Encompass Health Corp Q4 FY2020 Earnings Call

Good morning, everyone, and welcome to Encompass Health Fourth Quarter 2020 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. 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 Crissy Carlisle, Encompass Health's Chief Investor Relations Officer.

Thank you, operator, and good morning, everyone. Thank you for joining Encompass Health Fourth Quarter 2020 Earnings Call. With me on the call today are Mark Tarr, President and Chief Executive Officer; Doug Coltharp, Chief Financial Officer; Barb Jacobsmeyer, President, Inpatient Rehabilitation Hospitals; April Anthony, Chief Executive Officer of Encompass Home Health & Hospice; and Patrick Darby, General Counsel and Corporate Secretary. Before we begin, if you do not already have a copy, the fourth 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 risk and uncertainties, many of which are beyond our control. Certain risks and uncertainties, like those relating to our ongoing strategic review and its impact on our business and stockholder value, as well as the magnitude and impact of COVID-19, could cause actual results to differ materially from our projections, estimates, and expectations, as discussed in the Company’s SEC filings, including the earnings release and related Form 8-K, and the Form 10-K for the year ended December 31, 2020 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, 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. Before I turn it over to Mark, I want to reiterate that the strategic review for our Home Health and Hospice segment is ongoing. Our Board of Directors has made no decision. Accordingly, our 2021 guidance and our longer-term growth targets assume the continuation of the current structure of our business regardless of some growth targets mentioned depending on the ultimate outcome of the review. Additionally, due to the ongoing cause for strategic review, we will not be able to comment further on it today. With that, I'll turn the call over to Mark.

