Enhabit, Inc. (EHAB) Earnings Call Transcript & Summary

All right. Good morning, everyone. We're going to get started with our next session. I'm Jamie Perse, the health care provider analyst at Goldman Sachs. We've got Enhabit Home Health & Hospice. And with us, Barb Jacobsmeyer, President and CEO; and Crissy Carlisle, CFO. I think you guys are going to start with some opening comments. So I'll turn it over to Barb.

Okay. Great. Thank you. I just have a few things to cover this morning. Okay. So our last few quarters, we've seen the success of the strategies that we had put in place. And so when we look at our 2024 priorities, it's really been focusing on stabilizing that Medicare fee-for-service mix and our growth for home health really coming as a result of adding more of the frontline clinicians as well as having more of the payer contracts to be able to offer to our referral sources. For hospice, it's really been, if you think last year, the focus was on stabilizing the capacity for our clinicians in the field, and we put that case management model in place, which has helped us with the recruitment and retention so that we could really turn the focus now on business development, growing that census and gaining that operating leverage in the hospice fixed cost structure. And then de novos. We talked about real [Technical Difficulty] each year. Last year, we were able to add 8 of those 10 with the other 2 opened so far this year because we were ready, but the licensing surveyors had not been out to license those. And then continue on our people strategy, which has been very successful for us as we look to add more of the full-time nurses and now also focusing on therapy to increase the clinician count in the field. When we talk about the stabilization of the traditional Medicare, our home health business historically had a really high mix of Medicare business. A lot of that was because of the collaboration efforts with the Encompass Health first at the time. We do anticipate our mix shift to more follow industry levels going forward. That growth in Medicare Advantage elections really increase the relevance of a home health provider being seen as a full-service provider to referral sources. So when you think of between 2020 and 2023 enrollment, Medicare Advantage increased 29%. And so a referral source really looking at a provider saying, I need you to take care of all of my patients, not just one subset of patients. [indiscernible] our innovation strategy has really had a lot of success. When you look at quarter 1 of last year, only 6% of our non-Medicare visits were in those payer innovation, those better paying contracts. That has improved to 38% in quarter 1 of this year. And that's really helped driving that increase in our non-Medicare revenue per visit. Looking back at 2022, that was around $136 a visit. In the first quarter of this year, we realized $145 a visit. So we think about home health, really, again, it's about our increased clinical capacity and using those favorable contracts to be able to grow. When you look at those percent of total admissions, the purple is the fee-for-service Medicare and the orange is the payer innovation admissions. So again, quarter 1 of last year, only 58% were in those better paying groups. That left 42% of those admissions in really the less than desirable payment contracts that improved in quarter 1 of this year to 71%. So the more and more we can move to those payer innovation contracts, the more that also helps us offset any impact on that fee-for-service Medicare. And so we'll use the continued growth in our contracts. We now have 64 new contracts since our spin. We still have a pipeline of 30 new agreements and 28 historic agreements that we are working to renegotiate. So using those agreements, our staff and then utilizing technology like Medalogix Pulse really to help us manage those visits per episode so that we can see more patients with our clinical capacity we have today. Hospice, as I mentioned, was really about stabilizing the clinical staff. So putting that new staffing model in place in 2023 was critical to not only eliminating all the capacity constraints, but also the success in the recruitment and retention, so we could eliminate all the contract labor. And now the focus has really turned to building out those sales teams. And in addition to that, we've added admission departments regionally so that we can be more centralized in how we are handling that referral to admission process and being as timely as possible to give an answer to our referral sources. Our de novo strategy, again, we've opened 15 de novos since 2022 and continue on our goal of 10 de novos each year. A little bit more hospice than home health as we would like, where possible to have hospice where we have home health. And then again, our focus on our people strategy. This is something we've been really successful with. We just, in the first quarter, did our employee engagement survey, and we saw our Net Promoter Score in that top 25% of health care. So really pleased in the engagement of our employees. And it's why I think we've done such a great job earning recognitions over the years as being a top place to work. So we're very confident of the long-term outlook for Enhabit. Again, the demographics haven't changed. That aging population continues to grow. We're going to see a 5% CAGR in that addressable market of that aging population. We continue to be the lowest cost setting for health care, about 10x lower cost than your other care settings. So as everyone is working to manage those resources and those costs, home health and hospice is a great place to turn. And 77% of those age 50 or over has said, I would like to age in place. I'd like to age in what I call home, and again, home care being the place of choice for the care if and when possible. So for Enhabit, our longer-term outlook, when we look at, again, the new payer innovation contracts, the staffing that we've had in place, we have seen some nice growth over these past few quarters. So we expect to continue to grow at a mid- to high single digits over the next 3 years, again, with our ability to serve more referrals through those contracts and the clinical capacity that we have increased. For hospice, we have seen sequential monthly growth in our census this year. So this kind of shows by month where we've been each month growing our census, so we do expect hospice volumes to grow at a mid- to high single digits over the next 3 years, again, leveraging the investment that we put in the case management model and the build-out of our business development teams.

