Enhabit, Inc. (NYSE:EHAB) Q3 2023 Earnings Call Transcript

Enhabit, Inc. (NYSE:EHAB) Q3 2023 Earnings Call Transcript November 11, 2023

Operator: Good morning, everyone, and welcome to Enhabit Home Health & Hospice’s Third Quarter 2023 Earnings Conference Call. At this time, I’d 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. [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 Jordan Loyd, Enhabit Home Health & Hospice Director of Investor Relations.

Jordan Loyd: Thank you, operator, and good morning, everyone. Thank you for joining Enhabit Home Health & Hospice’s third quarter 2023 earnings conference call. With me on the call today are Barb Jacobsmeyer, President and Chief Executive Officer; and Crissy Carlisle, Chief Financial Officer. Before we begin, if you do not already have a copy, the third quarter earnings release, supplemental information and related Form 8-K filed with the SEC are available on our website at investors.ehab.com. On Page 2 of the supplemental information, you will find the safe harbor statements, which are also set forth on the last page of the earnings release. During the call, we’ll make forward-looking statements, which are subject to risks and uncertainties, many of which are beyond our control.

Certain risks and uncertainties that could cause actual results to differ materially from our projections, estimates and expectations are discussed in the SEC’s filings under the Form 10-K and subsequent quarterly reports on Form 10-Q, each of which will be available on the Company’s website once filed. We encourage you to read them. You’re 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 and the earnings release.

I would like to remind everyone that we will adhere to one question and one follow-up to allow everyone to ask a question. If you have additional questions, please feel free to rejoin the queue. With that, I’ll turn the call over to Barb.

Barb Jacobsmeyer: Thank you, Jordan. Good morning, and thanks for joining us. Let me open by thanking our 11,000 employees. This is an incredibly dynamic operating environment, and I’m so proud of our staff remaining focused on providing a better way to care for our patients, their families and each other. We are excited to be listed as number 42 in the U.S. News’ Best Health Care Companies to Work For. U.S. News ranked the top 379 publicly traded companies spanning 20 industries, analyzing publicly available employee sentiment and other data that demonstrates how a company supports the everyday experience of its workers. Recognitions like this are important and reflect our commitment to our team and their commitment to our patients.

I want to remind everyone that the purpose of today’s call is to discuss our financial and operational results and outlook. As previously announced, we commenced a strategic review process. Our Board is conducting a thorough process with the assistance of our advisers, and discussions with interested parties are ongoing. We will not be commenting beyond that, and so we ask that you keep your questions focused on our business and our results. We have a lot of important updates to discuss with you today, including the final home health rule, continued improvements in labor recruitment, retention and cost and progress with payor innovation. Let’s begin our updates with the final home health rule. CMS finalized a permanent adjustment cut that will result in a negative 2.6% impact, offset by a positive market basket update of 3.3%.

After productivity adjustments and fixed dollar loss ratio adjustments, the result is a positive 0.8% versus the proposed negative 2.2%. The continued march of these cuts where the home health community does not know what to expect from Medicare year after year is not helpful in creating a stable home health landscape. In fact, it is detrimental to larger policy goals of providing equitable, high-quality health care to seniors in their homes. While this final rule means we will be receiving less of a cut than under what was proposed, it does not restore home health reimbursement to where it should be. We know for a fact that CMS’ market basket projections have missed actual market basket increase figures by more and more each of the past few years.

Between 2021 and 2022, CMS’ final market basket projections missed the actual market basket increase by a combined 5.2%, but no corrective action has been taken. We anticipate this year’s update, ultimately, will also fall short of the actual market basket cost increase. Importantly, the advocacy efforts that we and the entire home health community are presently undertaking with Congress, the administration and in the courts will not stop merely because Medicare decided to cut home health marginally less than what was proposed. While the cut amounts are concerning at any level, the bigger issue is the fact that the permanent cuts and the ongoing threat of future temporary cut clawbacks created damaging overhang on the industry and adversely affect the availability of home health care services.

