Encompass Health Corporation (EHC) Earnings Call Transcript & Summary

All right. Great. I want to thank everyone for joining us. It's my pleasure to introduce Encompass Health here at our virtual Las Vegas Healthcare Conference. Encompass is the largest provider of inpatient rehab and one of the largest providers of home health and hospice services as well. Presenting today, we have Mark Tarr, President and CEO; Doug Coltharp, CFO; and Crissy Carlisle from Investor Relations. So we're just going to jump right into Q&A. You guys put out an 8-K this morning going through kind of the volume trajectory trends into April. So maybe that's a good place to start. You want to walk us through kind of what you're seeing across each of the businesses.

Sure, Kevin, and thank you for having us today. We're delighted to be here. So, yes, we released an 8-K. I think, the important takeaway is that we are seeing volumes rebound post pandemic. We're certainly seeing a general willingness in the public to have greater confidence engaging back into the health systems. We have seen the decline in number of COVID patients in our hospitals as well as our home health agencies. And along with that, we're seeing fewer and fewer of our own staff in quarantine. So in first quarter, there was at one point where we had 30 hospitals, 3 marketplaces that had been capped due to quarantine, COVID quarantine-related issues or just isolation of COVID patients in our hospitals. So that number is down to 2 this week. So there has been no capacity issues in our hospitals relative to COVID, either on the quarantine side or staff or the COVID patients. We've seen nice volume increases, downstream from the acute care hospitals that seem to be returning back to a normal rhythm. We've seen surgery schedules start to fill out now. So we're seeing the elective procedures begin to be admitted into our hospitals, primarily the lower extremity joint replacements as well as an uptick in our home health business with elective procedures. So all in all, we're very positive about the momentum that we see. We feel very good about what we did in Q1. And I mentioned at that point, that we felt we'd be taking some momentum out of Q1. And you can see the results with our April release on where we are.

Thanks. That's great. I guess when you think about your guidance and your expectations for the rest of the year, I mean, how are you thinking about that trajectory as we exit kind of Q4 of this year? Are we back to normal? Do you see pent-up demand at any point during the year?

We had factored in our guidance at the second half of 2021 we'd back to normal that the -- any major impacts from COVID would be primarily in the first half. We do think that there is a chance, there's pent-up demand out there. As we've said on our Q1 call, our patient population being 76 year olds in our hospitals and 77 on the home health side probably won't be the first group that goes back to select elective procedures. But we do feel this growing confidence with time to expect them to go back in and have those elective procedures. We also think that you will see skilled nursing facilities and assisted living facilities, their volumes increase with time, which ultimately impacts our home health volumes. And there's starting to be some anecdotal comments back from some of the providers in those 2 spaces that they're starting to see their populations come back after a real low point during the pandemic, too. So we think there's a lot of momentum going into the second half and hopefully will be beyond the pandemic then or at least very low impacts from the pandemic.

All right. Great. And I guess one of the things that you've kind of been seeing for a while is that there has been this shift of volumes out of the inpatient setting into the outpatient setting. It's been a long-term trend. And to some degree, it feels like that [indiscernible] boost during COVID. How do you think about the implications on your 2 main businesses of that shift? And as things return to normal, what does that mean at the end of the day for volumes? Does this volume shift persist longer than people might think? Can you capture more of that on the outpatient side? And then on the inpatient side, are there going to be pressures for longer than people might think?

I think the major shifts in terms of just post-acute settings, the beneficiaries are going to be home health. I think IRF will benefit from that as well. The sector that has seen the largest negative impact, of course, is skilled nursing homes. And a number of those patients that historically maybe have gone there for an active rehab program. I think many of those were low acuity patients. In large part, they have been lower extremity joint replacements. I think those patients, those that are able to go home and receive that rehabilitation in a home setting versus a skilled nursing facility, you're going to see that lower acuity take their opportunity to go home and have home health agencies treat those patients. I think on the other side of it, there have always been a fair number of stroke patients. There is always been a fair number of fractured hip patients with significant comorbidities that could have benefited from an IRF setting instead of being sent to a skilled nursing facility. So I think both of our sectors have a potential to benefit from changes in the post-acute setting world, just given what we saw from the results or lack thereof provided through the nursing.

Okay. That makes sense. I guess you guys have been talking about assisted living and nursing home volume coming back and that helping to boost, to some degree, the volume in the home health business. I guess it's just a little counterintuitive today to think about that being a tailwind when in theory you've been taking some volume out of the nursing home. So how does that net out in your view?