Then in regards to free cash flow, we continue to generate a significant amount of free cash flow each year. That free cash flow allows us to fund operations, service our debt and grow our business. In regards to funding our operations, we've only drawn on our revolver onetime post-spin, and that was the fourth quarter of 2022 when we executed 3 acquisitions and had a $15 million deferred payroll tax payment related to COVID relief efforts. Those stacked payments were well over $50 million. And even then, we only drew $20 million on the revolver, and we've already repaid $10 million of that. For servicing our debt, our current free cash flow priority remains delevering. And we recognize where we are with our leverage. We believe that the stabilization of EBITDA as well as the $20 million of required amortization on our term loan will help us to delever in 2024. I think in regards to growing our business, we believe that growth through new locations is a very important part of our strategy. As Barb already mentioned, we have a strategy to open 10 de novo locations per year. That's about a $2 million to $3 million minimal investment in those locations. We can build off the existing brand recognition where we already have home health as well as co-locate, which helps with some of the real estate related costs of the double location. We do continue to diligence opportunities that come our way. But having said that, we also, at the same time, acknowledge where we are with our credit agreement and our leverage and pay very close attention to any strategic opportunities in new markets, specifically in CON-type states where we would have to go in through an acquisition. I would also point out that we're always evaluating our capital structure and working with our financial advisers as well as our banking partners to evaluate opportunities to improve that capital structure.

Okay. Great. Well, thank you for that helpful overview. There's a number of things going on with the company. I'm going to focus mostly on fundamentals, but maybe one kind of corporate question to start. You sent a letter to shareholders last night. You've just come through this strategic review. I guess I'd ask it in this way, having gone through these processes and still very much in it, has anything changed in terms of your assessment on what you need to do to create shareholder value or key priorities? I mean you just laid out the 2024, but beyond that, more broadly, key priorities to address some of the concerns out there and create shareholder value?

Sure. I would say that remind folks that we've been a stand-alone company for 7 quarters. So we're still relatively new. We -- I feel that have been very confident in the strategy that we have established. Our Board helps and pushes us. We have a lot of expertise and skills with our Board. For example, things with payer innovation, technology, HR, things that really help us think differently as we're developing our strategies. And as we've shown, we've had a couple of quarters here in a row that we've been able to show that those strategies do work. They take time. But we don't see any shift in our strategy. We feel that what we're doing is working, and again feel that between the clinical capacity and the payer contracts, in particular, that we'll continue to see the progress that we've been making.

Okay. Great. I guess one of the biggest challenges you guys have faced has been just this mix shift from Medicare fee-for-service to Medicare Advantage, and the lower payments that come with that. At a high level, I mean, you guys have characterized it as once you get to industry average mix, that will stabilize and you're now at the industry average mix. I guess my question is, I've never really understood beyond the IRF Encompass headwind, why you'd be losing Medicare volume at the level of the referral source? So you've been adding incremental MA payers. Presumably, that increases your partnership, the value you can offer to your referral sources. Why is it that Medicare volumes at the referral source level have been kind of under pressure?