While our payment update does not cover our inflationary costs, we are working diligently to remain competitive for our highly skilled workforce. We will continue to manage our resources as efficiently as possible to meet the needs of our patients and the needs of our partners in the care continuum. Turning now to an update on staffing. We are very pleased with the continued success of our recruitment and retention of clinical staff. Recall that during the second quarter of this year, we had 200 net new full-time nursing hires. During the third quarter, we added another 166 net new home health full-time nurses, and we continue to hire for additional growth. With this success, we have eliminated all hospice nursing contract labor and are on track to have substantially all home health nursing contract labor eliminated by the end of the year.

Our home health team continues to do a great job managing productivity and optimization of our clinical staff. Our cost per visit increased 1.1% year-over-year as improved nursing productivity and optimization offset the impact of merit and market increases for clinical staff. For hospice, the implementation of the case management model and industry standard provides Enhabit with a platform for growth, driving positive recruitment and retention and addressing capacity constraints. This platform will allow us to grow and control our average daily cost per day. While cost per day increased year-over-year, it has now been stable over the past three quarters. With our hospice locations now fully staffed, we hired three new business development leaders with a combined 50 years of experience working with other hospice companies in the industry.

We are pleased to be able to turn our focus to growth versus managing capacity challenges and are optimistic as we head into 2024. And now let’s talk about our continued success with payor innovation. The strongest value proposition in our negotiations with payors continues to be our low 30-day hospital readmission rates, which is 20% better than the national average. Our payor innovation team has continued to succeed in demonstrating this value proposition to Medicare Advantage payors. We had another strong quarter, negotiating 11 new contracts, 10 of the 11 are episodic agreements. Since the inception of the payor innovation team last summer, we have successfully negotiated 48 new agreements, 2/3 of these are at episodic rates. Our home health business development and branch operation teams have been successful in moving volume to our payor innovation agreements.

During the third quarter, we admitted over 6,000 patients within our new contracts, that 72% sequential growth in admissions under these agreements. Remember that in quarter two, our new 2023 national agreement was effective for only two months. In the second quarter of this year, 10% of our non-episodic visits were in the new payor innovation contracts. In the third quarter, this grew to 22% of our non-episodic visits. We continue to estimate that every 5% of visits that shift from previous non-episodic payor contracts to new non-episodic payor innovation contracts represents an approximate $2 million increase to revenue and adjusted EBITDA annually. We are confident in our ability to make continued improvement in Medicare Advantage pricing and in the shift of our Medicare Advantage admissions to these improved payors.

Some payors are now recognizing the variation of quality results within the industry and are willing to pay for access to high-quality providers like Enhabit. Our success in staffing and nursing productivity and implementing the hospice case management model and our ongoing payor innovation contracting and in building on the quality of our services are examples of our continuing investment for the future to meet the growing needs of home health and hospice services. I will now turn it over to Crissy, to further discuss this quarter’s results, guidance and the 2024 outlook.

Crissy Carlisle: Thanks, Barb. Consolidated net revenue was $258.3 million for the third quarter, down $7.4 million or 2.8% year-over-year. Adjusted EBITDA was $23.2 million, down $8.5 million or 26.8% year-over-year. We estimate the continued shift to more non-episodic payors in home health, decreased revenue and adjusted EBITDA, approximately $8 million year-over-year. In our Home Health segment, total admissions increased 1.6% year-over-year, as continued strong growth in non-episodic admissions offset a reduction in episodic admissions. Our non-episodic visits grew to approximately 31% of our total home health visits in the quarter. This represents an approximate 800 basis point increase year-over-year and is consistent with the percent we reported in Q2 of 2023.

While we are making significant progress demonstrating our value proposition to payors as we negotiate new agreements with improved rates and are successfully shifting Medicare Advantage volume into our payor innovation agreements, the revenue and adjusted EBITDA impact from this volume shift has not been enough to overcome the financial impact from the erosion of Medicare fee-for-service volumes. We estimate the impact of this payor mix shift was approximately $8 million, net of the impact from improved pricing and payor innovation contracts on revenue and adjusted EBITDA during the third quarter. In our Hospice segment, admissions decreased 3.4% year-over-year, while average daily census decreased 2.8% year-over-year. Sequentially, admissions increased 1.6% over the second quarter.

