 shares of common stock for approximately $96.5 million during the six months ended June 30, 2025, under the $1.0 billion stock repurchase program, with $303.2 million remaining as of June 30, 2025.
• A cash dividend of $0.0625 per share was declared on July 30, 2025, payable on or about August 28, 2025.

Sentiment

Score: 6

Explanation: The sentiment is moderately positive. While the company's overall net income decreased due to the Concentra spin-off, the performance of its continuing operations, particularly the Rehabilitation and Outpatient segments, showed strong growth in revenue and profitability. The significant stock repurchase program is a positive signal for shareholders. However, the decline in the Critical Illness Recovery Hospital segment and the substantial future regulatory uncertainties introduced by the OBBBA, coupled with ongoing legal proceedings, temper the overall positive outlook.

Positives

• Income from continuing operations, net of tax, significantly increased by 53.8% for the quarter and 33.7% for the six months ended June 30, 2025, demonstrating improved profitability in core operations.
• Earnings per common share from continuing operations rose substantially to $0.32 for the quarter and $0.76 for the six months, indicating stronger per-share profitability from ongoing businesses.
• The Rehabilitation Hospital segment showed robust growth, with revenue increasing by 17.2% for the quarter and 16.4% for the six months, and Adjusted EBITDA up 14.7% for both periods.
• The Outpatient Rehabilitation segment also contributed positively, with revenue increasing by 3.8% for the quarter and 2.6% for the six months, and Adjusted EBITDA up 6.1% and 2.0% respectively.
• General and administrative expenses decreased significantly, primarily due to lower stock compensation expense and reduced accrued bonuses.
• The effective income tax rate from continuing operations decreased to 17.5% for the quarter and 20.3% for the six months, down from 32.6% and 31.2% respectively, due to lower permanent differences and state/local taxes.
• Equity in earnings of unconsolidated subsidiaries increased to $13.6 million for the quarter and $26.1 million for the six months, reflecting improved performance of minority-owned rehabilitation businesses.
• Interest expense decreased for the six-month period to $59.1 million from $68.7 million, primarily due to a reduction in total debt.
• A new interest rate cap effective March 31, 2025, limits Term SOFR to 4.5% on $1.0 billion of principal outstanding under the term loan until March 31, 2028, mitigating interest rate risk.
• The company actively repurchased 6,375,512 shares for $96.5 million during the first half of 2025, demonstrating a commitment to returning capital to shareholders, with $303.2 million remaining in the program.

Negatives

• The Critical Illness Recovery Hospital segment experienced a revenue decline of 0.6% for the quarter and 1.8% for the six months, and a significant Adjusted EBITDA decrease of 21.6% for the quarter and 23.9% for the six months.
• The decline in the Critical Illness Recovery Hospital segment's performance was attributed to a decrease in Medicare rates due to an increase in the high cost outlier threshold and the implementation of the 20% transmittal rule, along with increased labor expenses.
• Overall Adjusted EBITDA for the six months ended June 30, 2025, decreased by 4.7% compared to the prior year period.
• Cash flows provided by operating activities decreased by $104.6 million for the six months ended June 30, 2025, compared to the prior year, primarily due to the spin-off of Concentra.
• Days sales outstanding increased to 62 days at June 30, 2025, from 58 days at December 31, 2024, indicating slower collection of accounts receivable.
• Total net income attributable to Select Medical Holdings Corporation decreased significantly for both the three-month ($40.6 million vs. $77.6 million) and six-month ($97.3 million vs. $174.5 million) periods, largely due to the Concentra spin-off.