Well, it's for two reasons. One, we certainly -- everyone is seeing that shift right to Medicare Advantage. If you remember back even before the spin, there were data points that CMS was saying that Medicare beneficiaries, 50% would choose an MA plan by the year 2030. And actually, we hit that already last year. So there has been a more drastic shift to Medicare Advantage than I think anyone anticipated. And how that impacts us, and we heard it loud and clear from our business development team members is that everyone is wanting that fee-for-service mix. So when you go to a referral source and at the time, if someone only had a 20%, 25% of their patients in an MA plan, then maybe they were okay giving more of their fee-for-service to a certain provider. But when they started seeing that being more 50-50 and a provider would come in, and this is what our business development teams would say, I go to a referral source and they say, I can't have you coming in saying you only can service 1 or 2 types of patients. I need you to be able to service all my patients. And so it's been critical for us to be seen as that full-service provider to be able to service more of them. And you're right, we've seen the progress of getting on the contract. But I would say that it was very important that we had the new national agreement in May of last year and then really important to add the new national agreement in January of this year because that is a faster, more addressable market that we can serve with those providers.

And I guess just at the level of the sales force and how they're approaching these referral sources, and again, that process of competing for referrals. Has anything changed in the incentive structure for your team in terms of targeting Medicare patients or being accommodated trying to build volume with some of your payers? And anything that has changed on that front?

Sure. I would say a couple of things have changed. One, in how we look at the market. So we do spend a lot of time -- there's a team in Dallas that helps the business development team look at Medicare claims data, look at the MA data, and say, for example, if you're in a market that we've just signed a group of contracts, where are those patients today? Who are the referral sources that are servicing them? And what does their Medicare mix look like? So as we're helping to develop and redevelop books of business for our sales team members that we're really having them spend time concentrated in area that not only can we service these new contracts, but there's also a healthy mix of fee-for-service business. That does change. Give you an example, if it's a salesperson that has historically gone into like a senior apartment setting, it may be that has been a great place to be for years. But if there's been a really strong salesperson for one of the MA plans in there, you can see the dynamics change in that building rapidly. And so it's important for us to always be assessing and reassessing. And then for the sales team, yes, they are -- we have structured it for our sales team where there's tiers, and they get credit based on tiers of the types of the referrals that they receive and the admissions that come in. We will tier so that they -- it's not only about what the contract pays, but it's also about the back end. So a contract can look really good as far as what they'll reimburse us. But if we find that it's very cumbersome and we get denials on the back end and there's a lot of administrative work, a payer could move from being a Tier 1 to a Tier 3 or 4 depending on that entire process from referral submission to payments. And so they are tiered by that.

And is Medicare fee-for-service kind of top tier?

Medicare fee-for-service is top tier. We do have some of those regional agreements, though, that now pay us the same. And so they would be in that same top tier as fee-for-service Medicare.

Okay. And I think we're all looking for signs of stabilization and you've got some maybe early data points that the fee-for-service business has stabilized. You talked about the 3% sequential increase. I think looking back, and this is not apples-to-apples because as episodic and non-episodic, but 2 of the 4 prior years were up [Technical Difficulty] than 1Q. I'm just trying to get a sense of what normal seasonality looks like? And if this 3% sequential admissions increase in fee for services, how much confidence that gives you and stabilization and the outlook from here?

Sure. So you're right. Last year, we also saw that sequential from Q4 to Q1, it was about 1.9%, I think, if I remember right. And so we were pleased to see that be a 3.4%, some seasonality with that. But again, we continue to monitor that. It's really at a local level. We have 3 of our regions, 6 total regions for home health, 3 regions where they have completely stabilized, not losing Medicare fee-for-service year-over-year, the 3 regions that have struggled. And so we've worked with the sales team on what are the best practices, what are they scripting, how are they building out their book of business, what are things that we can learn from those that have been really successful to share with the other regions that are still struggling.

Okay. Let's go to the payer innovation side of things. You guys have you signed a little bit over 60 new contracts, a couple of them be national agreements that have really shifted the value proposition to the referral sources. I guess, first, it seems like the first contract was probably the hardest, and it got easier from there as you go. First you're negotiating now from a relatively better position. And two, you've built this muscle, you've been through the process a number of times. So talk to us about how the dynamics and the negotiating process with payers has changed? And if that's leading to kind of better outcomes and more recent contracts have yet to come?

