Encompass Health Corporation (EHC) Earnings Call Transcript & Summary

Good morning. Welcome to day 2 of the RBC health care conference, virtual edition. I'm Frank Morgan, the health care services and managed care analyst with RBC, and our first presenters today will be Encompass Health. We have CEO, Mark Tarr; CFO, Doug Coltharp. And we also have -- I will say hello to Crissy. Welcome to all of the crew.

And I guess as we start today, I'd like to -- before we get into really any details here, was just hoping to get a little bit of color around your strategic review process. I know you've said you will give us an update next quarter, but I was just curious. Could you provide us an update? Certainly, we got news from April Anthony's announced plans to retire and to leave the company. But I guess my question would be does this in any way -- does this departure in any way change those strategic options available to the company?

Yes. Well, good morning, Frank, and thanks for having us. And the answer to your first question is no, April's departure does not impact the options that we have with the strategic review. We -- as you know, we have said that we are well under the process. We certainly plan on providing an update as part of our Q2 earnings call. So we continue to make progress and happy where we are right now as a whole in that process.

Got you. And I know, other news, you recently posted an 8-K that included an update on the operating trends, and I was hoping we could walk through some of those. I noticed the comparisons, obviously, year-over-year are kind of goofy because of where you were, your comp from last year. But maybe when you look at it more on a normalized basis, maybe can you give us assessment of where you see the inpatient rehab discharges and how do those look relative to plan.

Yes. So Frank, overall, we're very pleased with what we see in terms of the momentum around our volumes. As we noted on our Q1 earnings call, we had commented in on the momentum we had in March and saw that carrying over into Q2. I would attribute the volume momentum really to a number of things. One, we're clearly seeing a significant reduction in the number of COVID patients. For us -- you may recall that we had stated we had, had as high as 30 hospitals at the height of COVID that had caps on volume because we had either so many patients in isolation in semi-private rooms that we couldn't use the full capacity or we had a number of staff out to the point where we were limited on staffing capabilities and that too capped volumes. So as of this last week, we're down to 2 hospitals that had any type of caps on volumes. We're starting to see a more -- what I would consider to be more normalized referral patterns coming from the acute care hospitals. We're starting to see more elective procedures start back in many of our markets, which will benefit both our hospitals and our home health segment. And so we're starting to see what I would consider to be a more normalized cycle, which is, to me, it's also indicative that the general population is becoming more confident in accessing health care, which is good for us all.

Got you. And you touched on home health care on the hospital side, but I think your release also said no real significant recovery yet on the senior -- either the SNF or the outside. So any color there? Any thoughts around kind of why there's a delay in seeing the recovery that you're already starting to see on the hospital side?

Well, the good news is we're starting to get access back to the ALFs and skilled nursing facilities. I think the challenge there has been their volumes have been down. We are starting to see that trickle back up, but it is not at the same recovery that we've seen in the acute care hospitals. The good news is that our sales and marketing teams have redirected their efforts. And as we noted, we had 3,000 new referral sources in the first quarter. So they are going out and reaching out to the needs of the patients and physician offices or surgery centers and other areas that there are patient needs.

Got you. So just sort of relative order here though, in terms of recovery: first, beds; home health, second; and then hospice, third. Is that a fair way to think about it?

I guess that's fair to say.

I'd probably flip hospice and home health. Hospice never took that big a setback. You had more of a change in the length of stay there, and that's been normalizing. But from an admissions or an ADC volume, hospice really didn't take that much of a setback. So the greater recovery needs to happen within home health.

Got you. And I guess that was going to be my follow-up question. When you -- when I think about the guidance, you updated to reflect -- when you reported the results in the first quarter, you updated to reflect basically the beat in the quarter and then the extension of the relief from sequestration. So I guess that was going to be my question, was hospice, what we're waiting on to see showing signs of recovery. But it sounds like maybe we should be looking at home health care before you might have a reason to rethink guidance, everything else continuing to trend as is. So home health is what we need to watch closer.

It was really, Frank, trying to determine whether some of the trends that we witnessed in Q1 were going to extend all the way through Q2. As you may recall, when we issued our original guidance at the beginning of the year, we had assumed that there would be a pretty significant recovery across all 3 business lines in the second half. So that degree of recovery is already built in. Of course, then, when we incorporated the Q1 results, you got the benefit of those trends. And really, the only update that was not included there beyond the extension of sequestration suspension was the trend line into Q2.

