Encompass Health Corporation (EHC) Earnings Call Transcript & Summary

Thank you everyone for joining us today. It's my pleasure to introduce Encompass Health. Encompass is the largest operator of inpatient rehab facilities as well as one of the largest providers of home health and hospice. Presenting today, we have Mark Tarr, who's President and CEO; as well as Mark Miller from Investor Relations. Before we jump into Q&A, I think there's some forward-looking statements you guys...

Yes. So first of all, it's great to be here. I've been asked to remind everybody that our disclosure statement can be found as part of our 8-K filing for our Q1 earnings, and that's out there on our website. So I can check that box now.

All right. Excellent. So I guess maybe jump into one of the big themes this week is labor. So can you talk a little bit about -- I think you guys raised your labor outlook for the IRF business, with Q1. Home health, I guess, was maintained. So what are you seeing as far as the labor outlook? And is this something that is a new base? Or do you expect there to be some bow that we start to actually see improvement on over the next year or so?

Yes. So on our Q1 earnings call, I stated that I felt like we'd seen a peak at the -- particularly around contract labor. We continue to believe that. We've -- really, our 2 segments, our hospitals or IRFs had significant use of contract labor. It wasn't such a factor on home health and hospice. The labor issues around home health and hospice dealt more with quarantine staff that weren't able to go out and care for the referrals we had. So we had plenty of demand, just the inability in the first quarter to go out and meet that demand. We had -- at one point, we had as many as 1,300 staff out on quarantine. So we're just undermanned, and now we've been in the process of hiring new nursing staff, and adding to that has helped to accommodate the volume. On the hospital side of the business, we did have excessive contract labor, just trying to meet the demands of the high volumes that we experienced in Q1. In the first quarter, we had $40 million or $40 million worth of contract labor usage, which is about a normal range would be $10 million to $12 million. And so it was on both the amount of FTEs. At one point, we had 750 contract FTEs. And if you think about what a normal run rate for the company would be, it'd be around 200 to 250 contract FTEs. So a lot of usage on that. Since the peak in the first quarter, we are starting to see some signs that, that is coming down. We've had a number of our hospitals that have been successful in terms of eliminating the number of contract FTEs and replacing that with our own full-time staff. The applications for open nursing positions continue to rebound and have increased from the low point right after the holidays. It's just never a good time to try to find -- somebody's looking for a job, but that has increased. And we've been successful in negotiating lower rates for the contract use that we have. And then we're starting to see some indications for the duration of a contract is not only at a hard, fast 13 week. We've had some negotiations lately that allow us to have a two-week out clause on those contracts. So altogether, we're starting to see some softening in the marketplace, which would be positive for us. We are certainly factoring that in for the second half of the year in terms of our guidance and what we're factoring in, in terms of market factors around labor. It's still very challenging out there, but we feel like we're getting our arms around it and starting to see some traction in our efforts to reduce the excessive costs.

And I guess when we think about that hiring dynamic, I guess there's just been a lot of conflicting views, sometimes from the providers, sometimes from the staffing companies, about where the nurse labor market is today; how much burn out there is; people permanently leaving the health care system or moving to more 9 to 5 type jobs, if they're a clinic or what have you; and then their willingness potentially to reengage back into the site of care they were at before. I mean the fact that you're hiring more is, I guess, is a bullish sign. But like where do you see this ending up? Are we going to end up at a vacancy rate that is above where it was pre-pandemic? But better than where it is now? Or can we get back to where we were previously?