Sure. So well, there definitely was a complete shift when we developed the payer innovation strategy. Prior, the company had a strategy where it was just basically just contract terms. And again, we all know that those discount rates were not ones that were sustainable. And so we really did restructure it that it is a complete value discussion, bringing the metrics, showing particularly those readmission rates because that can make a meaningful difference for a payer, challenging them to go back and look at their own member database and see what are your readmissions so that you can compare it to what we've done. . So you're right, those first few discussions really helped us build out kind of our presentation. I would say on the regional side, it does feel like there's a quicker cadence to getting across the finish line. I think because sometimes you can have more of the decision-makers around the table at the very beginning. It still is incredibly long to get that negotiation at a national level. Those have taken upwards of 12 to 18 months. And again, I think that's because you're working with one group and then they have to go to their economic group. And so there's just a lot of layers at the national, but we certainly have refined over time those data points, and I think that's helped us to be able to get the better rates that we're getting.

In terms of getting to a point where you can offer kind of -- you can cover all the patients that these referral sources might have. Now another roughly 60 targets. Some of them are renewals, some of those are new contracts that you need to add. How close are we to getting to point where you feel like you can compete for the majority of the business in these market?

Well, I think we are back at the table renegotiating with the other large national agreement that went into place in 2021. That's an important part of our strategy on either we're going to be successful with that, or at the same time, we're working with our team to move away as much as possible so that if and when we have to make a decision to walk away, we have very little risk to that. And that's kind of where we're approaching it now with even these regional renegotiation ones. If we're in a market that we have good coverage absent them, frankly, if we can't get a better agreement renegotiated is easier for our sales team to say we're not in network than to be in network and hesitate to take it. So I keep telling our team members in the field, my goal is within the next year or so, that they don't even think so hard, that the only thing they have that they can accept is what they want to accept. And so we really want them to not have to be putting so much brain power into making decisions on referrals as they come in, but to be in a place that we are contracted in servicing those that are willing to pay for high quality.

And in terms of the cadence of getting [Technical Difficulty] contracts in place. Any color? I recognize that the nationals will be on a slightly different time line than [Technical Difficulty], but there's a lot more of the regional plans. So any thoughts on just how we should think about getting through this [ 61 ]?

I think it is -- even within the regionals, there's a big range. Some of them work in parallel that when you're negotiating and reviewing contracts and reviewing the terms of the contracts, they're working in parallel to credential your locations. Others wait until you're done with all the negotiations before they credential. So it's really, really hard to say because it can be, again, from 3 to 4 months up to a year. But I would also say is that this is not the list that then we're done. We are constantly getting feedback from our business development team letting us know there may be what feels to us a very small agreement. But if it is an important agreement for a large referral source then we add it to our list. And so it feels like there's always new plans coming up and they may be small at this point, but if it's meaningful in that market or to that referral source then we're going to add them to our list. So the list we have, we'll continue to add based on feedback from the field.

Okay. And obviously, you've had pressure on the fee-for-service side. The MA side has had tremendous growth in volume. You just presented mid- to high single-digit volume growth outlook for admissions. I guess, first, just a clarification is that -- is the base 2023, so it includes 2024? And just -- why is that the right number? Why do you have confidence in that outlook?

Yes, the base is 2023. Think of it kind of as a 3-year CAGR. And we're confident based off of the trajectory that we're seeing predominantly in the non-Medicare business, right, Medicare beneficiaries continue to choose Medicare Advantage. And as we continue to not only grow the number of contracts we have, but also to improve those rates, it's to our advantage to continue to shift into, again, what we refer to as payer innovation contracts. We're very confident between that and the success we're having with those contracts as well as just the demographic trends themselves, that the mid- to high single digits is the right number.

And you said it's a CAGR-ed. Are you saying you can be mid- to high single digits each of the 3 years? Or in 3 years looking back retrospectively...

3 years looking back, it will be in that mid- to high single digits.

Sort of an accelerator.

That's right.

Okay. Maybe moving to hospice. You've stabilized sort of the labor piece there, case management model. I guess what has that done for you over the last [Technical Difficulty] so what do you expect going forward? You gave a few data points on April and May and the progress you're seeing month-over-month. But what's your confidence [Technical Difficulty] that continuing as a function of the labor you [Technical Difficulty]?

