Encompass Health Q3 2023 Earnings Call Transcript

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October 27, 2023

There are 10 speakers on the call.

Operator

Good morning, everyone, and welcome to Encompass Health's Third Quarter 2023 Earnings Conference Call. At this time, I would like to inform all participants that their lines will be in a listen only mode. After the speakers' remarks, there will be a question and answer period. Will be limited to one question and one follow-up question. Today's conference call is being recorded.

Operator

If you have any objections, You may disconnect at this time. I will now turn the call over to Mark Miller, Encompass Health's Chief Investor Relations Officer. Please go ahead.

Speaker 1

Thank you, operator, and good morning, everyone. Thank you for joining Encompass Health's Q3 2023 earnings call. Before we begin, if you do not already have a copy, the 3rd quarter earnings release, supplemental information and related Form 8 ks filed with the SEC are available on our website at encompasshealth.com. On Page 2 of the supplemental information, you will find the Safe Harbor statements, which are also set forth in greater detail On the last page of the earnings release. During the call, we will make forward looking statements, which are subject to risks and uncertainties, many of which are beyond our control.

Speaker 1

Certain risks and uncertainties like those relating to regulatory developments as well as Volume, bad debt and labor cost trends that could cause actual results to differ materially from our projections, estimates and expectations are discussed in the company's SEC filings included in the earnings release and related Form 8 ks, the Form 10 ks for the year ended December 30 1, 2022, and the Form 10 Q for the quarters ended March 31, 2023, June 30, 2023 September 30, 2023 when filed. We encourage you to read them. You are cautioned not to place undue reliance on the estimates, projections, guidance and other forward looking information presented, which are based on current estimates of future events and speak only as of today. We do not undertake a duty to update these forward looking statements. Our supplemental information and discussion on this call will include certain non GAAP financial measures.

Speaker 1

For such measures, reconciliation to the most directly comparable GAAP measure is available at the end of the supplemental information, At the end of the earnings release and as part of the Form 8 ks filed yesterday with the SEC, all of which are available on our website. I would like to remind you that we will adhere to the one question and one follow-up question rule to allow everyone to submit a question. If you have additional questions, please feel free to put yourself back in the queue. With that, I'll turn the call over to Mark Tarr, Encompass Health's President and Chief Executive Officer.

Speaker 2

Thank you, Mark, and good morning, everyone. We're very pleased with our 3rd quarter results, driven by continued strong volume growth and a substantial year over year reduction in premium labor costs. Our 3rd quarter revenues increased 10.8% and adjusted EBITDA increased 21.6%. Q3 total discharges increased 7.3% with same store discharges up 4.3%. Our strong volume growth continues to underscore our value proposition to referral sources, payers and patients.

Speaker 2

Our patient acuity continued to broaden with more normalized patient flows through the healthcare system. Stroke discharges were up 5.8% year over year, while knee and hip replacement and fracture of the lower extremity Discharges grew approximately 14% in the aggregate year over year, though off a relatively small base. Given the strong demand for inpatient rehabilitation services, we have continued to invest in capacity additions. We opened 140 bed de novo in the 3rd quarter, bringing us to 6 de novos year to date. We also added 26 beds to existing hospitals in the 3rd quarter for total capacity additions of 340 beds over the 1st 9 months of 2023.

Speaker 2

Based on favorable weather conditions And construction efficiencies, we are accelerating the opening of our Fitchburg, Wisconsin Hospital from Q1 of 2024 to Q4 of 2023. As a result, We now plan to open 2 de novos in Q4 and add 5 beds to existing hospitals, resulting in a total of 4 41 beds for the year. 3 of our bed addition projects originally scheduled for 2023 have shifted to 2024 due in each case to local permitting issues. As a result of this shift, we expect to add more than 150 beds to existing hospitals in 2024. We continue to build and maintain an active pipeline of de novo projects, both wholly owned and JVs with acute care hospitals.

Speaker 2

We currently have announced 18 de novos with opening dates beyond 2023. During Q3, we again met the increasing demand for our services, while reducing contract labor and sign on and shift bonus expenditures. Contract labor was down approximately $6,000,000 or 24% From Q3 of 2022, while sign on and ship bonuses decreased approximately $10,000,000 or 41% from Q3 of 2022. For the 2nd consecutive quarter, Our talent acquisition efforts resulted in over 200 net same store RN hires. Please be mindful that hiring results may vary significantly from quarter to quarter based on seasonality and other factors.