I think some of this is with us. Look, we had a nursing shortage well before the pandemic, and it was already a challenging environment, the pandemic just made it that much more difficult. If you look at the average age nurse in the United States, it's well into the 50s. So I mean it is -- that's an aging aspect. On a positive note, the applications for nursing schools have gone up, I think, since COVID. And that's going to be a longer-term part of the overall solution. When we think about labor, specifically around nursing, we think about retention. At the same time, we think about recruitment. Obviously, if you're not turning over your staff, you're not having to hire as many people. So we put just so much effort into our retention of our existing nursing staff from everything from education to certification. We make sure that we are paying a market-driven rates. We've done market adjustments in the past year, 1.5 years to make sure we are staying at or slightly ahead of the marketplace. So we're not having to have that excessive turnover. We've added significant resources into our talent acquisition team, both in Birmingham as part of our hospitals, as well as the home health team in Dallas. And we've grown more sophisticated about how we recruit. The nurses are looking for jobs in a different manner than they did several years ago. So things like platforms like Indeed and the algorithms that are out there to get in front of nurses with social media, and we just -- we've become much more sophisticated around that, which I think has led to some of our success with the ability to make Encompass Health known and the opportunities that we have for nursing positions. And we have 147 locations now. So we have a good geographic coverage across the United States that offer opportunities for nurses that want to be in certain parts of the U.S. And then finally, we brought on 8 new hospitals last year, and each one of those de novo hospitals. Proud to say we had no contract labor in the new hospitals. So that showed us that some of the functions around recruitment can be centralized as part of the talent acquisition team in Birmingham. They were the ones that helped us staff all the de novo hospitals. So we're learning as we go along. And I'd say we're getting more sophisticated about it. It's a changing environment. And if you're not first to market, if you don't -- if you're not the first one to reach back out to a nurse candidate that shows some degree of interest in your company, you're going to lose out to the five other opportunities they have out there. So we want to make sure we're very responsive to the changing marketplace.

And anecdotally, we've seen a couple of examples in our hospitals where nurses that left to go to acute have returned back to the IRF where they had worked originally.

I think that inflation is going to force some of the nurses back into the marketplace. And I think that there is some element of structural changes, but I also think that there's opportunity for nurses to kind of settle on the sideline and coming back into the marketplace now. And -- so I think that longer term, this will kind of resolve itself. But I think that all this unemployed nurses have had to look at different ways of appealing to the workforce, whether it's flexible scheduling or other benefits that need to be considered in there, and just try to get creative in a manner that maybe we weren't as responsive as an industry in the past to a changing workforce.

So is 4% to 5% wage growth on the IRF business, the way to think about 2023 as well? Or does it start to come back down to...

I'll put out there for our guidance considerations for this year. I'd like to think that there would be some normalization for next year. It's probably a little bit early to say on that. But we do think that there is going to be a certain degree of normalization in the labor force in the second half of this year. And hopefully, that will continue into 2023.

And how do you think about the ability of the company on both sides of the business to get the pricing you need to offset these labor pressures? I mean, usually Medicare is always a little bit low and a little bit lagged. So I mean, how does that work?

The Medicare rate increase -- let's talk about the IRF side of our business first. We get 1 rate increase a year. And that is typically kind of controlled by a rolling 4-quarter period, of which CMS is pulling data for. So to think that, that period is going to match up exactly with where our labor cost increase took place is a little bit unrealistic. So I think that the likelihood to catch up with the accelerated labor cost is more likely to be over more than one period. In other words, maybe part of it's this year, part of it's next year, and gets caught up to where that should be. On the -- and so on the home health side of our business, we're absolutely going back in, working with the contracts that we have, working with the payers that -- where we have opportunities to renegotiate with those payers. I think home health in the past has been a bit exploited because it's been a very fragmented industry. And so there's been an element of treating it a bit like a commodity by some of the payers, knowing that if one agency wouldn't care for the patient, well, there would be others that would be willing to step up. But I think that now going forward, the payers are looking for quality of care. There are differences among the various agencies and providers out there. And to get the quality you're looking for, you're going to have to account for the labor increase. And so I think that the environment is better now than what it's been in the past in terms of going back to the payers that are aware of what the labor market's like and having that negotiated in. On the hospital side, that will work its way in. We're now down to a differential between our MA reimbursement and our Medicare fee-for-service reimbursement of about 5%. And so we made great strides in our contracts with MA plans in terms of tying that to our Medicare fee-for-service CMG rate. So about 80% of our contracts now are on Medicare fee-for-service, much different environment on the hospitals than it is on home health with regards to the differential between MA and Medicare fee-for-service.