So I think that the patients are certainly there. It has been a journey, right? I think there's a lot of folks that have wondered why couldn't you be building out business development while you were doing the case management model. And a lot of it was because the sales team and the business development team want to say yes, right? It's very discouraging to say, yes, today, no tomorrow and they just feel like they can't be out or committed to the referral sources. So it was important that we had that stabilization and that we eliminate those capacity constraints. When we knew we had done that, we did hire 3 new VPs midyear last year. Those 3 VPs of business development all came from competitors with deep hospice experience. That part has been important as they have now started to add the direct salespeople in the field as well as helping us build out, again, our book of business there. We, I think, had overcorrected. We had tried to make sure that we didn't have a lot of cap exposure. And I think, unfortunately, while we really eliminated the majority of our cap exposure, I think we overcorrected and really spent a lot of time with referral sources that had very short length-of-stay patients. We need to find a balance to that. And so that's really been the focus now is to say, yes, we want to be seen as a good provider to the acute care hospitals to the facilities but we also need to make sure that we're out there with the physicians and the other referral sources that have those patients that we can have that balance is, frankly, that's how we will continue the traction and growing the census.

And I guess this touches on both businesses, but you've talked about clinical efficiency and trying to get your teams to operate at the top of their license, you provided some data points on that. It seems like there's room to grow there. Just give us a sense of where you are in some of the other key labor initiatives as well as hiring, just the environment you [indiscernible] across both businesses?

I'll talk about the labor environment and then the efficiency. On the labor environment, we, again, have done a great job on the recruitment and the retention. I will say though, now that we have our own data and our own data warehouse, we've challenged ourselves to look at the data on our hiring and our retention. We were able to see that last year, half of our nurses that left us left in the first 6 months of employment. And so it really begs the question -- obviously, there's room for improvement on onboarding, but it begs the question on are we hiring the right individuals in the beginning. We did see more and more candidates coming from facilities that frankly were burned out on high volumes of patients that they were having to care for. But what you find is if they've never had exposure to caring for people in the home, it is a very different environment. And so what we're really working now is to say, what does that picture look like of the right candidate so that we can be more selective. We saw in the first quarter, a 30% increase in our Nursing Canada pool. That to me tells us then that we can be more selective now so that we can have that greater success of retention. We see that when nurses and therapists are with us a year or longer, they stay. It's really making sure that we're doing the right hiring and the right onboarding. So that's kind of from the labor front. On the efficiency front, it really is about using the tools that we have for home health, using not only Medalogix Pulse to determine the right care plan, but now the leader is seeing a dashboard of their patients and saying, if I'm a leader and I look at my dashboard this morning, and I have my low risk, my medium and my high-risk patients. If I notice that they all have the same visit scheduled, that's a problem. My high-risk patients should have more visit scheduled. My low risk should not have the same. So we've really talked to them that their most precious resource is their clinical resource. We have to use it wisely. So if I have a very low-risk patient, and maybe I can make a virtual visit or a phone call, and I can use that visit to do a new start of care. So that's the tools that we're using to increase that efficiency on the home health side as well as our optimization, which is the work at the top of your license. So it's really important for us. Most of our clinicians are salaried, so we need to make sure, for example, that our RNs at that local level are fully productive and then add an LPN so that we can work on those optimization goals. On the hospice side, it's really using -- use another tool from Medalogix, let them use to really help us see where is that patient in their journey? Where are they? And are they getting close to transition? We want to be out there as much as possible in that last week of life. But it's understanding, again, if I'm the case manager, the nurse case manager, I look at my patients today and say, we're instead of just thinking about visits, where do I need to be? Where maybe can I make a phone call? How do I manage my patients so that they're getting the best care for what they need today?

Okay. And a similar question on the outlook you provided on the hospice side, mid- to high single digits. I guess what's the timing in terms of getting there sustainably? I assume it's also a CAGR of 2023, and it will ramp. But I guess what data points can we look at externally as leading indicator? Is it all about the labor growth and adding clinical capacity? Just give us [Technical Difficulty]confidence there.

That's right. The big driving factor is the fact that we no longer have any clinical capacity issues in our hospice segment. And then as we continue to build out our business development team and able to increase the admissions and regain some of the lost referral sources, that's what's going to drive it. And you can see the trend that we've had every month in 2024 that was included in the slides that we just showed, and seeing that ramp up in the ADC or average daily census.

Okay. I guess going to the -- you've just come off all the TSAs with Encompass. I guess just on the P&L, can you talk about the cadence for the balance of the year, in particular, the cost piece as you've rolled off those TSAs. What efficiencies can you drive from that perspective? And what's the change from 1Q kind of fully roll off the TSA?

