Encompass Health Corporation (EHC) Earnings Call Transcript & Summary

Hi. Good morning. Thank you for joining us. I'm Sarah James, the emerging health care delivery model and provider analyst at Barclays, and we are very excited to have with us today Encompass Health's CFO, Doug Coltharp, to give a presentation. So I'll turn it over to you, Doug. Thank you so much for joining us.

Great. Thank you, Sarah, and good morning, everybody. It is wonderful to be back in person. Perhaps like many of you, this is the first equity conference that we have been back in person since the onset of COVID. As a matter of fact, I think the last time we all gathered was actually at our Investor Day, which took place in early March of 2020. So it's great to be together. I'm going to start with just a brief overview of the company, and then I'll get into some of the components of our strategy and our financial performance. To the extent that we do not use all of our allotted time for my remarks, then Sarah will open the floor for some questions. So Encompass Health is an integrated provider of post-acute services. We do this through a network of both inpatient rehabilitation facilities and home health and hospice locations. We say integrated because about 60% of the patients who get discharged from an inpatient rehabilitation facility require follow-on home health services, either nursing and/or therapy. And part of our strategy, and I'll address this greater detail in just a moment, is in markets where we have both of our service lines to try to use that for care coordination and to enhance the patient transition from one side of a care to another, which historically has not been done well by any providers. Our network consists of 145 freestanding IRFs, 251 home health agencies and 96 hospice agencies. Together, we are spread across 42 states and Puerto Rico. Looking more specifically at the IRF business. We are, by far, the largest player in this space. It's a little bit of a big fish in a small pond. We do about $4 billion a year in the IRF business out of a total industry, all payers, that is just at about $12 billion. We have about 25% or about 1/4 of the licensed IRF beds in the U.S., and we serve about 30% of all Medicare beneficiaries who receive IRF services during the course of the year. Again, we complement that offering with a smaller but very effective home health and hospice offering. This is about 20% -- a little over 20% of our business or about $1.1 billion in revenue. The primary emphasis thus far within this business segment has been on the home health side of the business. We have 251 locations. I should note that 96 of those locations overlap with our IRF business in terms of being in the same market, and thus facilitate that coordination of care between the 2 businesses that I referenced just a moment ago. Hospice is a smaller but rapidly growing business for us, and all 3 of these businesses generate from the same demographic tailwind. We've got a slide on that in just a moment that we're going to review. As you are probably aware, we are in the process of rebranding our home health and hospice business to Enhabit. This process started in February of this year with the Dallas corporate office that serves as the administrative hub for this business segment. We're going to begin rebranding field assets in the middle of April, and our anticipation is that the vast majority of that will be completed by the end of the second quarter. So why are we doing that if we're trying to facilitate integration between the business? And again, as you are probably aware, if you're sitting in this room, that is because we are proceeding towards a spin-off of 100% of that business segment into a separate publicly-traded company. And the time frame I just cited for attempting to complete the bulk of the rebranding activities coincides with the target date we have for completing that spin-off. So if I've mentioned a couple of times already that we have the strategy of the 2 businesses working together, why is it we're looking to separate them into distinct public companies? And so there are a couple of things. We first got into the home health and hospice business at the beginning of 2015 via an acquisition, and we did that because of that statistic I cited just a moment ago that about 60% of the patients who are flowing out of an inpatient rehabilitation facility required follow-on home health services. And it was our belief, and I think it was a belief that was shared by many others at the time, that we were moving rapidly and inextricably towards episodic payment models across all payers. We stood here now 7 years later and very little progress has been made in that regard. But that is not reason enough to separate the businesses. There really are 2 other components of that. Over that 7 years that we have had the 2 businesses together, the process for our IRF working together in a highly coordinated way with our home health business has been designed, refined and improved consistently. And that's a process that we call clinical collaboration. And so just to give you a little bit more background on that, of course, clinical collaboration, we can't pass a home -- a patient from our IRF to our home health business unless they exist in the same market. We went from about 17 overlap markets, what we refer to when we have the 2 businesses in the same market, back in 2015 to now having 96, so that platform is in place. And then we use a measurement called clinical collaboration. And that looks at all of the patients in