Encompass Health Corporation (NYSE:EHC) Q1 2024 Earnings Call Transcript

Encompass Health Corporation (NYSE:EHC) Q1 2024 Earnings Call Transcript April 25, 2024

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Operator: Good morning, everyone, and welcome to Encompass Health's First Quarter 2024 Earnings Conference Call. [Operator Instructions] Today's conference call is being recorded. 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.

Mark Miller: Thank you, operator, and good morning, everyone. Thank you for joining Encompass Health's First Quarter 2024 Earnings Call. Before we begin, if you do not already have a copy, the first quarter earnings release supplemental information and related Form 8-K 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. 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 including the earnings release and related Form 8-K, the Form 10-K for the year ended December 31, 2023, and the Form 10-Q for the quarter ended March 31, 2024, 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. 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-K filed yesterday with the SEC, all of which are available on our website. I would like to remind everyone 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.

Mark Tarr: Thank you, Mark, and good morning, everyone. The broad-based momentum of our business continued in the first quarter evidenced by 13.4% revenue growth and adjusted EBITDA increase of 19.2%, owing largely to our Q1 results, we are increasing our 2024 guidance. Doug will cover the details of the quarter and increased guidance in his comments. Demand for [Earth] services remains strong, and we are continuing to invest in capacity additions to meet the needs of patients requiring inpatient rehabilitation services. During Q1, we added 51 beds to existing hospitals. Over the balance of the year, we plan to open 6 de novo hospitals with a total of 280 beds as well as a 40-bed freestanding hospital to be licensed as a satellite location of an existing hospital.

Consistent with our historical practice, the satellite will be accounted for as a bed addition. We anticipate adding another 93 beds to existing hospitals in 2024, inclusive of the aforementioned satellite. We continue to build and maintain an active pipeline of de novo projects, both wholly owned and joint ventures with acute care hospitals. Since the beginning of this year, we've announced 3 additional de novo projects, bringing our pipeline to 14 hospitals under development with opening dates beyond 2024. We -- we remain keenly focused on further enhancing the quality of our patient care and resulting outcomes through the deployment of clinical technologies and protocols. We have previously highlighted the installation of in-house dialysis capabilities at many of our hospitals.

We now offer this service in 88 of our hospitals and we'll continue the rollout to additional locations in 2024. As another example of an ongoing clinical project, our quality of life improvement project incorporates an individualized approach to inpatient care in which our therapists focus on a specific patient's interest, lifestyle, home improvement and community mobility needs. The goal of this program is to improve the patient's inpatient experience and readiness for discharge to their community. On March 27 of this year, CMS released the 2025 IRF proposed rule. This included a proposed net market basket update of 2.8% and which we estimate would result in an approximately 3% increase for our IRFs beginning October 1, 2024, based on our current patient mix.

The IRFs final rule is expected to be released in late July or early August. Review Choice Demonstration, or RCD, began in August 2023 in Alabama. Recall that under RCD Cycle 1, which lasted 6 months, every Medicare claim was reviewed for documentation and medical necessity. The affirmation rate target set by CMS under cycle 1 was 80%. All 7 of our Alabama hospitals ended Cycle 1 above the target affirmation rate. For Cycle 2 in Alabama, which runs from May 1 through October 31, we had the choice of continuing with 100% pre-claim review or a random spot check pre-claim review of 5% of claims. Based on our Cycle 1 claim experience, we elected to continue with 100% pre-claim review for Cycle 2. The target affirmation rate for Cycle 2 is 85%. On March 1, CMS announced it is expanding IRF RCD to Pennsylvania for hospitals billing to the Medicare administrative contractor, Novitas.

Our 9 hospitals in Pennsylvania will not be subject to RCD at this time as they build to a different Medicare administrative contractor. During Q1, many providers across the U.S. health care spectrum experienced significant disruptions due to the cyber-attack on Change Healthcare. We have historically used change for the vast majority of our claims processing across our payer base. Our teams and our centralized business office and information technology quickly rallied to successfully implement workarounds using alternative third-party vendors and enhancing our own claims processing capabilities. As a result of these efforts, we experienced minimal impact to our Q1 cash flow from the change outage. We resumed claims processing would change in early April and continue to maintain the alternative channels we recently developed.

Across our 160 inpatient rehabilitation hospitals, we are daily providing high-quality, cost-effective care to medically complex patients. Our dedicated clinical teams work collaboratively with physicians to administer this care, producing leading scores in patient satisfaction and quality outcomes. This value proposition increasingly resonates with patients, caregivers, referral sources and payers. The demand for inpatient rehabilitation services remains considerably underserved, and continues to grow as the U.S. population ages. We intend to continue to expand our capacity and capabilities to meet this need. Now I'll turn it over to Doug.

Douglas Coltharp: Thank you, Mark, and good morning, everyone. As Mark stated, we are very pleased with our Q1 results. Revenue growth for the quarter of 13.4% was primarily driven by volume as total discharges grew 10%, inclusive of 6.7% same-store growth. Q1 revenue growth did benefit from both leap year and the timing of the Easter holiday. Our Q1 revenue also included a $6.9 million increase in provider tax receipts, primarily attributable to prior periods. Q1 adjusted EBITDA increased 19.2% to $273 million, driven by revenue growth, stable premium labor trends and prudent expense management. Other operating expenses as a percent of revenue decreased 80 basis points, benefiting from the favorable impact of on-site dialysis implementation and efficiencies in our recruiting efforts.

Q1 adjusted EBITDA included approximately $5 million related to the aforementioned provider tax receipts. Q1 net preopening and ramp-up costs were $1.8 million as compared to $4.2 million in Q1 last year. Given the timing of our new hospital openings and the balance between joint venture and wholly owned de novos, our net preopening and ramp-up costs will be concentrated in the final 3 quarters of the year. We anticipate $15 million to $18 million of de novo net preopening and ramp-up costs for 2024 as compared to $6.6 million in 2023. We continue to generate significant levels of free cash flow. Adjusted free cash flow for the quarter increased 5.6% to $167.6 million due to higher adjusted EBITDA, partially offset by an increase in working capital which was unrelated to the Change Healthcare outage and higher cash tax payments.

Primarily based on the strength of our adjusted EBITDA growth, our net leverage again declined falling to 2.5x from 2.7x at year-end 2023. We ended the first quarter with no amounts drawn on our $1 billion revolving credit facility and more than $130 million of cash on hand. As Mark alluded to, based primarily on our Q1 results, we are raising our 2024 guidance as follows: net operating revenue of $5.25 billion to $5.325 billion, adjusted EBITDA of $1.03 billion to $1.065 billion and adjusted earnings per share of $3.86 to $4.11. The -- the key considerations underlying our guidance can be found on Page 12 of the supplemental slides. And with that, operator, we'll now open the lines for questions.

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