Our monthly average daily census trended up each month of the third quarter and this positive trend continued in October. This is the first positive trending we’ve experienced since November of last year. And as a reminder, the hospice final rule for fiscal year 2024 went into effect on October 1, 2023, and is expected to increase our reimbursement rates by 2.9%. Over the past two quarters, you’ve heard us talk about the diversification of our referral sources and the expansion of the number of admissions coming from facilities. These patients tend to be admitted to hospice care later in their journey. This diversification of referral sources is lowering our hospice cap exposure. With the hospice Medicare fiscal year ending on September 30, we’re pleased to report that we had only one location with approximately $20,000 of cap exposure.

This is a significant improvement from 2022 during which we have four locations with a combined cap exposure of approximately $1 million. Our Home office, general and administrative expenses increased to 10.2% of consolidated revenue, primarily due to merit increases, investments in talent acquisition and employee development and a declining revenue base. We have now anniversaried our stand-alone company costs. These costs totaled $5.8 million in the third quarter of this year compared to $5.5 million in the prior year period. By the end of June this year, we transitioned all services from Encompass Health, except for certain technology services. All that remains as of today is the transition of our PeopleSoft Financials and HR systems, and we expect to complete that transition of those services by the end of Q1 2024.

Let’s transition now to the balance sheet. Information on our debt and liquidity metrics is included on Page 15 of the supplemental slides. We regularly assess our financial performance and evaluate that performance against our obligations including those in our credit agreement. As we continue to work with our advisers as part of our strategic review and with uncertainty in the debt markets, prior to the close of the third quarter, we proactively reached out to our bank group and received a waiver for the Q3 2023 covenant period. This waiver was obtained out of an abundance of caution. We ended Q3 with a leverage ratio of 5.14x versus a covenant of 5.25x. As you can see from our financial performance and Q3 leverage position, the waiver we proactively obtained was ultimately not needed.

Over the last few weeks, we continue to work with our bank group to amend our credit agreement to provide additional cushion to the financial covenants. As part of this amendment and as shown on Page 16 of the supplemental slides, we secured financial covenant relief for the six quarters ending Q1 2025. The levels we requested and received, like the waiver, were done out of an abundance of caution as we continue to operate in an industry with shifting dynamics in payor sources and reimbursement. It’s notable that the financial information provided to the bank group for the amendment process was before the issuance of the final home health rule. The amendment to our credit agreement includes a permanent reduction in our revolver commitment to $220 million.

As of today, we have $180 million drawn on the revolver, leaving us with $40 million of availability. As a reminder, we have drawn on the revolver only once since our separation from Encompass. That draw was made in the fourth quarter of 2022 when we had three acquisitions and a $15 million deferred payroll tax payment associated with COVID relief efforts. That represented over $50 million of stacked payments and we only drew $20 million on the revolver. Since that time, we’ve repaid $10 million of that draw with cash on hand of approximately $30 million and the $40 million of availability under our revolver, we believe we have adequate liquidity to support our operations, including our de novo strategy. Let’s turn now to guidance. Our greatest challenge in forecasting relates to the shift of Medicare eligibles into Medicare Advantage and forecasting not only the mix of traditional Medicare admissions versus Medicare Advantage admissions, but also forecasting the shift of Medicare Advantage into our payor innovation contracts.

While our progress with our payor innovation agreements has been strong, it has not been enough to overcome the negative impact of the continued erosion of Medicare fee-for-service volumes. As a result, we revised our full year 2023 adjusted EBITDA guidance to a range of $93 million to $98 million. In regards to free cash flow, we generated approximately $48 million during the first nine months of 2023. Free cash flow in the fourth quarter is dependent on the timing of working capital needs, specifically accounts receivable. Based on our revised guidance, we expect to generate between $50 million and $67 million of adjusted free cash flow in 2023, which equates to a free cash flow conversion rate of approximately 54% to 68%. Before opening it up for Q&A, I want to touch briefly on our outlook for 2024.