Yes. So I guess maybe to dig into that for a minute. I guess, first, on the Medicare rate in home health, there's a behavioral adjustment, which CMS hasn't officially backed off of yet. I mean what's the outlook there for kind of the rate update. We've seen the hospice freight, which was fine, I guess, but maybe probably insufficient...

I think people are tying it to what ended up in -- for the skilled nursing industry and what they did with that and assuming that, that is going to be the same for the home health. I don't think that, that is necessarily the case. They may choose to do that. But certainly, the industry is pushing back and saying, this is based upon data that's been collected during a period of pandemic. And that kind of data should not be used as a means of isolating and pointing at certain behavioral trends during a pandemic that would be conducive with the post-pandemic setting. And there are reports from Dobson DaVanzo that have produced data that would counter some of the assumptions that CMS would have to take into account in order to put in that 6% behavioral impact. So certainly, the industry is pushing back on it. But also be counter -- if you think about what the administration has done in terms of talking about the importance of health care in the home and how important that is going forward. And that is -- the health care inflation. So it would be very challenging for the industry to take that on right now during a PHE.

And then on the Medicare Advantage side, it would seem like the shift out of the inpatient into the home would be like the most obvious thing for managed care company to see the value of. So what has been the historical driver to those discounts? And how do you close that gap?

I think you do it with your quality data. And you have to make a value proposition. You have to separate yourself out from other providers in the marketplace. And so to the extent that your readmission rates are lower than others or your quality indicators or patient satisfaction, I think most of these firms will be data-driven. If you can produce the data and show them the value that it can bring, particularly in a longer-term time period of care for the patient.

We also have on the home health and hospice side, a team that works -- that has done work with ACOs and is now working on value-based care payment methodologies. So to the extent that, that's where managed care is looking to go, we already are focused on that.

And that that's a good point. I mean these additional resources, historically, we've not done a lot with the MA plans. And I think that we certainly try to focus in on Medicare fee-for-service and really target our marketing and sales efforts there. But I think longer term, we certainly realize that it's important to be involved with MA plans and have relationship with the MA plans that are out there and try to negotiate and work with them for contracts that are inclusive of the quality assumptions that would go along with the care for those patients.

And what is the delta right now between MA and...

Right now, it's about 40% discount between Medicare fee for service and that.

And for what it's worth, Humana this morning was talking about how they kind of felt like given the labor shortage and your incentive to focus on fee-for-service volumes over a discount, that, that might help narrow the gap a little bit. But they don't -- Kindred's -- maybe they're more open to your concerns than the typical MA company, but I guess there's some optimism there. And so then, obviously, the company is in the midst of a spin. And I guess from the outside at least, I think the perception has been this has taken a while. So can you talk a little bit about the process and where we are. And from here, when you think the resolution of the spend will happen.

Yes. So it has taken a while. I mean, this has been a very comprehensive process taken on by our board. We've utilized the outside firms. Our banking advisers are Citi and Goldman Sachs, and clearly, they're the best out there and walked out from a legal perspective. But we -- the Board started this process with no preconceived notion in terms of what the outcomes would be. They weren't -- they didn't go into this is going to be an IPO or a spin or sale. So we evaluated all the options that were out there. And we announced that we're going to be heading down the direction of the spend that would be the transaction that would be July 1. And the goal would be to do what's in the best interest of our shareholders and not do it with the mindset of what's the next 30 days in a very volatile market, but what's in a longer-term perspective and the best shareholders, and that's where we are now at spend.

Okay. Great. And then we think about the IRF business kind of the ex home health business. How are you thinking about the growth of that stand-alone business going forward?