Speaker 2

Review Choice Demonstration or RCD began on August 21st in Alabama. Recall that under RCD, every claim is reviewed for documentation and medical necessity. We elected pre claim review as we believe it allows for a more iterative process and the potential for real time adjustments. Our results thus far are encouraging. The affirmation rate target set by CMS under RCD is 80% of claims submitted during the 1st 6 months and our affirmation rate is well above that.

Speaker 2

Given our Q3 results and expectations for Q4, we are updating our 2023 guidance to include Net operating revenue of $4,770,000,000 to $4,800,000,000 Adjusted EBITDA of $940,000,000 to $955,000,000 and adjusted earnings per share of $3.41 to $3.52 The key considerations Underlying our guidance can be found on Page 12 of the supplemental slides. Now with that, I'll turn it over to Doug for further color.

Speaker 3

Thanks, Mark, and good morning, everyone. As Mark stated, we are very pleased with our Q3 results. We continue to see significant improvement in year over year premium labor costs. Our Q3 contract labor Plus sign on and ship bonuses of $33,300,000 was comprised of approximately $18,900,000 in contract labor and $14,400,000 in sign on and ship bonuses. This compares favorably to $24,800,000 in contract labor and $24,200,000 and sign on and ship bonuses in Q3 last year.

Speaker 3

Contract labor utilization declined year over year and sequentially. Q3 'twenty three contract labor FTEs of 388 represented a 19% decline from Q3 'twenty two and an 18% decline from Q2 of 2023. Contract labor FTEs as a percent of total FTEs was 1.5%, A 40 basis point decline from Q3 'twenty two and a 30 basis point decline sequentially. Agency rates declined year over year and were up modestly sequentially. Our Q3 'twenty three agency rate per FTE was approximately $192,700, down from approximately $204,600,000 In Q3 'twenty two, I'll remind you that rates are impacted by the license level of the clinician utilized as well as by geographic specific market conditions.

Speaker 3

Sign on and ship bonuses decreased $9,800,000 or 41 percent from Q3 'twenty two and were roughly flat sequentially. As we consider contract labor and ship bonuses for Q4, it is worth noting that holiday coverage typically requires premium pay rates. Partially offsetting the benefit of lower premium labor costs in Q3 was an increase in our internal SW per FTE rate. This rate, which excludes contract labor And sign on and ship bonuses increased 6% over Q3 'twenty two, similar to the level of increase we saw in Q2. The increase was attributable to proactive market adjustments, primarily for nurses, higher compensation for new hires and planned merit increases.

Speaker 3

These actions are contributing to our success in new hiring and improvement in turnover. Our updated guidance assumes a continuation of this trend in Q4. In line with expectations, EPOB for the quarter was 3.41, an increase From 3.39% in Q3 'twenty two and from 3.38% in Q2 'twenty three. Revenue reserves related to bad debt increased 20 basis points to 2.2% as a result of write offs of older claims Denied by the Departmental Appeals Board, which we have elected not to appeal to federal district court. Our de novo and bed addition strategy continues to generate solid growth and contribute to share gains.

Speaker 3

Our de novos performed exceptionally well in Q3, contributing $900,000 in adjusted EBITDA. This brings year to date net preopening and ramp up costs to $7,600,000 We still expect full year preopening and ramp up costs to be $10,000,000 to $12,000,000 due to the opening of 2 hospitals in Q4 and the cost we expect to incur in Q4 for hospitals scheduled to open in the first half of twenty twenty four. As can be seen on Page 14 of the supplemental information, the acceleration of our Fitchburg opening into 2023 And the progress on a number of pipeline projects scheduled for 2024 2025 has led to an upward revision of our 2023 de novo capital expenditures estimate to $315,000,000 to 325,000,000 Year to date adjusted free cash flow of $432,200,000 represented a 47% increase from the 1st 9 months of 2022. As can be seen on Page 13 of the supplemental information, We have updated our assumptions for certain cash flow items contributing to an increase in our 2023 Adjusted free cash flow estimate to $445,000,000 to 500,000,000 Finally, we ended Q3 with a net leverage ratio of 2.8 times, down from 3.4 times at the end of 2022.

Speaker 3

Our balance sheet and liquidity remain well positioned. With that, we'll open the lines for Q and

Operator

A. At this time, we will open the floor for questions. Our first question will come from Kevin Fischbeck with Bank of America. Please go ahead.

Speaker 3

Hey, morning, Kevin. Hey, good morning, Kevin. Good morning.