So I think the types of patients, I think that the nursing homes will -- the volumes will start to come back to nursing, but I think what you're going to see is a different kind of patients. And I think you're going to see patients that historically are able to receive rehab, active rehab, those short-term patients, short-stay patients in a nursing home, those are the patients that will go home with home health. I think you're going to have more of a convalescent type of patient in a skilled nursing facility. They will still need to have care provided to them. And so I don't think that you'll see a large number of the types of patients that we're currently treating with our home health there in the assisted living or the skilled nursing facilities. So I see it being a change due to more of a convalescent patient going to a skilled nursing facility versus home or to an IRF.

Okay. That makes sense. And then the company is in the process of reviewing strategic alternatives for the home health and hospice businesses. How do you think about the potential range of scenarios there? Are you feeling confident there's going to be some sort of transaction on that asset? Or is you keeping that asset still a very viable potential outcome?

So we announced in December that we are going to be undergoing a strategic alternative review for the home health and hospice. That process is well underway. As we've said, we are evaluating all options, whether that is a partial separation, complete separation, merger, sale. We did not go into the process with any bias in any direction. We are being very -- working with our advisers, and we're doing a great deal of due diligence on this. As you might imagine, it's a very comprehensive and complex review. Our focus right now is identifying how best to return our shareholders for long term. And so what we hope to provide and certainly intend to provide an update on our Q2 earnings call and update investment community where we are in the process at that point.

Okay. I guess maybe with that potential transaction out there, it might make sense to kind of step back and say, if you do get rid of that home health asset, how should we be thinking about the RemainCo growth there? You obviously outlined some long-term targets on the IRF side. But I just want to make sure that we're thinking about it right if you think about G&A, deleveraging and things like that. I mean what should we be expecting from the RemainCo if you spin-off the home health business?

Well, as we've announced, we have 8 hospitals, 8 de novo hospitals that we're bringing on in 2021. We have 12 that we're bringing on in 2022. So we'll be using a pretty substantial amount of our free cash flow and funding the growth for the next few years, just servicing the growth opportunities that we have in our IRF facilities. And -- but we're very excited about the future of that if that were the way that we would go and think that the free cash flow that we have would either help fund the growth or we would certainly consider continuing on with the dividend program or the potential for share buyback.

I think the segment results that we've been publishing provide a pretty good proxy for a starting point of the IRF business, even as a RemainCo. The long-term targets that we put back out with the fourth quarter earnings release and the issues of guidance this year will remain intact for the IRF business because those were specific to the IRF. In terms of the leverage profile, we would continue to target leverage for that business at about 3x. And with regard to the impact on G&A and any stranded costs that we might incur as you separate out the home health and hospice business, it's important to remember that we've maintained a fair degree of autonomy for that business along the way. And so even if there is some friction [indiscernible] completely offset dollar-for-dollar, the G&A expenses that might have been associated with providing centralized services to home health as you separate it out, that -- those costs are likely to be absorbed by the expansion in the IRF business, which as Mark just referenced is accelerating over the next several years.

Yes. Maybe next just talk a little bit about that organic growth on the IRF side because it is an acceleration as always been -- it's looking to be part of your plan to be these de novos, but it is a market acceleration in the next couple of years. How do you think about the 2023 and beyond opportunity? I mean is this a new run rate? Or is this more about Florida opened up and this is a huge opportunity in the near term, but it should normalize to something else longer term?

No. We put out there for the next 5 years. We think it will be between 6 and 10 new IRFs per annum. Obviously, we're exceeding that in 2022. Florida is playing a role in that. But if I look at the composition of our pipeline today, you've got the 12 to 15 opportunities that we had identified beginning back on the Investor Day March of 2020 that are related to Florida. But you've got an equal or potentially larger pool of identified projects that exist outside the state of Florida. And those cut across both CON and non-CON space.

Kevin, you've also seen us with a number of announcements. They're also a combination of 100% owned, solely owned or projects that we're doing with either current partners where we're adding hospitals into that partnership or new partners, such as the hospital we opened this year in San Angelo, Texas with Shannon Health.

I think the partnership that we announced last week with Piedmont and Georgia is really exciting. There, we're taking a couple of existing hospitals and turning those into JVs. But it's also giving us the opportunity to look at expansion opportunities in a strategically very important market for us and one that has had some challenges with regard to CON procurement.

And I guess, how do you think about the joint venture versus 100% fully owned? Which is a better economic outcome for you guys?

It depends on the market. Well -- and really, they both kind of wind up at the same place. From a pure ROIC perspective, you're going to do better on the joint venture. You cut the capital that you're putting forward in half in some joint venture because we're managing the facility. We also get the benefit of a management fee as part of our economics, get more than 50% of the economics and 50% of the capital and that drives it. But from a pure growth and EBITDA perspective, you prefer to be 100% owned. We like the blend of those markets. It depends on any number of things. There's a single dominant acute care system in a market. And a lot of times, it's going to make sense to go in with a joint venture relationship and derisk and treat. If there are several acute care hospitals, we all have roughly equal market shares. We can find it better to be independent and play Switzerland [indiscernible].