Risks

• Changes in government reimbursement policies, such as those for Medicare and Medicaid, could reduce revenue, increase costs, and decrease profitability.
• Adverse economic conditions, including an inflationary environment, may continue to cause increases in labor and other operating costs, negatively impacting business, operating results, cash flows, and financial condition.
• Shortages of qualified nurses, therapists, physicians, or other licensed healthcare professionals could limit the ability to staff facilities, increase dependence on contract labor, and significantly raise operating costs.
• The failure of Medicare-certified long-term care hospitals or inpatient rehabilitation facilities to maintain their Medicare certifications could lead to a decline in revenue and profitability.
• Government investigations or assertions of regulatory violations may result in sanctions, reputational harm, and increased costs.
• Acquisitions or joint ventures may prove difficult or unsuccessful, consume significant resources, or expose the company to unforeseen liabilities.
• Private third-party payors may adopt payment policies that limit future revenue and profitability.
• The loss of key members of the management team could significantly disrupt operations.
• Claims asserted against the company, including professional malpractice and general liability claims, could result in substantial uninsured liabilities.
• Security breaches of information technology systems, or those of third-party vendors, may lead to legal and reputational harm and potential violations of HIPAA or HITECH.
• The One Big Beautiful Bill Act (OBBBA), signed July 4, 2025, is estimated to reduce federal Medicaid and CHIP funding by approximately $1 trillion over the next 10 years starting in 2027, potentially leading to state-level Medicaid reforms, provider tax adjustments, reimbursement cuts, and elimination of optional services or patient populations.
• The change in LTCH outlier reconciliation criteria from a 10% to a 20% change in the cost-to-charge ratio (CCR) increases the likelihood of outlier payments being recouped by Medicare Administrative Contractors (MACs) and may delay reimbursement appeals.

Future Outlook

The company anticipates continued impact from regulatory changes, particularly the One Big Beautiful Bill Act (OBBBA) signed in July 2025, which is projected to reduce federal Medicaid and CHIP funding by approximately $1 trillion over the next decade starting in 2027. This may necessitate state-level Medicaid reforms, potentially leading to adjustments in provider taxes, cuts to Medicaid reimbursement rates, and elimination of certain optional services or patient populations. While the calendar year 2025 Medicare physician fee schedule (MPFS) final rule reduced Medicare payments for therapy services by approximately 3%, the OBBBA mandates a 2.5% increase to the calendar year 2026 MPFS conversion factor, which, after factoring in other proposed policies, is expected to result in an approximate 2% increase in Medicare payments for physical and occupational therapy services in 2026. The company also expects approximately $1.3 million of estimated pre-tax losses from its interest rate cap to be reclassified into interest expense within the next twelve months. The company plans to pursue new joint venture relationships with health systems, open new outpatient rehabilitation clinics, and consider opportunistic acquisitions for future growth.

Management Comments

• Management believes the presentation of Adjusted EBITDA is important for investors as it is a common analytical indicator of performance within the healthcare industry and is used internally to evaluate financial performance and allocate resources across segments.
• Management attributes the decrease in revenue per patient day in the Critical Illness Recovery Hospital segment to a decrease in the Medicare rate, influenced by the increased high cost outlier threshold and the implementation of the 20% transmittal rule.
• Management notes that the increase in cost of services relative to revenue was principally due to increases in labor expense and a decrease in revenue within the Critical Illness Recovery Hospital segment.
• Management indicates that the decrease in general and administrative expenses was primarily due to lower stock compensation expense resulting from modifications to restricted stock awards related to the Concentra spin-off and a reduction in personnel expense from accrued bonuses.
• Management believes that internally generated cash flows and borrowing capacity under the revolving facility will be sufficient to finance operations in both the short and long term.
• Management acknowledges that the healthcare industry is labor intensive and has recently experienced higher labor costs due to an inflationary environment and a competitive labor market, with suppliers also passing along rising costs.

Industry Context

The healthcare industry continues to face significant challenges and opportunities. The company's performance reflects broader trends, including rising labor costs due to inflation and a competitive labor market, which are impacting the profitability of labor-intensive segments like Critical Illness Recovery Hospitals. Regulatory changes, particularly those affecting Medicare and Medicaid reimbursement, remain a dominant factor. The passage of the One Big Beautiful Bill Act (OBBBA) introduces substantial uncertainty regarding future federal funding for Medicaid, which could force states to reform their programs and potentially reduce provider reimbursement. While some telehealth flexibilities have been extended, the overall trend in Medicare physician fee schedules for therapy services indicates ongoing pressure, though the OBBBA provides a statutory increase for 2026. The company's strategy of expanding rehabilitation and outpatient services, often through joint ventures, aligns with a broader industry shift towards value-based care and community-based services, while the challenges in critical illness recovery hospitals highlight the sensitivity of highly regulated, inpatient segments to reimbursement policy changes.