Well, good morning everyone. And thank you, Crissy. We have a history of adapting to change and doing it well. Looking back on 2020, I am proud of our company and how we responded to the changes going on in the world around us. Both of our business segments quickly responded to meet the needs of our patients, our employees, and our business partners. The patient experience has always been at the center of what we do. This year in particular, the impact of our caring and compassionate teams has been on full display. As our hospitals were forced to close their doors to visitors and as our homebound seniors were isolated from family and friends, often the only direct contact patients had for weeks at a time were their Encompass Health clinicians. I have heard countless stories of how our staff have connected patients to loved ones and showed them the kind-hearted care they so deserved. COVID-19 shut most of the world down, yet our employees were keen to work, putting the well-being of our patients first. They are truly our heroes. Turning to the performance of both of our segments in 2020, our Inpatient Rehabilitation segment opened four new hospitals and expanded existing hospitals by 117 beds. They successfully responded to regulatory changes impacting our reimbursement, achieving better than initially expected prices and continue to demonstrate our value proposition to Medicare Advantage payers, with Medicare Advantage discharges increasing 34% year-over-year. We also continue to develop and implement post-acute solutions. We fully deployed our proprietary readmission prevention model. This program uses predictive analytics to determine the risk of a patient readmitting after they are discharged from an Encompass Health Hospital. In our pilot market, the use of this tool lowers the 30-day readmission rate by 280 basis points. So we are excited about how this tool further enhances our value proposition to healthcare providers and payers. In addition, we deployed a home health agency quality reporting tool and began the development of a skilled nursing facility quality reporting tool to ensure we are accessing the highest quality clinical partners and building preferred provider networks in all of our markets. Additionally, we expanded our proprietary marketing tool known as the post-acute care strategic analysis or PACSA to include DRG-level information on cost and quality to enhance our conversations with providers and payers. Now, regarding our Home Health and Hospice segments, we aim to deliver industry-leading margins, despite the pressures brought on by PDGM rate changes and COVID-related challenges. In the fourth quarter of the year, we exceeded our prior year adjusted EBITDA margin by 250 basis points. This strong margin resulted from the proactive management of our field conditions via our new therapy compensation model and our continuous focus on productivity. The effective management of our patient care plans supported by the MetaLogic care tool and effective management of our spending on routine administrative costs. Both of our segments continue to focus on clinical collaboration. Our Medicare claim collaboration rate is over 43%, and our Medicare Advantage rate increased to over 15% in 2020. Additionally, in the fourth quarter, we executed a new national contract with United Healthcare for our home health service line that will bolster not only our clinical collaboration opportunity for Medicare Advantage patients but will also produce a new avenue for referral growth. We have a lot to be excited about as we enter 2021. Our Inpatient Rehabilitation segment is well-positioned as the market leader and is waiting for the increasing demand of their growing population. From 2010 to 2018, the supply remained relatively stable, yet the 65+ population grew 32%. There’s a supply and demand imbalance, and we are one of the few companies with both the operational expertise and capital necessary to build and operate new facilities. With eight new hospitals expected to open in 2021, we expect to add 100 to 150 beds to existing hospitals. We will also continue development on the 10 new hospitals we expect to open in 2022. We have a robust development pipeline, and we expect more growth-related announcements throughout the year. We will continue to educate stakeholders about the value proposition of our inpatient rehabilitation hospitals. We will continue using data to show our outcomes and total episodic cost to healthcare providers and payers, demonstrating that we are the high-quality, cost-effective provider. Specifically, we plan to build on the momentum we had in 2020 with Medicare Advantage by focusing on getting more one-on-one meetings with local and regional MA medical directors who heavily influence the pre-authorization process. We will also remain focused on developing and implementing post-acute solutions. Our robust technology capabilities, including the use of predictive data analytics, differentiate us from our competitors. In 2021, we will monitor the data from the readmission prevention model we deployed in 2020 