a IRF overlap market who are being discharged to home health. What percentage of those flow into our home health business? And that number has risen from about 9% in 2015 to between 30% and 35% depending on the measurement period right now. What we've also determined is that those protocols are so well defined that we have been in the process for about the last 2 years of looking to extend many of the same procedures and many of the same operating approaches to third-party home health providers in non-overlap markets, and we've been able to see some of the same success with regard to the coordinated patient care journey even when we don't own the business. And then significantly, and it's been a bit of a pullback here within the last 6 months-or-so because of a lot of things that are going in the market, but the valuation, the equity market valuation, for these 2 businesses had separated by a fairly good degree. And as we began the strategic alternatives review for this business segment in December of 2020, that was in part due to the fact that we did not believe that we were getting adequate appreciation for the home health business that we held within the confines of Encompass Health. A number of financial statistics here on what we anticipate both businesses will look like or some of the impact on both businesses when we effect the separation. And this should really be viewed more as a point in time versus an ongoing target. And so first, out of the gate leverage, we would anticipate that Enhabit, the home health and hospice business, will have an initial leverage of 3 to 3.5x. You may note that, that is a little bit higher than some of the publicly traded peers, and we think that with time, just given the point that we are at with regard to the earnings cycle, the business will naturally delever. That would leave the IRF business with an out-of-the-gate leverage of about 3.25 to 3.5x. And given the strong cash flow generations and the large amount of unencumbered real estate on our balance sheet, that's a level that we have felt good about operating at for an extensive period of time. Not surprisingly, when you separate these businesses into 2 public companies, there are going to be some administrative cost additions that take place. And so our anticipation is that on a full year run rate basis, when fully implemented, we will add about $26 million to $28 million in administrative expenses to the home health and hospice business. And if you follow our company, know that we report on a segment basis, essentially that $26 million to $28 million would now be a level of cost additions that occurs below the segment level. And conversely, you're not going to get a dollar-for-dollar reduction in the G&A that remains at Encompass Health just based on the fact that we have been able to get some scale economies and utilize some of the infrastructure that is resident in our corporate headquarters in Birmingham to serve both business segments. So here, we're anticipating that G&A at the remaining parent company would decrease on an annual basis by about $5 million to $10 million. That is, in part, going to be determined by the duration and the specific nature, which is still being refined of any transition service agreements. And then finally, the branding does incur some onetime expenses. And so we estimate that to completely rebrand the home health and hospice business as Enhabit is going to require about $10 million to $13 million in onetime operating expenses and about $3 million to $5 million in CapEx. Again, the vast majority of that should be incurred before the end of the second quarter, and we're going to get to our guidance in just a few moments. And I want to note that none of the costs related to the separation of the businesses is included in our consolidated guidance for the year. We do anticipate that as we approach the separation date, we will break the guidance into 2 pieces, one for each of the companies that's going to be established. I mentioned previously that both of our business segments in all 3 of our business lines really benefit from very strong demographic tailwinds. And this has been the case looking back almost 7 or 8 years, and it's going to be the case looking forward another 7, 8 years. You've got roughly a 15-year period, and it's largely due to the aging of the baby boomers. The average age of the patients we treat in our hospitals is 76, in home health is 77 and in hospice is 81. And the CAGR surrounding that age cohort has been growing at between 4.5%, 5% and is projected to continue doing so into the future while the rest of the U.S. population has been growing at less than 1%. So they're making more patients, and within that demand driver for the services we provide, the incidence [indiscernible] that we treat in each one of the 3 business lines has not been diminishing. It's not as if there's any technological obsolescence that exposes you at any 1 of these 3 businesses. And on top of that, if you look specifically to the home health and hospice business, both of those businesses, particularly as we emerge from COVID, are benefiting as well for a preference amongst caregivers and patients and families to see an increasing number of services delivered in the home setting. In spite of a lot of challenges from the emergence of new variants and COVID and some of the things that came up, particularly in the second half of the year with regard to accelerating labor inflation, we had a good year from a financial perspective. We increased our consolidated revenues by more