Got you. Okay. Well, maybe we'll go a little more division specific here at a high level. How do you feel overall about the regulatory and reimbursement backdrop, the environment? And maybe the update to the PPS seems to have -- or the update to the system last year seemed to go without any incidents or without any financial fallout. So maybe just your expectations around the IRF side from a regulatory and reimbursement standpoint.

Yes. So Frank, I think that really, the regulatory front in both segments is -- could be termed as being stable. I think what CMS is doing with -- they're still doing with the PHE and if you look at the proposed rule that came out for IRFs, it was pretty much as expected, market basket of 2.2%. Everything else -- the language within the rule pretty much dealt with just some technical areas. There was no mention of the review choice demonstration. So I would definitely term the regulatory environment as being stable right now.

Got you. I know when you -- certainly, when you gave your guidance, there does seem to be this focus on an acceleration of development activity. Really, you've seen it this year in nick. So I'm curious, when you look at your portfolio, look at the organic growth opportunities, what's driving this -- what do you see as the biggest opportunity to accelerate the development of the de novo strategy?

Yes, Frank. You're -- we're very excited about the pipeline that we've announced for both this year and next year. And what's driving it is really you get this demographic tailwind and you've got an increasing need for rehabilitative services at the same time that the total number of facilities has been pretty stable across the U.S. but the demand has increased. So we think we're well positioned to take advantage of the increased needs with the demographic tailwind. Then you have the State of Florida which has abolished the CON, which, as you know, that's a state that we've had 12 hospitals -- legacy hospitals there. So we -- for years, we've said, "What if we didn't have to deal with the CON in the State of Florida? Where would we like to either add beds to existing hospitals or what would be the potential to have new markets where we build de novos?" And we have pursued the State of Florida. I think we've gone very aggressive being first to market. And so whether it's the State of Florida or the other states where we've announced de novo hospitals, we've got 8 coming on for this year. We've announced 12 for next year. So like I said, we're very excited about the pipeline for new growth opportunities.

I would say, Frank, also to add to that, one of the things that we hadn't counted on when we began increasing the amount of development activity we have in the IRF sector was the fact that during the pandemic, we believe the differential in services between SNFs and IRFs has been accentuated in a very positive way for the IRFS. And that's going to drive more patient volume our way. And if you think about it on a national basis, even before the pandemic started and you just took as an indicator of what the total addressable market for IRFs is there -- is out there, only about 15% of CMS eligible -- CMS-13-eligible discharges coming out of acute care hospitals in this country are winding up going into an IRF setting. And so even if, upon further review, some of those CMS-13 patients aren't appropriate for the IRF setting, more than 15% are. So there's clearly an unmet need out there across the country. And we think we're well positioned in terms of our free cash flow and our capital position as well as our operating expertise to be able to fill in that void.

That's an interesting comment and an interesting fact. But I'm curious, beyond the pandemic, what else does it take to change it? I mean that seems like a massive -- massively under-penetrated part of the market. And is -- do you feel like that's the case in the markets where you actually are? Do you think you're that under-penetrated? Or do you think that's just more of a representative nationally?

I think that's a national figure. I think it has a lot to do with 2 things. One is Mark stated, if you look at the supply of IRF beds in the U.S., for about a 10-year period from 2008 to 2018, it was relatively flat. As a matter of fact, it may even have been down 1%. And yet, during that time, I think the aged -- population over age 65 grew something like 35% to 40%. So you had a growing disparity between supply and demand because the incidence of the conditions that are treated in the IRF stayed proportional within that over 65 population. The second reason that conversion rate into IRF is so low is because you've still got many, many markets in this country that don't have an IRF offering at all. And so when it's not available, those patients are going to go to another setting. And that's why you see us adding beds in places like North Dakota and in Idaho and so forth, some less populated areas than you might think of but still with a critical mass of Medicare-eligible beneficiaries to provide us with good occupancy levels.

Right. We've talked for a number of years now in terms of our ability to handle a higher-acuity patient and being able to take a patient that may be medically complex that other rehab providers or the post-acute providers would not take. And then comes the pandemic, which reiterates even more our ability to do a great job with the higher-acuity patients. So I think that really positions us well either in new markets or existing markets where you have the confidence of the acute care hospitals in terms of working directly with us and our willingness to take patients that they otherwise have not considered for rehabilitation and we get those patients back home.