Speaker 4

So I guess, we'd like to ask about labor. Obviously, a lot of progress on Contract labor expense and sign on bonuses. But overall, the wage outlook has gone up and now we've seen sequentially Contract labor wage has gone up for a couple of quarters now. I mean, how would you characterize the overall labor market today? And how do you think about the ability to if this year you've had the benefit of contract labor coming down, how do you think about the ability to manage through With the labor pressure into next year?

Speaker 4

Thanks.

Speaker 3

Hey, Kennen, this is Mark.

Speaker 2

As you know, we've made really nice progress On the contract labor side and the premium pay categories, I would characterize it's still very tight market out there. Certain markets are A little bit more challenging than others to find staff. We've done a really nice job in terms of our recruitment of our ends, which is The most challenging segment of our staffing base at this point, but I think we've Put systems in place and have the initiatives at our hospitals to be successful going into next year and Competing very strong in this really tight market.

Speaker 3

Yes. Just to add a couple of things to that, Kevin. First of all, I think what you're seeing in terms of the sequential increase in rates Has more to do with the fact that as we reduce our reliance on contract labor, what we're seeing is more of a concentration at Higher license levels and in those geographies that are more expensive and where it's a little bit tighter. So some of that is kind of self fulfilling. As we look to 2024 from a premium labor perspective, we think that it's either going to be stable or improving further.

Speaker 3

We've been successful in getting the contract labors, FTEs down to 1.5%. That's not where we were pre pandemic, which was just under 1%. Do we think that there's an opportunity for further progress? Yes, but at minimum, we don't see that ticking back up above that. Then we also think that with regard to the 6% increase in SW per FTE that we've been running this year evidence the fact that we've been able to hire 404 or 402 Net new RNs in each of the last two quarters, we believe that we've hit the right level excuse me, that was over the last two quarters Cumulative.

Speaker 3

We believe that we've hit the right level in terms of being able to procure that new talent And our turnover has been reduced as well. And as a result of those factors, we don't think that we're going to have to anniversary another 6% on top of the 6 This year, we would expect labor inflation to moderate considerably next year.

Speaker 4

Okay. That's helpful. And then I guess as far as volumes go, there's been a lot of talk about seasonality and Normal seasonality, I guess, where do you think that you are in the industry is as far as IRF volumes? Are we back to kind of Normal and normalish growth from here? Is there any pent up demand?

Speaker 4

How are you thinking about This is as a base for future growth, but also seasonality. Thanks.

Speaker 2

Ken, we've commented In past quarters, and I think that holds true now is that the pandemic gave First, a real chance to show the difference in post acute settings and I believe that We have continued to take market share from skilled nursing facilities or other areas that otherwise may have taken Similar types of patients. And so I think we're well positioned going forward to continue to provide value to referral sources and the payers.

Speaker 3

As you think about our discharge growth for the second half of this year, of course, Q3 we just reported, Recall that we are up against more challenging comps from last year. In the back half of last year, total discharge growth was running north of 7% with more than 4% of that coming from same store. And so we really felt like the seasonal patterns started to reestablish themselves in the second half of this year And it feels like that is continuing this year. With regard to pent up demand, there's no doubt that we are seeing an increased flow Of some of those lower acuity hip and knee replacements that Mark described, What's offsetting some of that is a reduction in COVID patients. And so it's the demand that we're seeing in those categories is actually probably a little Higher than might otherwise show through into the total discharges.

Speaker 3

But generally speaking, it feels like we're kind of back into our traditional seasonal flows.

Speaker 5

Great. Thanks.

Operator

Thank you. Our next question will come from A. J. Rice with UBS.

Speaker 6

Hello, EJ. Good morning, guys. Thanks. Hey, how are you guys? First question was more technical.

Speaker 6

You're highlighting this $3,500,000 write off of the de novo project. I don't There's any background on that. It's sort of unusual for you not to move forward with 1. But I mean, my main point on that is you've updated the guidance. It looks like you're including that, so that the actual underlying increase in operating results is a little more than on the Surface might include, but I want to just confirm that.

Speaker 3

No. And A. J, I'm sorry we didn't make that more clear in our materials. That write off is below the adjusted EBITDA line. And you're right, it's less unusual in terms of the fact that we're Deciding not to press forward with a de novo project and more unusual in terms of its scope.

Speaker 3

We're managing an active pipeline of approximately fifty Projects and then what you don't necessarily see is there are about 20 behind that that are in what we in eloquently describe as exploratory mode. We will from time to time and we have in the past have a project that for various reasons sometimes it's getting hung up in the CON process We'll elect not to move forward with. In almost all instances, those items are less than $1,000,000 We had one that Approximately $1,000,000 it was actually included in Q3. What was unusual about this project is that we had gotten further along. It's a project in the Midwest with an existing joint venture partner.