It’s too early to provide specifics, but these are the factors we are considering as we think about next year. Let’s start with our Home Health segment and pricing. Based on our preliminary analysis of the final rule, we expect our Medicare pricing to increase approximately 1.2% in 2024. And we expect our Medicare Advantage pricing to improve based on the success of our payor innovation team, including a full year of impact from the national agreement that became effective May 1, 2023. In regards to volumes, we expect the success we’ve had with our payor innovation team and our recruitment and retention of clinical staff to drive volume growth in 2024. With our traditional Medicare mix of Home Health revenues now in line with our peers, we expect the continued decline in our traditional Medicare volumes to slow to a more industry-like rate in 2024, and the new episodic payor innovation contracts will provide an avenue of growth to offset some of the continued erosion of traditional Medicare in the future.

On the cost side of the equation, we believe a 3% wage increase will be sufficient to maintain our success with recruitment and retention. And we are also closely monitoring the results of the Medalogix Pulse rollout that was completed in Q3 to determine what impact it may have on our 2024 visits per episode. For our Hospice segment. For pricing, we expect our reimbursement rate will increase approximately 2.9% for the first three quarters of the year based on the final rule. For volumes, we are clinically staffed to grow and are working with our talent acquisition team to further build our business development team for growth, and we are starting to see the results of those efforts with monthly sequential increases in average daily census.

In regards to cost, we expect our cost per day will not increase in 2024 as we expect volumes to increase without the need to hire a significant number of additional staff, resulting in operating leverage against the fixed costs associated with our case management staffing model. Based on these factors, we believe the Company is well positioned for revenue and adjusted EBITDA growth in 2024. With that, I’ll ask the operator to open the lines for Q&A.

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Q&A Session

Operator: [Operator Instructions] Our first question will come from the line of Brian Tanquilut with Jefferies.

Brian Tanquilut: Crissy, thanks for all the color that you shared with us. So maybe just to kind of like dig a little deeper into some of these comments. As I think about cost per visit, what do you think operationally you guys will need to do between now and into next year to drive EBITDA growth, especially as we think about the CPV line?

Crissy Carlisle: Well, I think, again, it gets down to productivity and optimization, Brian. We really focus on the density and scale of our markets. And we’ve demonstrated our ability to offset that 3% wage increase even in 2023. And again, we expect to continue to do that in 2024, again, as our volumes continue to grow.

Barb Jacobsmeyer: And Brian, I’ll add to that. I think the other thing to keep in mind is that we did use more contract labor this year, mainly because we had success with hiring. So as we’ve kind of talked about before, we tended to use contract labor more when we knew that there was an end in sight in employees coming out of orientation. So being able to now get rid of that by the end of the year will also create an opportunity for us on that cost per visit in 2024.

Brian Tanquilut: That’s really helpful. And then maybe I just think about the top line, right? And your comments on fee-for-service volumes and the new payor innovation contracts. How do you think, number one, how should we think about the remaining opportunity to drive new contracts into the system? And then within the existing contracts, obviously, there’s a ramp there. How should we be thinking about the runway left on that ramp and what the right sort of mature level would be for some of these wins that you’ve had over the last year?

Barb Jacobsmeyer: Yes. I mean I would say, other than the national agreement, many of these are at a regional level. So it’s really hard to give numbers consolidated when we look at so many of the regional contracts that cover multiple states. What I would say is that the branch directors and the business development folks in each individual market have now the tools in place to be able to prioritize that. We also have gotten continued feedback from our sales team in the field on what other payor agreements would be helpful to be on to be seen as a more full-service provider. So in addition to our success, we still have another 40 contracts in our pipeline that are being worked today. So again, it’s about really the execution at that local level on driving the volume, not only into the new payor innovation, but to utilize that longer list of payors that we can take to also continue to earn that fee-for-service business.