than 10% and our consolidated EBITDA by almost 20%. And each of our 2 business segments for the full year of 2021 were able to generate both revenue and EBITDA growth on a year-over-year basis. In addition to good financial results, we made substantial capacity additions to both of our businesses, and we have somewhat different strategies on both of those businesses. On the IRF side of the business, we are adding to our capacity through a semiorganic strategy, and that is by building de novo IRF facilities, freestanding IRF facilities, and then complementing that with bed additions to existing hospitals. And the 2 go hand-in-hand. We will, in most instances, virtually all instances, acquire sufficient land and build an IRF de novo to accommodate the existing demand, but with the capacity to easily expand that facility to address what we believe will be future increases in demand through bed additions. If you look specifically at 2021, we opened up 8 new de novo freestanding IRFs that, in aggregate, added 350 beds to our platform, and we complemented that by adding 117 beds to our existing facilities so that our total bed count in 2021 increased by 4.4%. You're going to see much of the same strategy as we move into 2022. Right now, we believe we'll get 9 freestanding IRFs opened in 2022. There's some timing issues at the end of the year that could potentially pop up to 10, and we'll add at least 100 beds to existing facilities. So the overall increase in the bed count, 2022, is likely to be fairly similar to that which we experienced last year. Slightly different strategy on the home health side of the business, where based on a variety of factors, we lean a little bit more on the acquisition component of that. And last year, we were able to make $102 million of acquisitions that closed during the course of the year, expanding our footprint into some new geographies and adding complementary hospice markets to areas where we already had home health and creating some new overlap markets between our home health and IRF business as well. We also embarked on a relatively nascent and new de novo strategy for home health and hospice, and we've got 3 locations open. As we move into 2022, we anticipate that we'll have a roughly similar level of acquisition opportunities out there. We are seeing a pretty good pipeline of emerging opportunities, and it's our expectation that we'll be able to open 10 de novos in 2022. I mentioned our consolidated guidance before. You can see that here in just a moment. We're going to flip to a slide so that I can give you some insight as to the key considerations underlying this guidance. And so looking specifically here at the adjusted EBITDA range, it's a pretty broad range. It's a $50 million range that goes from $1.015 billion on the low end to $1.065 billion on the high end. Our 2021 actual was kind of right in the center of that. It was $1.028 billion. So well, what factors might lead you to take a step back in 2022? And we should be emerging out of COVID. And it's really 2 things, and that takes us into the guidance considerations. One is, all of you are probably aware we have benefited from a sequestration holiday in the Medicare program ever since the public health emergency came into effect in the spring of 2020, and it's been extended a couple of times. And now it is slated to phase back in. And so the schedule for that, and recall sequestration is a 2% deduction from your Medicare fee-for-service payments, a 1% deduction is scheduled to go in, in the second quarter of this year and then the full 2% deduction will go in beginning in the second half of this year. And we estimate that for our consolidated business, that's about a $50 million year-over-year headwind to EBITDA. And then on top of that, as you saw with virtually all providers, for a variety of reasons, almost all of which we believe are tied specifically to the emergence of the Delta and the Omicron COVID variants, labor conditions tightened dramatically in the second half of last year and the cost of labor increased very substantially. If we just look at the second half of last year compared to 2020, our SWB per FTE in both businesses was up nearly 9%. Some of those same factors have continued as we had anticipated into the first quarter of 2022. It is our expectations that we will get incrementally better as we progress through this year, and then we're also going to be anniversarying those substantial year-over-year increases when we get into the second half. And so you see in this slide a labor inflation expectation, 3% to 4%, essentially for both businesses that is less than what we experienced last year as a result of those 2 phenomena. And then, again, a final reminder here that as we look at this consolidated guidance, this does not include any of the expenses, those that will be borne leading up to the separation, those are associated with the rebranding, none of those are included in this guidance. So I'll conclude with this slide, which gets back to our expansion strategy, it ties into the demographic [ tail wave ] that we have, but we believe that we've got very strong growth opportunities continuing in both business segments, whether they are together or whether they are separate. And so it's going to be a combination of strong organic growth that relates to that demographic trend and the increasing demand for our services, our favorable competitive position and the underlying demographics. With that, Sarah, I think we've got just about 5 minutes if we wanted to open it up for any questions.