Speaker 3

We had acquired some land. We were actually doing some of the site work. Unfortunately, every time we refined our estimate for the cost to build this facility, it was getting worse And worse in a way that we weren't able to use some of the other offsets we've effectively used on other projects. In addition to that, this was a particular market where the labor market conditions were moving in an adverse direction as well. So we had some difficult talks with our joint venture partner, but ultimately we concluded together that it did not make sense to press forward at I really view that as an anomaly given its size because it's unusual for us to get that far down the path Before we make that kind of decision, I don't think it speaks to any lack of enthusiasm with regard to our

Speaker 6

Okay. All right. And maybe just to follow-up, I'll take a stab at this one. I know you're not going to give formal 2024 guidance Until you report Q4 or at least till around the 1st of the year, but you've talked about labor inflation moderating Some of the things around volume and de novos, what in your mind are the puts and takes we should keep in mind as we're trying to As you said right now and think about next year?

Speaker 3

I think you hit on the keys, which is one, we look at volume growth heading into next Obviously, we'll be up against challenging comps, given the good discharge growth we've had this year, but we're going to benefit from the continued maturation Of 25 de novos that were added from 'twenty one through the end of 'twenty three and the addition of 150 beds to existing hospitals, And we do anticipate that moderating labor inflation will occur as we anniversary the percent increase in SWFTE we're anticipating for 'twenty three. Those are going to be the primary drivers.

Speaker 6

Okay. Thanks a lot.

Operator

Thank you. We'll take our next question from Brian Tanquilut with Jefferies.

Speaker 2

Hey, Brian. Good morning, Brian.

Speaker 7

Hey, good morning, guys. Congrats on the quarter. Doug, I guess my first question is, I think about your revised guidance for the year and What you've reported so far in the 1st three quarters, the Q4 kind of is a little different from typical seasonality in terms of contribution to the year. So just curious, Is there anything we should be thinking about in terms of what that like sequential decline or flattening that's implied in the guide for Q4? Thanks.

Speaker 3

Yes. So as we move into Q4, we're obviously benefiting from the price increase. Not surprisingly, because we have really kind of established Normalized seasonal flows, we would expect discharges from Q3 to Q4 to be kind of relatively flat In that range, so you're not getting a pickup there sequentially. You're consuming a pretty good chunk Of the pricing increase with the merit increase, which was a little over 3%. And then we're also anticipating That you'll see somewhat of an increase, which is not atypical.

Speaker 3

It was a little bit of an anomaly in Q4 last year in the length of stay And then just kind of some regular way increases in supplies in OOE, some of which is attributable to Seasonality. So not a lot to call out there. And again, it's You had a very strong Q3, so it's not surprising that we're kind of calling the ball here for Q4.

Speaker 7

Okay. That makes sense. And then Mark, maybe as I think about your comments in the release on or in the slide deck on pricing on the commercial side, How should we be thinking about commercial price trend, or managing our price trend as we look at 2024?

Speaker 2

We continue to work on payers as we've done in past quarters with the MA Contract negotiations we've had as we move more contracts towards CMGs, you're starting to see Less of the differential between the fee for service Medicare and MA plans. I think it was down to 3% or 4% Differentials last quarter, so we continue to make progress there. And I think you expect to see that going forward.

Speaker 3

Yes, Brian, the other thing I'd call out as you think about the movement from Q3 to Q4 is the impact of 2023 de novos. As we discussed in our comments earlier, we had a really strong quarter in Q3 where those Actually contributed $900,000 in EBITDA, but we're still anticipating that the preopening and ramp up costs for the full year We'll be in that $10,000,000 to $12,000,000 range, which implies a $3,500,000 to $5,500,000 swing the other way in Q4.

Speaker 5

Got it. All right. Thank you, guys.

Operator

Thank you. Our next question comes from Pito Chickering with Deutsche Bank.

Speaker 3

Hey, good morning, Pito. Hey, there, guys.

Speaker 8

You've got Kieran Ryan on for Pito. Thanks for taking the questions. Thank you. You mentioned that the hip and knee patients continue to present at a pretty good rate in 3Q, and I know you called out Some strong ortho demand in the 2nd quarter. So I guess just could you just comment on if that strength in ortho continued into 3Q and If there's any other specialties you want to call out, whether that's neuro, stroke or anything like that?