And Kevin, there are times when we'll enter market as a wholly owned and then partner it later on as we see strategic opportunities. And the joint venture model, we always like to stress, we've been doing that particular model for over 30 years now. It's our first partnership with Vanderbilt in Nashville, and we've never had a partnership unwind. So we're very proud of that track record. And I think it's been a very effective business model for us.

Specifically an example of what Mark's talking about is with Piedmont. We're taking our existing Newnan Hospital, which is suburb of Atlanta that's been highly successful, and we're folding that into the partnership. Piedmont is actually paying cash to acquire [indiscernible] interest based on our current market value. And we're also taking our Henry County facility, which is not yet open, but it's very far along in development. We had initially pursued on a solo basis that part. So we've got a lot of flexibility with regard to that, as Mark suggested. We have more than 1/3 of our hospitals operating in JVs. We have more experience in joint venture relationships than anybody else.

Yes. And I guess when we think about all these de novo facilities, oftentimes when companies are [ opening ] and [indiscernible] there's a decent amount of start-up losses associated with that. I mean how do you think about that? Should we be forecasting a bigger drag in 2022? Or do you think that the long-term CAGR that you've outlined for IRF growth is more or less a consistent growth target over the next few years?

I think because you're accelerating, you're going to see a couple of years where there's going to be an EBITDA drag. Pointing to $15 million to $20 million of reopening expenses plus EBITDA drag from the ramp-up this year. With 12 openings next year and with the 8 that have opened this year still seasoning into 2022, we're going to see an even larger drag in 2022. That's going to start to flip in 2023. I would assume that by the time we get to the second half of 2023, the EBITDA contribution from the early vintages of this accelerated growth are going to contribute enough EBITDA to overcome start-up and ramp-up costs associated with the next class.

Kevin, it's about between $1 million and $2 million per hospital preopening costs.

And then you got 6 to 9 months before you're EBITDA positive on a 4-wall basis.

Okay. And then you guys are still active, even though you're going to do a strategic review of buying home health and hospice assets, the Frontier deal, reasonably sized deal. How do you see the M&A outlook there? What's the pipeline look like? And how are you thinking about home health versus hospice assets?

So certainly, the M&A pipeline for hospice recovered very quickly. It really became pretty robust in the second half of last year. That was not surprising because unlike the IRF business, the SNF business and the home health business, hospice was not undergoing the payment [indiscernible]. And hospice has remained relatively steady, at least from an ADC perspective through the course of the pandemic. Although I think most of the providers, ourselves included, have shown some short-term issues with regard to [indiscernible]. So it's fairly easy to model the business on a go-forward basis and to reach some agreement between buyers and sellers on the price of the asset. And those were, however, trading at pretty significant multiples. So we took a look at a number of those properties but ultimately did not choose to act on. There wasn't a lot of activity in the home health space in the second half of last year, and that was at least partially attributable to the combined impact of PDGM and the pandemic. And adding to that was, of course, the fact that even a lot of the smaller providers have received some form of aid under the CARES Act. We're starting to see that free up right now, and I think Frontier is a good indication of that. And we're still under the anticipation that it's going to be an accelerated level of consolidation activity. It really needs to happen in the business. Even with some of the consolidation activity that had taken place particularly prior to 2020, you still have something like 11,000 licensed home health agencies in the U.S. And the overwhelming majority, more than 90% have less than $5 million in revenue, which is very difficult for those sized entities to continue to compete when you've got all these incremental quality reporting measures [indiscernible] And there's a real desire on the major players ourselves included to increase their scale and their market density.

Okay. That makes sense. And then I guess one of the things that we've been kind of monitoring -- or we're always monitoring, I guess as per providers is labor outlook. COVID seems to have created some pressures there over the last few quarters, and it seems that the providers generally kind of saying they expect labor costs to moderate, but it seems like their staffing companies are talking about a supply/demand shortage just as big, if not bigger, in 2022 than it was during 2020. So I'd love to hear your thoughts about labor and potential pressure and how you may be able to offset it?