Yes. Absolutely. Happy to take questions if there's questions from the audience. If not, I'm just going to jump in with questions myself. So I think one of the areas that investors are thinking a lot about is how your relationship continues post spin-off. So right now, there's a lot of collaboration. As you just mentioned, last year was a key initiative to go into new markets of overlap. So how do you think about that relationship evolving?

Yes. And just to make sure that everybody heard the question, Sarah's question was when we separate the 2 businesses, we've had this very beneficial aspect of clinical collaboration. What's our degree of confidence that we'll be able to continue with that? And so I would point to a number of things. One, again, we've been -- essentially been married. The 2 companies have been married for 7 years right now, and we have really refined and instituted across those 96 overlap locations the best practices that are required to drive clinical collaboration. But people know each other in both businesses. Now there's always turnover, but the relationship exists. The second is you've got to have the overlap locations. So we start really on third base in that out of our 145 IRFs, 96 of them already have one of our home health businesses. So they're present in that market. The third thing is if you look at the composition of the patients coming out of an IRF and into the home health business, there is a heavier proportion of those that are requiring home health therapy services than exist in the overall home health population. And so in those 96 home health locations that are in our markets, we've already put the staffing in place to address that higher percentage of IRF therapy patients, so they are there. And then the fourth thing that I would point to is that the CEO of our home health business is Barb Jacobsmeyer. And many of you may know that prior to June of this year, Barb served as the President of our inpatient rehabilitation facility segment, and Barb was really responsible for driving the clinical collaboration across the platform. So the operators on the IRF side know Barb very well, and Barb has a complete understanding of what is important to any kind of hospital, but specifically in IRF, in terms of transitioning a prospective home health patient to another side of care.

Great. And then another area of interest is supply cost and labor. So we're going through hyperinflation right now. How does that factor into your '22 guide? And then on the labor side, how do you think about clinician churn as we move from '21 to '22?

And the question was what are our expectations regarding labor inflation trends and really general supply chain inflation trends. So I would -- again, as we came into the year, we had anticipated that the first quarter from a labor perspective would look very much like the back end of last year. And then you'd see some improvement in the second quarter and then a very substantial improvement in the second half of the year. As we look at the business and how we're trending so far in the first quarter, we can get still a good set of assumptions. But when we think about supply chain specifically, we were not anticipating any outsized inflation in those expenses. We think we've done a pretty good job of diversifying our supply chain and creating efficiencies and so forth. The whole situation right now in terms of China shutting down some for COVID and what's going on in the Ukraine with Russia creates some risk around that, but I think there's enough room -- I'm confident there's enough room within that EBITDA range to really accommodate even some unforeseen inflation that might arise.

Okay. And I always like to wrap up these events with a broad question to you around what do you think that The Street is missing or undervaluing about Encompass?

I think they're missing the fact that we've just got a great group of assets that has experienced some bumpiness, largely the result, almost exclusively the result of temporary exogenous factors. And it can feel like when you're in the middle of that, those things are going to persist forever. They are not. And the earnings generation power of each of these 2 business segments post-COVID is very substantial. I like the assets we have in place. I like the demographics behind it. We're proven operators in both business segments, and I really like the leadership team that we have in place as well.

Great. Thank you so much for joining us.

Thanks, Sarah.