Yes. So we're very excited about the growth of that business. So we mentioned earlier, we brought on -- so we've -- historically, if we had a 2 to 4 new de novo growth opportunity in hospitals, that was kind of our ongoing basis. A couple of years ago, we announced that we were going to go double down on that. And so last year, we brought on 8 new de novo hospitals. We'll bring on new -- 9 new de novo hospitals this year, and we have 10 that have been announced for next year. So our growth targets are 6 to 10 new de novo hospitals per year. We'll add somewhere between 100 and 150 bed additions to our existing hospitals every year. And ultimately, the discharge CAGR to be somewhere between 6% and 8%. And so we're very excited about the continued need for services. We really have accelerated the opportunities. If you look at certain states like the state of Florida that abolish their certificate need requirement a couple of years ago. That's an example of a state where we already had 12 hospitals in that state. We always knew the other markets, that if we just had the opportunity without the CON, that we'd quickly move into. And so we've been aggressively building new hospitals there. We've also built hospitals in some new states up in the Midwest area. And so -- and a portion of those are joint ventures with acute care hospital systems. Our portfolio of 147 hospitals right now have -- 54 of those are partnered with acute hospital systems, of which that remains part of our strategy. We've done this now for over 30 years with both academic [ micro systems ] as well as community-based [ micro systems ].

And how are you thinking about that pipeline longer term? To your point, like we actually know the numbers is not entirely Florida, but this ramp-up has happened once...

Yeah. I just used it more as an example because they -- we really accelerated our presence...

Is it -- so do you think that 6% to 10% is -- I mean, obviously, it's the right number for next year, too. But like is that the right number for -- through the next 5 years?

We think that's sustainable for the next 5 years. I mean if you look at the demographic tailwind, our average age patient is 76 for the next several years. I think the CAGR for Medicare beneficiaries in that age cohort is right at or close to 5 -- 4.8, 5. With the baby boomers entering that age cohort that drops down afterwards, but we've shown really nice track record with the de novo hospitals that we brought on. We have proven that we've shown a nice opportunity to take market share from other providers out there. I think that's one of the things. With COVID, we made the decision early on working with our clinical teams that we would take COVID patients. And not all post-acute providers took COVID patients. I think that was a great benefit to our referral sources. If you take into consideration, about 9% of the admissions into our IRFs come directly from an acute care hospital. So the acute care hospitals are working for post-acute providers that could work with them during COVID. And we already had a growing reputation for our ability to take on a higher acuity patient. And the last 2 years have really given us an opportunity to continue to develop that reputation in the marketplace. We've treated over 22,000 COVID patients now between our IRFs and our home health. I'm very proud of the way that we were able to get great outcomes for that. And I think reputationally, that has had some -- it's going to have some stickiness -- has had some stickiness in terms of the referral sources that we either had before COVID, but we just now to get more patients from, or referral sources that never really recognized us in the past, are now using us. So very pleased with the growth.

And how do you think about margins for that business? Because margins came down during COVID. And so would you expect to get back to pre-COVID levels?

This year, you have 2 factors on margins. You have not only the labor, but you also have sequestration. And so next year, that will start to anniversary throughout. And we think that when things start to normalize out, we can get back into that low 20% area on EBITDA margin.

And this ramp-up in de novo -- oftentimes, we hear a company talk about de novos and the startup losses and things like that. So I mean, that's kind of, I guess, a fully loaded number that includes this drag from this de novo development.

So it's about -- it's a little bit over $1 million in start-up costs per de novo. So just use that as a proxy.

Okay. Perfect. And then I guess the same thing on the home health and hospice side. I mean, how do you think about that business? And I think in particular, once you bought that business, there was a lot of opportunity to kind of bring the referral source from into home. How is that going to work post spin? And does it have an impact on the growth of that business?