and will develop and pilot a fall prevention model specific to inpatient rehabilitation. Our strategic sponsorship of the American Heart Association/American Stroke Association is continuing. In 2021, we plan to co-brand and launch stroke continuing education programs for healthcare providers as part of our educational efforts for patients and families on the importance of inpatient rehabilitation after a stroke. We are featuring Encompass Health patient success stories on the Association support network blog and launching videos to assist stroke survivors with completing daily activities. Let's talk now about why we are excited about Home Health and Hospice. We have a strong demographic tailwind, an increasing patient preference for in-home care, a growing number of seniors experiencing four or more chronic conditions, and the cost-effectiveness of treating those conditions at home are better than we have seen in a decade, and there are accelerating opportunities for market share capture, both organically and through industry consolidation. As you may recall, in December, we announced that we are exploring strategic alternatives for our Home Health and Hospice business. Being one of the top providers in the nation, as measured by both our financial results and our quality outcomes, allows us to consider a wide array of transactions and structures. Our strategic review is ongoing, and no timetable has been established for its completion, so we remain focused on the diligent execution of our strategy for both segments. In 2021, we look forward to the full return of elective procedures and the resulting growth that we will produce for our home health service line. We also look forward to the continuation of the strong trends we have experienced in Hospice. In addition, we believe there is strong interest in partnering with Encompass Home Health among accountable care organizations, and Medicare Advantage payers in value-based payment arrangements. Over the past few years, we have participated in various ACL arrangements where we demonstrated our value through the achievements and savings for these organizations. We will continue to build and rely upon these experiences to become even more innovative in the way we work with Medicare Advantage payers. Our goal here is simple: to deliver higher quality outcomes for their members and better shared financial outcomes for our organizations and their plans, with a combination of industry-leading readmission rates resulting in more healthy days at home for our patients. Success in prior risk-based payment arrangements and a commitment to scale and density at the regional level make Encompass Health the clear choice for organizations engaged in risk-based payment models for America's seniors. Operationally, we are excited about the full deployment of the MetaLogics care module and the further improvements it will produce in both quality outcomes and our operating margins. This tool assists us in ensuring our patients have a care plan that includes the right number of visits performed by the right level of staff at the right time to achieve the desired outcome. We are also collaborating with two home care organizations that provide personal care support through the Smith at Home program to meet the growing need for these services in our markets. Additionally, we are rolling out a virtual visit platform with national payers. This virtual platform app allows patients to participate in a secure video call via a personal device such as a smartphone, tablet, or computer with their physician, nurse, care manager, or other medical staff. As we look ahead in 2021, we are confident the fundamentals of our business are intact and strong. In fact, we believe COVID-19 has created an even stronger awareness of the high level of care we provide in our inpatient rehabilitation hospitals and further reinforced home as a preferred care setting. We expect stakeholders will increasingly divert admissions away from skilled nursing facilities to higher value outpatient facilities and home care providers. And as the population ages, the demand for high-quality services will increase. Our initial guidance for 2021 includes consolidated net operating revenues of $5 billion to $5.17 billion, consolidated adjusted EBITDA of $925 million to $955 million, and adjusted earnings per share of $3.31 to $3.53. We remain confident in the long-term prospects for both our business segments. Yesterday, we issued longer-term growth targets for our company, which you can see on Page 16 of the supplemental information accompanying our earnings release. This outlook includes an 8% to 10% CAGR for consolidated net operating revenues, an 8% to 10% CAGR for consolidated adjusted EBITDA, and a 5% to 7% CAGR for adjusted free cash flow. These targets are supported by our strong financial foundation and the substantial investments we have made and will continue to make in our businesses. We feel very good about the strength of our organization, its team, and the opportunities that lie before us. Now with that, I'll turn it over to Doug.