Legal Proceedings

• Oklahoma City Investigation: The company and Select Specialty Hospital Oklahoma City, Inc. received civil investigative demands (CIDs) on August 24, 2020, from the U.S. Attorney's Office for the Western District of Oklahoma. The investigation stems from a qui tam lawsuit alleging billing fraud related to respiratory therapy services at SSH-Oklahoma City and Select Specialty Hospital Wichita, Inc. The company is cooperating, but the timing and outcome are unpredictable.
• Physical Therapy Billing: The U.S. Department of Justice (DOJ) has been investigating the company since October 7, 2021, for potential False Claims Act violations related to billing for physical therapy services. A related qui tam lawsuit, filed by a former employee, was unsealed in May 2024, alleging billing for one-on-one therapy when group therapy was performed, overbilling, and billing for unreimbursable unskilled services. The company's motion to dismiss the second amended complaint was granted in June 2025, allowing for a final amendment. A third amended complaint was filed in July 2025 with substantially similar allegations, which the company intends to move to dismiss. The timing and outcome of this matter are unpredictable.

Related Party Transactions

• Related party operating lease costs amounted to $1.833 million for the three months ended June 30, 2025, and $3.667 million for the six months ended June 30, 2025.

Stakeholder Impact

• Shareholders: Benefit from increased earnings per share from continuing operations and the ongoing common stock repurchase program, as well as consistent cash dividends. However, the overall net income decline due to the Concentra spin-off and potential future regulatory impacts could affect share value.
• Employees: The company faces increased labor costs due to an inflationary environment and competitive labor market, which could impact compensation strategies. The reduction in personnel expense related to accrued bonuses suggests some cost management in this area.
• Patients: Regulatory changes, particularly those affecting Medicare and Medicaid reimbursement, could influence the availability and scope of services offered, especially if states reduce Medicaid coverage for certain services or populations due to the OBBBA.
• Government Payors (Medicare/Medicaid): Changes in reimbursement rates and policies, such as the increased LTCH outlier threshold and the OBBBA's impact on Medicaid funding, directly affect the company's revenue from these programs.
• Creditors: The company's debt levels and liquidity, including its revolving facility availability and interest rate cap, are relevant to creditors. The reduction in total debt for the six-month period is a positive for creditors.

Next Steps

• Monitor the impact of the One Big Beautiful Bill Act (OBBBA) on Medicaid funding and state-level reforms starting in 2027.
• Observe the implementation of the 2.5% statutory increase to the calendar year 2026 Medicare physician fee schedule (MPFS) conversion factor.
• Continue to pursue opportunities to develop new joint venture relationships with large, regional health systems and other healthcare providers.
• Open new outpatient rehabilitation clinics in local areas to leverage existing referral relationships and brand awareness.
• Evaluate opportunistic acquisitions for future growth.
• Monitor the progress and outcome of the Oklahoma City Investigation and the Physical Therapy Billing legal proceedings.
• The Board of Directors will consider future dividend declarations based on financial condition, operating results, cash needs, and debt terms.

Key Dates

Recommendation

The company presents a mixed financial picture. While the core continuing operations show improved profitability and strong growth in the Rehabilitation and Outpatient segments, the Critical Illness Recovery Hospital segment, which is the largest, is experiencing declines in revenue and Adjusted EBITDA due to Medicare rate changes and increased labor costs. The significant stock repurchase program is a positive for shareholders, indicating management's confidence and commitment to returning capital. However, substantial future regulatory uncertainties, particularly the potential impact of the One Big Beautiful Bill Act on Medicaid funding, introduce considerable risk. Ongoing legal proceedings also add an element of unpredictability. Given these offsetting factors – solid performance in some segments versus challenges in others and significant external headwinds – a 'hold' recommendation is prudent. Investors should monitor the company's ability to mitigate the impact of regulatory changes and manage labor costs, as well as the outcomes of the legal proceedings.

Keywords

Healthcare, Rehabilitation, Critical Illness Recovery, Outpatient Therapy, Medicare, Medicaid, SEC Filing, 10-Q, Financial Results, Hospital Operations, Patient Services, Regulatory Risk, Labor Costs, Stock Repurchase, Dividends, Debt Management, Legal Proceedings