Operator: Your next question comes from the line of Joanna Gajuk with Bank of America.

Joanna Gajuk: So I guess a follow-up to the comments around the Medicare rate update, right? So you said 1.2% and the wages growing 3%. So you’re saying essentially, you assume the volume growth will help you offset or — that 3% cost inflation, right? And in the end, the combined entity, you expect EBITDA to grow. Is that a way — how to think about it?

Barb Jacobsmeyer: Well, certainly, I think as we look to giving guidance in 2024, we’ll certainly have more details around them. But I would say it’s volume growth, it’s continued focus on productivity and optimization. It’s getting rid of all the contract labor and then it’s also the visits per episode that we rolled out in Medalogix Pulse to all of the locations by the end of the third quarter. So there will be kind of a combination of the offsets that we’ll have a lot more color on as we prepare for ’24 guidance.

Joanna Gajuk: Obviously, understood, yes, there’s going to be a more detailed guidance, but to figure it, I just asked that. And then my other question, and I guess a follow-up to some comments around pricing and then in segments. In the slides, you talk about revenue reserves, I guess, benefiting the pricing in segments. So what was this, I guess, benefit, I guess, in the quarter in millions of dollars? And how should we think about this impacting Q4, if at all?

Crissy Carlisle: Yes. So Joanna, remember that in the spring of this year, we disclosed a material weakness in regards to our accounts receivable reserves and revenue reserves and took a $12 million adjustment in the fourth quarter of 2022 based off of that analysis. We noted at the time that as we continue down the path of remediating that material weakness and redesigning our controls around that process, that if and when we got to a point that we believe the $12 million was overly conservative that we would inform the community and take that back into revenue. And that’s what we did in the third quarter, we’ve redesigned the controls at this point, and they’re still in the process of being tested. But again, based off of this redesign, we determined that we were able to take that $1.5 million on a consolidated basis of that reserve.

And so that was the net impact to the Company in the third quarter of this year. It’s too early to say what would happen in the fourth quarter. It’s something that we’re continuing to look at, again, as we test the operating effectiveness of the redesigned control. But again, the Q3 impact was a $1.5 million good guy.

Joanna Gajuk: And I mean, but it sounds like you do not assume a similar benefit in Q4, correct?

Crissy Carlisle: I think it would be premature to assume such.

Operator: Your next question will come from the line of Whit Mayo with Leerink Partners.

Whit Mayo: Just looking at the 10 new MA contracts that you guys signed in the third quarter, does this cover where you have 1% of your current admissions, 50% of your admissions? I’m just trying to visualize the coverage aspect of these new contracts to figure out how impactful this really could be.

Barb Jacobsmeyer: I don’t know that I know it by admissions. That’s why we’re looking at — as we look at our visits, what percentage of our visits from our prior ones can we move in. As I think we’ve talked about in the past, the initial goal is not necessarily to focus on those for additional growth, but to be able to move from some of those really poor paying non-episodic agreements into these new agreements. So at this stage, that’s been the focus, and that’s why the plan is continue to update everyone on where we are with that percent of non-episodic that are in these new payor innovation contracts.

Whit Mayo: No, that’s helpful. I appreciate it. And then maybe my follow-up question. And I know, Crissy, you’re in the middle of the planning process or beginning the process. But how do you think of the right corporate overhead costs for next year? I didn’t hear you talk about that. Presumably, you probably need to reload for some of the bonus accruals, maybe there’s some opportunities to bring that down with some of the transition costs from a former parent company or something, I don’t know. But just any thoughts there would be helpful.