Thanks, Mark, and good morning, everyone. As Mark stated, we are pleased with the performance of both of our segments. We actually ended the year on a positive note with fourth-quarter consolidated net operating revenues up 2.5%, consolidated adjusted EBITDA up 0.7%, and adjusted EPS of 9.4%. We continue to generate high levels of free cash flow, with adjusted free cash flow increasing 55.6% in the quarter and 12.3% for the year. In our inpatient rehabilitation segment, our revenue per discharge was higher in 2020 than initially expected, primarily due to the higher acuity of our patients throughout the year, as well as the suspension of sequestration that began on May 1. Inpatient rehabilitation volumes started strong before being significantly impacted beginning in March. Patient census recovered substantially in the second half of 2020, returning to 2019 levels or higher. However, as we discussed previously, we experienced an increase in our average length of stay, which resulted in a year-over-year decrease in discharges and EBITDA margin. Specific to the fourth quarter of 2020, revenue in our inpatient rehabilitation segment increased 4.1% compared to 2019, driven by pricing. Growth in revenue per discharge primarily resulted from a higher acuity patient mix and an increase in reimbursement rates, along with the suspension of sequestration. Adjusted EBITDA decreased 3.2% in the fourth quarter of 2020 compared to 2019, primarily due to increases in bad debt expense, group medical expense, and costs associated with PPE. In the fourth quarter of 2020, we performed a review of our accounts receivable balances and related reserves, which resulted in a $4.5 million increase to bad debt, primarily related to prior period denied claims. Our bad debt expense for the full year 2020 was 1.6%, within the initial guidance range we provided for the year, and we expect that debt to be in a range of 1.4% to 1.6% for 2021. Turning to our Home Health and Hospice segment, our home health line of business also started strong in 2020, with episode starts in January and February up 8.5%. Limitations on elective procedures, senior living and skilled nursing facility access restrictions, and COVID-19 surges in states where we have market concentrations limited our growth in 2020. We exited the year with episode starts up 2.2% over prior year levels, despite the fact that our admissions during the quarter declined 27% from senior living facilities, 36% from skilled nursing facilities, and 12% from patients receiving elective procedures in acute care hospitals. In addition, there were an average of 360 employees per day on COVID-related quarantines during the fourth quarter, which represented a 48% increase over the third quarter average and further impacted our ability to convert referrals into admissions. Our home health team continued to manage costs well, contributing to fourth-quarter adjusted EBITDA growth of 11.9% over the prior year. Our cost per visit was down almost 4%, with the primary driver of this improvement being changes to our compensation structure made in May 2020, coupled with the productivity of our full-time staff. As we start 2021, we believe our return to volume growth in both segments involves the return of orthopedic and lower extremity joint replacement cases and the mitigation of COVID-related isolations and quarantines. As discussed, many of our markets continue to have limited elective surgeries, particularly with elderly patients with complex medical conditions. In 2020, we treated approximately 4,500 fewer orthopedic and lower extremity joint replacement patients than we did in 2019, and our home health agencies treated approximately 3,100 fewer cases. With regards to isolations and quarantines, at any given time, 10 to 15 of our hospitals were impacted in the fourth quarter of 2020 by census caps due to isolation needs for patients with COVID and/or staffing constraints due to quarantines. In January 2021, that number increased to approximately 30 hospitals. In the fourth quarter of 2020, approximately 360 of our Home Health and Hospice employees were quarantined on average at any given time, with that number increasing to almost 500 medical professionals impacted by ongoing staffing challenges. So we believe we will see reduced capacity and staffing constraints remain elevated through at least the first half of 2021 and will begin to normalize thereafter. Regarding expenses, we will continue to focus on managing staffing levels to volumes. We provided wage increases to our hospital employees effective October 1, 2020, at the same time when we received our fiscal year Medicare price increase of 2.3%. We expect benefit costs to increase by 5% to 8% in 2021 due to general inflationary increases, as well as the rebound of employee-deferred medical visits and procedures. While we do not expect our PPE pricing to return to pre-COVID levels, we do expect the higher costs we saw in 2020 to subside as allocations from primary, lower-priced vendors continue to increase. We expect utilization of PPE to remain elevated as precautions continue throughout 2021. We will also incur $15 million to $20 million of pre-opening and ramp-up costs associated with new hospitals as our development activities continue to accelerate. In our Home Health and Hospice segment, our primary focus in 2021 is on increasing institutional and early admissions with the return of elective procedures and the expected normalization of the mix of patients. We expect to maintain the savings realized from the compensation structure changes enacted in 2020. However, we anticipate that the nursing staff challenges across the country will lead to increased compensation rates for the home health nursing discipline, which comprises approximately 44% of our total visit volume. We expect to mitigate a portion of these increases through LPN optimization and the improved care planning supported by the MetaLogics care tool. As Mark stated earlier, we have reinstated longer-term growth targets for our company, and we believe we have the capital structure to support investments in our growth. We are fortunate that one of the characteristics of our business model is that we generate consistently high levels of free cash flow. Our 5% to 7% adjusted free cash flow CAGR target over the next five years is based on a high base year in 2020 and reinforces our confidence in our expected free cash flow. Our net leverage was a very manageable 3.6 times at year-end, and our debt maturities are well spaced. We are well-positioned financially and operationally for the future. With that, operator, we will open the lines for Q&A.