So we're starting to see more and hear more about marketplaces that it's getting tighter, particularly on the nursing side. And for us, it's been a little bit more problematic on the home health side than it has been on our hospital side. I think a couple of things are happening here. You have more and more people that are, once again, entering back into the health care environment. So patients going back to receiving care. So you're having an increasing demand. You also have some short-term dynamics going on that I tie back to pandemic. You have some nurses that during the pandemic had decided to set it out for a year and let the pandemic go and then they'll get back into the workforce. You had a number of nurses that have entered traveling programs that have gone to marketplaces that had a big COVID surge. And now that has dissipated. They were able to make a lot of money. And now they're going back to their home market or whatever market they want to be. And so they will begin to enter the workforce, but they may be taking the next couple of months off because they've made a significant amount of money. And they just have what was already existing in terms of a bit of a nursing shortage. So I think some of that will normalize out. You'll have those nurses that will reenter the workforce. You'll have nurses that had been in the travelers program, making a lot of money, they will go back to their marketplaces. And then we'll have a bit more of a normalization. But longer term, and I think this stuff will help to reach some sort of a pre-pandemic level, but we had some nursing shortage even then. So we've put a lot of focus on retention of our nursing staff. We've put a lot of focus on bringing on recruiter staff in terms of our own company so they can more effectively fill open slots that we have within our organization. And then we'll have to look at market adjustments where necessary. But we're doing everything we can around the edges right now before we go in and start doing a great deal of market adjustments. But we'll do what we need to mitigate the nursing shortage. Like I said, it is starting to be a bit more problematic now than it was. And we'll see what we can do to mitigate. There's a lot of different options to take doing that. But in the long run, we think nursing is going to be more problematic this year than it has been in the past.

Okay. All right. That makes sense. There's other trend that we are seeing within both businesses is that MA has been growing as a percentage. Can you talk a little bit about how you think about the profitability of MA versus fee-for-service businesses? Is there anything that we should be thinking about as a result of that shift?

Yes. So we've been experiencing pretty aggressive M&A growth on the IRF side of the business for a number of years preceding COVID. You might recall that in 2019, I think our IRF M&A book of business grew about 19% and that had been preceded in 2018 by something like 12% or 13%. It accelerated even further during the pandemic. We think that is a recognition of the Medicare Advantage plans of the value we bring to the table, particularly in treating a higher acuity patients. We're optimistic that it's going to be sticky as we move forward, although we don't expect to see that same level of percentage growth. I think as you know as well, Kevin, we've also been successful really over a period of 8 or 9 years on the IRF side in narrowing the gap between the fee-for-service payment and Medicare Advantage. If you wound the clock back in kind of that 2011, 2012 timeframe, you would have seen a differential where MA was about a 25% to 30% [indiscernible] service. A relatively even percentage of our MA back been was on a case rate basis [indiscernible] If you fast forward that to today, the payment differential is only about 8%. It's now into the high single digits. And about 80% of our MA revenues are paid on an episodic basis versus [indiscernible]. That's a really healthy trends. Feel good about there. I cannot tell you the same rosy story with regard to home health. And unfortunately, in spite of some of the investments you see managed care companies making directly in the space, they do not seem ready, although I think they're getting there, differentiate home health providers on the basis of quality. And they default instead to the lowest price in the market because they tend to be more concentrated in larger dense markets where a lot of small mom-and-pop agencies who are out there who are willing to trade volume for price. There's always somebody that will undercut you. And so as a result, if you look at our aggregate Medicare Advantage business on home health side, the discount to fee-for-service is still in that 25% to 30% range. It really hasn't moved at all. And we really spend our time and our resources there, both in terms of the sales force and our clinical resources pursuing the Medicare fee-for-service business which is more profitable for us because it's there.

Okay. That's helpful. I guess one of the things that we've seen I think a little bit about this to some degree, but asking most of the companies how they think about how COVID has impacted the business? Are there things today that you're doing from a care perspective or from an operations perspective as a result of COVID that you think now is going to be the new normal going forward?

Yes. Kevin, I do. I think the fact that we decided early on once we saw that we could clinically do a great job with COVID patients, we were there to help our referral sources early on. And so we took COVID patients right from the start. We have great outcomes with COVID patients. I think that we built a great deal of goodwill with our referral sources, and we showed them what we could do with high acuity patients. So we have been talking about this value proposition for a long time with regard to stroke patients and MA plans. Well, I think that that is going to expand the scope of the types of patients not only stroke patients, but other patients that have medically complex profiles. And I think that our reputation in the IRF sector as a whole and Encompass within that sector has benefited from our ability during the pandemic of taking a highly acute patient. And the same thing with our home health segment, too. Our home health team took COVID patients right from the start. And I think that builds a great deal of goodwill into the future in terms of working and maintaining those relationships with our referral sources.

A few other things in that category. We have diversified our supply chain and access more domestic resources. That will be an ongoing thing. We've learned how to utilize vehicles like -- such as this videoconferencing and teleworking with referral sources and other constituencies and not just reporting to work from home. That will continue. We've put testing, rapid testing equipment and supplies in all of our hospitals. That will continue. Overall, I think we've improved the efficiency of the business.

All right. Unfortunately, I think that's all we have time for. So I want to thank you guys for joining us today, and I look forward to doing this in person in Vegas next year.

Thanks for having us, Kevin. Appreciate it.

Thank you, Kevin.