Crissy Carlisle: Yes, Whit, you’re absolutely right. It’s a little too early for me to give specifics on that. I think the best guide that I would tell you right now is, again, we’re really closely monitoring all of our corporate costs, and you’ve heard about some of the actions that we’ve taken in the latter part of this year in regards to items like virtual clinical orientation, even not the home office, but looking at some of the back-office staffing of our hospice locations and such and the moves that we’ve made in order to control those costs. I do think it’s important to note that you can look at kind of the $5.8 million of stand-alone company costs that were in the third quarter. That may increase slightly in the fourth quarter and first quarter of next year, again, as we kind of continue to roll off of the final big piece, the PeopleSoft piece being the biggest piece of IT from Encompass, but it may be — what I’m looking at right now is, are we running towards the lower end of that original $26 million to $28 million estimate of stand-alone cost, and even possibly running under it on a go-forward basis.

So I think that’s what I’m very interested in at this point.

Operator: [Operator Instructions] Your next question will come from the line of Jamie Perse with Goldman Sachs.

Jamie Perse: I wanted to get a little bit more color on just what you think is going on with the Medicare fee-for-service business, that being down 11%. I know you guys have been asked about this in the past and have said the markets are down 4-ish percent. So is there a reason that you think at this point you can diagnose why you’re underperforming the market? And then relatedly, I mean, just what gives you confidence in the comments for ’24 that you’ll be more in line with market growth and fee-for-service?

Barb Jacobsmeyer: Yes. So I think probably the biggest thing to look at is where our peers have been as it relates to a percent of their home health revenues being fee-for-service Medicare. And our peers have been pretty consistently in that 60% to 65% range over the last few years. As we noted, we’re at 65% this quarter. And so we are nearing more of that normal range of our peers versus our historic 75-plus percent. So that’s what gives us confidence that we’re really more at a peer average now, so that what we should experience in the future will be more like what our peers are experiencing as folks move into MA from traditional fee-for-service Medicare.

Jamie Perse: Okay. And then I also wanted to follow up on the comments next year around Medicare Advantage pricing growth. I don’t think you gave a number there, just said you thought it’d improve with the mix shift towards the payor innovation contracts. But I guess, one, what’s included in those comments with respect to the United contract. Any color on where you are in that negotiation process and how we should think about the potential rate update for that contract next year? And then any more precision you can provide on MA pricing next year would be great.

Crissy Carlisle: Yes, Jamie. It’s too early, and I don’t know that we would provide precise pricing, especially on a specific contract because that’s kind of forbidden via the agreements themselves. We like the trends that we’re seeing, again, as we continue to shift more visits into the payor innovation contracts, but I’ll certainly keep your request in mind as we head into 2024 guidance and determine what we are willing to say and what we can say within the confines of our agreements. Again, from a per visit pricing, our agreements are kind of coming in at that 25% to 30% discount compared to the historic 35% to 40% discount. So we like what we’re seeing there and are confident in our ability, based on what we’ve seen thus far in 2023 and our ability to shift into the higher paying contracts.

Jamie Perse: Okay. And if I could squeeze one last one in, just following up on an earlier question. What’s been your contract labor expense for ’23? And would it be right to assume most of that goes away next year?

Barb Jacobsmeyer: I have — we can certainly get you the expense side. I have the utilization side of it. So when you look at — and this is quarter three information right now, but — so for example, in quarter three, 1.3% of our home health visits were performed by contract nurses that was compared to 2.2% last quarter. And then hospice visits, there was only 1% of hospice visits performed by contract nurses and that was more in that beginning part of the quarter, but we’ve eliminated all hospice contract labor by the end of the quarter. Last year, this time, 6% of our hospice visits were done by contract labor, just to give a comparison for hospice.

Crissy Carlisle: And Jamie, the only thing that I would add to that is when you look at our hospice cost per day, you see that the year-over-year increase was about 8.5%. In the prior two quarters, it was in the double-digit increase. Well, again, with the elimination of contract labor by the end of the third quarter for that segment, that was a reduction in our cost per day of about 200 — of that increase, I should say, of about 260 basis points. So you see the magnitude it can have.

Operator: And I’ll now turn the call over to Jordan for closing remarks.

Jordan Loyd: Thank you, Regina. If anyone has any additional questions, please feel free to call me at (469) 860-6061. Thank you again for joining today’s call.