Thank you. Again, we ask that you limit yourself to one question and one follow-up. Our first question comes from the line of Whit Mayo of UBS.

Hello, Whit.

Good morning, Whit.

Hey, thanks. I really just have one question for right now. When I look at the performance of the home health business in the fourth quarter and it seems like EBITDA now is tracking above my pre-COVID forecasts for the fourth quarter, growing up 11% year-over-year, and it feels like there is some momentum coming into 2021. When I look at the cost per visit, you are tracking significantly below first half levels, which would seem to imply some noticeable tailwinds coming into 2021. So how are you thinking about the direction of those trends? And can you comment a little bit more on the visits per episode and some of the initiatives you may have in the field and how that could trend? It just feels like there perhaps is a little bit of a disconnect between the near-term performance versus what may be implied within the full-year range. Thanks.

Could I ask April to give her insights on that?

Sure. So I certainly appreciate the perspectives. We are pretty encouraged about the trends we are seeing on the volume side. As Doug mentioned, if you look at December trending, we continue to trend in the right direction from a volume perspective. Despite shifts in our skilled nursing and senior living patients, as well as the ongoing challenges, I think our team has done a really good job replacing that volume with other sources. We are obviously encouraged about that and believe that once the COVID pressure is released, some of the historical sources will return to us. We think all of those impacts are very COVID-driven and relatively short-lived. We are also encouraged, as Doug mentioned, about our cost per visit and feel like the compensation structure changes that we made back in May served us well in the third and fourth quarter. We see that continuing opportunity. But we aren't concerned about costs per visit in the nursing discipline. The shortage that exists, which has just been exacerbated by COVID among nurses in the community, is just going to make costs per visit go up in that discipline. So we are cautiously optimistic; we feel good about the changes that we have made. But we also recognize the global pressure we are seeing in the nursing discipline. Finally, as it relates to volume, if you look at the data in the slide deck we have provided, we've made nice progress this year, incrementally reducing our visits per episode down over the course of the year from the second quarter being somewhat of an anomaly, but we see improvements there. I think there is room to leverage this better as we deploy MetaLogics more effectively. Given that our focus this year has been on staffing and managing COVID-related risks, our implementation has not been as successful or as quick as we had anticipated. So we see opportunities going into 2021 to better leverage the effectiveness of those tools. We are encouraged about the trajectory and momentum that can take into 2021, but we are also cautiously optimistic, recognizing that the COVID risk is not behind us. We can't fully predict what’s going to happen in the first half of the year regarding volume impacts, and we are not quite sure about nursing costs. We plan to continue pressing forward, encouraged by the margins we have produced, and we will work hard to sustain those but maintain a cautiously optimistic tone in our projections.

Can you provide any numbers related to the inflation in your nursing discipline this year, perhaps the cost per visit? Any guidance on this would be helpful as we look ahead.

Well, not specifically there, but if you look at the 2% to 3% wage increases reflected in our guidance, we think it will be disproportionately allocated to the nursing discipline. You may see a lesser rate in some therapy disciplines where supply and demand imbalances will have a higher proportion of those wage increases across the board like nursing.

Your next question comes from the line of Brian Tanquilut of Jefferies.

Hey, good morning, Brian.

Good morning. So Doug, my question for you, as you look at where your guidance is, and I am sure you have looked at where street numbers are, how are you thinking about what the delta is there? What do you think the street expectations are, and any color that you can give in terms of the moving parts on the guidance that investors might have missed? And what is driving some of that disappointment today?

Yes. Most of the models aren't detailed enough overall from analysts’ perspectives for me to be able to point to specific areas of differential. Our guidance is driven-off our budget. Our budgets are built in a painstaking, brick-by-brick fashion from the bottom up. Suffice to say, there is substantial more detail that goes into the provision of our guidance. Having said that, some of the areas I think that analysts may not have had complete visibility into relate to things like $15 million to $20 million in pre-opening and ramp-up costs associated with our new hospital activity, the normalization of some of our employee benefits, particularly group medical expenses in the skilled nursing side of the business, and just some of our expectations regarding the impact of COVID on both volumes and expenses in the first half of the year. Those will be the areas I would point to as the primary differences.

Got you. And then Mark, I guess, you adjusted the long-term guidance ranges? And how are you thinking about the progression back to the endpoint goal for 2025 in terms of revenues or earnings? Is this an indication of your belief in the fundamentals of the business? What kind of recovery pace are you thinking about to get to these revised long-term growth targets?

Yes, Brian. Our growth targets reflect our confidence in the long-term opportunity to continue to grow our business and the demand for services. We're experiencing the typical seasonal rebound that we would have seen previously, and in both our operating segments, there are challenges in meeting all that demand right now. Given the number of quarantined staff and capacity caps Doug mentioned regarding semi-private beds at our hospitals, we are very bullish on our opportunities. We've got a robust pipeline, with eight hospitals coming on this year and ten already announced for next year. We will continue to look for acquisition opportunities in Home Health and Hospice. The fundamentals are there to support these growth targets in our long-term outline.

Brian, if I could add to that, we've set a reset to the CAGRs of a lower 2020 base to arrive at the same station in 2025 that were implied with the growth targets laid out at our Investor Day last March. That's reflective of the fact that our shortfall in 2020 was solely related to COVID, and we believe that the impact from COVID is temporary and doesn’t reflect any fundamental change in the underlying business demand for either one of our two business segments. On top of that, our growth plans have not changed. We continue to invest heavily in capacity additions and will continue pursuing organic growth opportunities in both segments.