So we refer to that as collaboration -- collaboration dealt with the patients that we discharge from our hospitals to home health and what we called our overlap markets where we had both the hospital and home health representation. We collaborated on the processes of everything that goes into clinical collaboration for a patient. So it's a smooth transition from the hospital to home health. What we've seen is that we could replicate much of that in marketplaces where we had willing home health providers, but we didn't have an Encompass home health provider. So we know that, that can continue with home health provider that is not owned by us. There are certain things that we have to be careful of since we won't own that company, there are HIPAA rules and compliance rules that we'll have to comply with that will -- puts in a position to do certain things differently. But the one thing that we think will stick are the relationships, the referral relationships and the service accountability that our home health has provided for our hospital discharges. So even though they'll [ recall it ] and have it, they'll be a separate company, many of these relationships, these referral relationships, will continue. And of course, patient choice is what drives that. But we think that we can have a higher quality with an organization that we can work well with and that will be Enhabit.

Okay. That's helpful. And I guess when you think about capital deployment on the IRF side stand-alone, with all these de novos, is that basically the free cash flow of that side of the business?

That's the focus right now in terms of -- we like to own our real estate and own 70% of our real estate. So we're investing in our growth and our opportunity to continue on with the de novo. And also, I mean, we love the bed additional strategy. That is a really good return there. So that 100 to 150 beds of bed additions to our existing chassis also a really great way for us to invest in our capital.

And then on the home health side, I guess, deals is still going to be there. How are you thinking about the deal pipeline there, multiples?

So we still continue to look at all opportunities that are out there. Historically, we have used $50 million to $100 million worth of acquisitions annually is kind of a marker for -- that was our growth marker on that. After July 1, they will clearly move on to a freestanding company, in which they will be reviewing the opportunities they have for acquisitions, but I think they'll be well positioned to take advantage of this fragmented marketplace. I do think that when -- a lot of the stimulus dollars that are working their way through the system go where I think there are going to be a lot of some of the small agencies that are going to be looking for opportunities for -- to be acquired.

Okay. And then, I guess, when we think about the home health asset -- it appears that the company, during COVID broadly, grew a little more slowly than where the peers were growing. So can you talk a little bit about why that was the case and if there's a reason to be...

On the health...

The health side, yes.

I think if you go back, a lot of that growth that some of our competitors have gotten were specifically from the MA plans. And that was one of the reasons that we've added resources that Mark mentioned earlier and gives us a better chance to go out and have a greater presence in terms of negotiating with the MA plans and being a provider and being part of their profile to care for their beneficiaries.

And then I guess when we think about the overall margin profile for that business, I mean, is that business under-earning today versus where you think it should be? I mean the labor problems are here, the volumes have impacted. It feels like there's opportunity there, but I don't know how you...

We have -- we think the long-term prospects for home health are very strong and that being for Enhabit. Certainly, between COVID the last 2 years and having an impact on volumes, and now you bring the labor component into that, this is going to normalize out. And so the longer-term prospects for Enhabit and the industry, I think, will be very strong. We're just in a period of transition right now that is putting a damper on some of the results that you see from an earnings perspective.

And then maybe just last question. On the IRF side, -- you mentioned that the de novo pipeline, you're increasingly doing JVs. Can you talk a little bit about what the benefit is of doing one with the JV versus doing it on your own? How do you think about that?

So if you look at our pipeline right now for de novos, about half of them involve joint ventures. We evaluate marketplaces, whether we should go into a wholly owned versus a partnership. Some of the hospitals that we're building are with partnerships. We already have one existing hospital, and they have expanded their presence and we're doing a second hospital with them. So we take it market by market. We have a great reputation as being a great partner. And in certain markets, it's just strategically more important for us to consider partnering than going into and building wholly owned. Or they've reached out to us. They have a small unit within their hospital and want to have a bigger footprint and they're looking for both expertise in operations and a capital partner.

I guess what is the benefit to you for doing versus having some economics and having...

So you're in a marketplace where they have a higher profile name. In some marketplaces, they have a strong presence there. They have an existing referral pattern. And you can go in and you can be part of that existing brand without having to start from scratch and developing your own brand in the marketplace.

All right. Great. That's all we have time for. Thank you very much.

Thank you.