So Frank, we'll see many instances when we decide to put a de novo in a market where the historical conversion rate of the CMS-13 patients into an IRF setting has been in the low single digits. By getting in there with one of our hospitals and educating the discharge planners in the acute care hospitals, by educating the physicians in that market and by educating the payers who serve that market about our specific clinical outcomes, we're able to drive that conversion rate substantially higher, typically to close to 20%.

That's interesting. Does it -- I know some companies have used the JV model sort of as a way to partner with that local hospital system. It sounds like that the market is so under-penetrated that -- I mean is that really a necessity? Is that just something you use in very unique circumstances?

No, we've got -- about 1/3 of our portfolio are joint venture arrangements with acute care hospitals. As a matter of fact, our first JV was right there in your home city of Nashville and Danville. That was over 30 years ago. So we assess each new de novo opportunity in each market as to whether, strategically, it's something that we should go in and partner with a predominant system within there or is it something that we are comfortable and I think it's to our advantage to go in as the sole owner. And then we've also had markets where we'll go in as the sole owner and then eventually partner with an acute care hospital system in that marketplace. So we assess all these markets as whether we should partner or not partner. And very proud to say we've never had a partnership unwind in the 30-plus years we've used that as a business model.

Right. Those JV arrangements usually come about in 1 of 2 ways. Many times, we'll look at a market that we think is attractive and is underserved from an IRF perspective but there's an IRF unit within an acute care hospital that services that market, that is running at some level of low productivity. And so we can create a win-win by approaching that partner and saying, "We'll build a brand-new freestanding de novo on or proximate to your campus. You can get an in-kind equity stake in that new facility by essentially contributing your unit, contributing those licensed beds and the ADC. And then you can, with a relatively low capital cost, reconvert those beds within your unit to more traditional medical and surgical purposes, which are more productive for you and still have a presence at post acute, albeit with a better operator." So that's one model. The second is we're going to a market where an acute care hospital -- a very high-quality acute care hospital has no presence in the IRF space but they have an interest in being more proactive in the post-acute space. And so they'll make a cash contribution to buy an equity stake in our facility, and it creates a good referral relationship.

Got you. It's interesting with these great growth -- with the growth potential in this sector, you are starting to see other people talk about post acute. So I'm curious. Who do you see out there like, for example, in Florida, where there's the CON being -- rules being changed there? And I know that HCA here in Nashville has talked about their intent to develop some IRF assets, and I think they called out Florida. So are you seeing other people come into the market, other IRF operators? Or are you seeing more interest from hospitals getting more active?

It's -- we think it's been a big benefit to us to be first to market and be very aggressive about going in and buying real estate and announcing our presence. Yes, HCA has announced that they are looking at either adding or expanding units in State of Florida. We expected that. We compete or work with HCA in other marketplaces where we still get referrals from some of the hospitals that have rehab units that may be at capacity. But we've not seen a large number of people enter the State of Florida. We have -- there are some one-offs that are out there who've announced onesie-twosie government opportunities. But we would fully expect there could be others, but we're very confident in our ability to go in and compete effectively and take market share away from those that may be in the marketplace.

And Frank, recall that getting into the IRF business is capital-intensive proposition. And so when we're talking particularly -- depending on the market in Florida, where land can be quite expensive, the total capital investment for a 50-bed, all-private room inpatient facility can run $35 million to $40 million. And so in addition to the capital investment, you've got to have the operating expertise. And there aren't a lot of providers and/or private equity funding businesses that are running around with a combination of both the available capital and the operating expertise. HCA is a bit of an anomaly. There are not too many HCAs out there, and they're in a lot of business lines. So even as they increase their position in post acute, specifically in the IRF space, it's not really going to make a dent in the overall marketplace.

Got you. Maybe we'll switch gears a little bit here and talk about your MA strategy that you seem to be taking a bigger interest in that area, having signed a contract with United. And I think you called out some of the numbers, so I'm curious. Maybe if you could provide us a little bit more color on that strategy on the IRF side but then maybe also on the home health care side.