Speaker 2

We continue to see Growth in our stroke program, I think as I noted in my comments, around the orthopedic, Pete, it was just kind of getting back to normalized flow that we had seen prior to the pandemic. So it's not an area that is growing off of a very large base, but we have placed a huge focus over past several years in growing our stroke program, we've seen nice gains on that. We've seen nice gains in other neuro and continue to focus on those categories.

Speaker 3

Again, these are some smaller categories, but brain injury was up 8.6%, Cardiac was up 2.4%, so a little bit lower there. Major multiple trauma up 10.4%. This was a quarter again and we discussed this more in Q2 where the strength of our discharge growth Was across patient categories and across very broad based across geographies as well, which is encouraging to us.

Speaker 8

Awesome. Thank you. And then just quick follow-up, would you be able to give an update on RN turnover? I think You were running at 22% year to date after 2Q. It sounded like maybe a little bit more sequential improvement there or?

Speaker 2

Our most recent quarter and most recent trend on a month basis has us at that 22%, 23% Turnover rate continued. What we have seen progress on, we've put a lot of focus on is the turnover within 1 year of Hiring of the RNs and that's an area that we knew we could see improvement on. We've seen improvement on that. We've put a lot of focus on The orientation and on boarding of our nurses, which we think will help us longer term And continuing to hold or decrease that turnover rate.

Speaker 3

It's important to note as well, we tend to focus on the nursing, But our therapist turnover on a year to date basis at the end of the 3rd quarter was less than 8%.

Speaker 8

Thanks so much.

Operator

Thank you. Our next question will come from Matt Larew with William Blair. Please go ahead.

Speaker 2

Hey, Matt. Good morning, Matt.

Speaker 5

Hey, good morning. A follow-up a bit on the patient mix question, but obviously, it was another strong quarter on the MA side as it has been Really for the last several quarters in particular. And just so similar to Kieran's question, any particular patient categories or any trends to call out on the MA side?

Speaker 3

So if we look at in aggregate at MA, for the quarter total MA discharges were up Approximately 13%, that takes us to just under 18% on a year to date basis. And importantly, when you look in the same store for MA, it was 11% for Q3 and just under 15% On a year to date basis, continue to see very good growth in MA for stroke patients. But one of the things that we've highlighted with regard to Overall discharge growth in MA is our value proposition now seems to be resonating with those MA plans across a broader patient spectrum. So we're seeing the broadening of the acuity there as well.

Speaker 5

Okay, thanks. And then just to follow-up on the hospital that you pulled forward from 2024 into 2023, What really allowed you to accelerate that opening process? Is this related to that pre fabrication that you've been doing or is this More of a licensing or staffing issue and depending on what it is, can you apply this to the extensive pipeline you have in place right now?

Speaker 3

Yes. So we'll be honest with you, the single biggest factor was favorable weather patterns. But it was also then we are getting more efficient with regard to the utilization of prefabrication, so that contributed. We've been stating all along that our objective with regard to the moving to full prefabrication Was to realize a 15% cost reduction versus conventional and an improvement of 25% in terms of speed to market. So we're not quite there yet on all of the projects in the pipeline, but we're making good headway.

Speaker 2

We've had good luck with staffing in that marketplace So it was all around the construction side and not about staffing or just being prepared to take that first patient.

Speaker 5

All right. Thank you.

Operator

Thank you. Our next question will come from Ann Hynes with Mizuho Securities.

Speaker 2

Good morning, Anne.

Speaker 9

Hi, good morning. So the ramp up cost of $10,000,000 to $12,000,000 this year, is that a good number to use for 2024 Moving my first question. And then secondly, is there anything on the regulatory or legislative side that is on your radar for 2024? Thanks.

Speaker 3

So, Ed, on the first one, haven't quite put a pencil to it yet for 2024, I think it's probably a pretty good proxy since we opened 8 this year and we're looking to open up another 8 next year.

Speaker 9

Okay.

Speaker 2

And we continue to stay focused on the regulatory side, everything from Discussions around MedPAC was site neutral to we commented here on RCD and There are other things out there, but I would say those two things are closest to mine right now.

Operator

Thank you. At this time, we have no further questions in queue. Will turn the call back to Mark Miller for any additional or closing remarks.

Speaker 1

Thank you. If anyone else has additional questions, please call me at 2059705860. Thank you again for joining today's call.

Operator

This does conclude today's call. We thank you for your participation. You may disconnect at any time.

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Earnings Conference Call
Encompass Health Q3 2023
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