Yes. So the dollars in the TSA for the first quarter were only $100,000. As we've noted previously, all that was remaining by the time we got to the first quarter was just the people [Technical Difficulty] financials part of the transition in that -- that happened early to mid-March of this year. So the payment to Encompass is only [Technical Difficulty] you're not talking about a lot of TSA-related dollars. Our goal, of course, is to ensure we have the infrastructure in [indiscernible] our clinical team so that they can provide the best patient care and focus on patient care within the field. . I think it's fair to say that we're at a run rate of about $27 million to $28 million of home office costs per quarter. Going forward, I think our teams have done a good job of managing the stand-alone cost. You may recall that, at the time of the spin, we were talking about a $26 million to $28 million addition per year. And based on our efforts, we've ended up around 23 to 24 of those stand-alone costs. So a good job analyzing that and minimizing it to the best that we could. But again, I think that, that $27 million to $28 million per quarter is a good run rate.

Okay. And your margin outlook for the year, the implied midpoint is consistent with 1Q. I guess just talk us through puts and takes relative to that. What are some of the headwinds that you're offsetting? And what are the opportunities to kind of improve margins [Technical Difficulty] longer term?

The biggest headwind we face is certainly no big secret, right? It's Medicare reimbursement. It's not adequate to cover the inflationary cost that we're experiencing, especially with wages. I think that the payer innovation contracts and the improved rates we're seeing, those improved rates dropped to the bottom line, right, the cost to treat that patient, whether they're traditional Medicare or Medicare Advantage is the same. And so that's going to be the margin difference is our success in continuing to get improved rates as well as shifting into the payer innovation contract.

Okay. And on the cost per day or cost per visit, these have come down to 3% type of range. I know some of that's contract labor coming out, but how should we think about the next 1 to 2 years? Are those levels may be adjusted for contract labor, just give us how to think about that?

Yes. I think that, again, the 3% wage seems to be a normalized level. When we talk about 3%, remember that on the cost per visit side of a home health, 90% of our cost is labor and benefits. And we feel good about kind of a 3% merit cycle on each year for right now based on what we know. There will be pockets we expect, there to be pockets geographically where we may have to make some market increases. But again, we think that through the optimization of our staff and some of the use of Medalogix Pulse in that right care plan sizing that we can continue to offset some portion of that.

Okay. That only helps us then help drive that productivity [Technical Difficulty] and really logistically keep clinicians in a smaller geography. And so that not just helps how many visits they can get, and so that growth also helps us on that productivity and optimization side.

Okay. And I think the claim that you guys are presenting as you're pretty close to stabilization of these pieces in place, and here, we should start to see more consistent acceleration in volumes and [Technical Difficulty] kind of that guidance today. How should we think about that translating revenue growth and longer-term margin potentially? And I think back to the IPO, and I think that mid-teen-ish type of EBITDA margins, a lot's changed since then in terms of mix profile of the business, but how should we think about the next phase? And if you are able to execute on these objectives, what that means in terms of growth outlook and margins over the next [Technical Difficulty]?

And again, I think it comes down to Medicare reimbursement and the uncertainty that we have there and what they come out with, and we'll know soon enough what the proposed rule says later this month or early part of July. And then our ability to continue the payer innovation strategy. And again, we've demonstrated our success there and have no reason to believe that we'll not continue, and then again, optimizing our clinical staff.

And I guess closing with one last one just on the capital position. You've presented 70-ish percent type of free cash flow conversion. I guess, one, is that sustainable right away to think about free cash flow conversion. And then two, just the cadence to improving the balance sheet position leverage. Some of that's just a math exercise. But I guess what else can you do to kind of accelerate and prioritize getting back to both capital position?

Yes. I tend to think of our free cash flow conversion more in that 50% range. I think some of what we saw in the first quarter was timing of working capital. Payroll and receivables sometimes make a big difference in that. So I tend to think of it again more as 50%. So if you use that 50% free cash flow conversion and think about $20 million of required amortization on our term loan, and $2 million to $3 million per year on de novos, the rest is up for grabs, and priority right now would be repayment on the revolver to continue to delever. We do, as I mentioned, continue to diligence acquisition opportunities. And if we saw something strategically, we'd certainly consider it, but that remains the priority right now.

Great. Well, I think with that, we're out of time. Thank you, Barb and Crissy for joining us.

Thank you.

Thank you.