Well, for IRF, you've heard us talk for a number of years now about how we take our value proposition, which is essentially our -- the outcomes that we go out to the regional medical directors for these MA plans or the regional authorities that are helping to consider to pre-auth our request and show our outcomes and show that we can provide patients with the opportunity to get back home and have a lower occurrence of readmission back to acute care hospitals. So ultimately, it's a lower cost per episode of care, and that's been -- we've had nice success with that. You've seen our growth and our overall MA discharges, particularly with stroke. But then as we've seen the success we've had with that, with our outcomes, that's also expanded then into other diagnostic categories, many of those that may have a neuro basis. And once again, we think that also the pandemic has given us an opportunity to increase our relationships with the MA plans. So the value proposition has definitely gained traction with MA payers for IRFs. On home health, we've been very discerning in terms of which contracts we work with and sign. We didn't want to just chase low-paying volume. We wanted to make sure that strategically, we are working with payers that had a sense of the value for the quality that we can provide. And we felt that's the case with United. Clearly, we have a short history with them. The contract went into effect in February so we've got a few months. We've been happy with the volume we've seen from it. And we think that strategically, it's going to be beneficial. But we want to make sure that we are not chasing contracts where the MA payers themselves just view home health as a commodity but have some recognition of the value, of where it plays relative to quality in care for the patient. I think that the fact that you've seen some of the payers get involved with home health now, you've got Humana, for instance. So clearly, the payers are starting to recognize the value of home health and the role it can play not only in the quality of the outcomes but the overall cost of care of a patient.

And the contract terms there, are you getting with United -- is that an episodic payment model? Or is that a per diem?

It's per visit.

I'm sorry, on the -- yes. That's on the home health care side. On the IRF side as well?

On the IRF side, we're now at -- 83% of our contracts are based upon CMG. So there's about a 7% discount on the MA plans to the Medicare fee for service, which we've significantly closed the gap on that over the years.

And Frank, just a point of clarification. The United contract that we announced several months ago, that national contract is applicable to home health services only. The IRF business -- we do a lot of business on the IRF side with United, and it's not subject to a national contract. The rates are negotiated on a regional basis.

Got you. Thanks for the clarification there. I guess one of the side effects of this is that -- with MA is -- I noticed, in the most recent quarter, you referenced bad debts being a little bit higher, and I think you attributed that to the MA side with copays and deductibles. So is that something that you would view as sort of an isolated event? Or is that something that we should watch as a potential trend?

Well, put it in context, our bad debt rate ticked up about 10 basis points. It was not overly significant. It is reflective of the fact that we have more MA patients coming through and that those MAs have different -- those MA patients have different payment plans than certainly our fee-for-service patients. And they have different payment plans and different responsibilities, deductibles and copays than they had in prior years. And so our admissions teams have not been really set up to go through the process of making sure they're collecting what's due at the outset. There are some things that we can do administratively that we believe will address that. We also want to be careful. You probably saw some of the articles that came out recently on community and some of their -- community health and some of their collection efforts. We're not opining as to whether or not those were appropriate or not appropriate, but there's a sensitivity, particularly in this environment, about getting too aggressive in trying to collect some of those payments. So we'll be very prudent about any revisions we make to our operating procedures there.

Got you. We are very close to the end of our time. So maybe just one last quick one. As it relates to labor, really sort of the hours of contract labor and the rates on contract staffing, certainly, that's been a major topic through the pandemic. But maybe talk to us about some of your experiences to date and what the effect of both from a utilization and then from an actual rate there is. And where do you see those trends now?

So Frank, we had our operators in this week. We had a chance to get their updates in terms of what they're seeing in the marketplaces. And clearly, post pandemic here, there are a number of factors going on; some of them which will normalize out, I think, with time. We're already starting to see some of that. But what we're seeing on labor, it's particularly tight on nursing. It is more of a market-by-market versus a national trend. We've seen it be a little bit more of a challenge on the home health side than we have on the IRF side, but both segments are really focused on retention. We have aggressive recruitment efforts going to fill open positions. You've seen a number of markets with nursing, over the years -- particularly with the pandemic last year, nurses have just -- they're sitting it out right now and waiting until after the pandemic to get back in the marketplace. You've seen other markets where they've seen a migration out because nurses went to other areas and traveling programs where they got paid a significant premium to go to markets that had surging COVID incidents. And now they're coming back because those contracts are no longer available to them. So yes, right now, we're paying a premium for contract labor. And we had -- some of the markets are already starting to see that come back down a little bit in terms of what they're paying per hour for contract labor. But it's got our attention. We're focused on it in both of our operating segments.

Okay. Thank you very much, Mark, Doug and Crissy. Thank you all for being with us today. And that concludes this fireside chat. Everyone, have a great day.

Thanks for having us, Frank.

All right. Take care.