Any uncertainty we have right now is just near-term, all tied to COVID, and how quickly we will be able to respond with vaccines and get on the other side of this pandemic.

Your next question comes from the line of A.J. Rice of Credit Suisse.

Hey, A.J.

Hi, A.J.

Hey everybody. Maybe just part of a follow-up on that previous discussion around the long-term targets. I appreciate you guys reinstating that. I think though, if you string out the midpoint out to 2025, you end up with an EBITDA target that’s about at least $70 million below the midpoint of the March 2020 Investor Day outlook in terms of margins, about 90 basis points lower. Is there something that has changed? Because it sounds like from your previous comment just a minute ago, Doug, you thought it was coming out to the same point, but that’s not actually what we get? I wonder how you are factoring in this demonstration project that CMS has put forward. Do you think that’s going to have any impact on the outlook if that goes into place next year? Any thoughts on that?

A.J., I am actually getting midpoints when I compare the two that are substantially closer than the delta that you just suggested. I'm not going to say that it's exactly the same number, but they are closer. So I don't want to get into a math reconciliation exercise right here. With regard to the Review Choice Demonstration, there is more that is unknown than is known. It's really in the very early stages. It could have a positive impact and reduce the amount of claims denials after the fact. Our home health business has demonstrated that because we are process-oriented and have great management information systems in place, we can adjust effectively to new regulatory requirements as needed. I am confident that if we move forward with Review Choice Demonstration, we will execute effectively and it will not be disruptive to our business.

As Doug noted, this further substantiates the investment we made in our electronic medical records a number of years ago, positioning ourselves through our documentation and standardization across the board to ensure the documentation is there, and we're well positioned if RCD moves forward.

Okay, alright. Thanks a lot.

Your next question comes from the line of Matt Larew of William Blair.

Good morning, Matt.

Good morning, Matt.

Hi, good morning guys. Doug, I wanted to follow up on Brian's question but maybe focus on the second half of ‘20 versus 2021. Even after adding back or removing those startup costs, the EBITDA margin for ‘21 is about 100 basis points lower than for the second half of ‘20. And obviously, you characterized that there are a number of tailwinds on the home health side, returning volumes et cetera. There has been frustration that those were not expected for the first quarter, so I guess I am trying to think what other things we might need to take into consideration. Visit acuity reversal, COVID costs, or maybe bad debt increases or PPE? Are there any numbers you can point us towards that would help bridge that gap?

So, Matt, I’m trying to reconcile the second half of 2020 to the second half of 2019?

No, sorry, in the second half of 2020, the EBITDA margins were about 19.7, and I think the guidance for 2021 is 18.5. I’m just trying to understand that, considering the positive metrics discussed.

Yes, I think that given the move past the sequestration pretty quickly accounts for at least half if not more than half of that. If you combine that with the likely timing of a lot of the pre-opening and ramp-up costs associated with the hospital openings, you have substantially closed the gap just between those two numbers.

Okay, we will look again; I thought I contemplated that in my model. Fair enough. Maybe I will just ask then about the Medicare Advantage side. You have given some nice updates throughout the year about pricing and volume trends. Can you provide any additional color on the United contract you hinted at? Is it a preferred provider relationship to an extent? Is there any share involved? That would be great.

April will cover the United contract first.

Yes, we are excited about joining the panel of national contract providers for the United Healthcare contract. There’s a combination of good and bad here. In the long run, being part of that national contract will give us volume opportunities and better opportunities to serve patients coming out of our facilities. However, historically, we received some United business more of a one-off basis, and we've been paid episodically. So when we shifted to this national contract, as much as we are excited about it, we also recognize there could be some near-term margin pressure brought on by the transition from episodic payments in 2020 to more fee for service payment starting in February 2021. So we believe it's a beneficial relationship and once all our staff are off quarantine, we anticipate a significant growth in that relationship.

I’ll ask Barb Jacobsmeyer to give her insight into what we are seeing from MA plans with regard to our hospitals.

We have seen nice growth; the relaxation between May and September of the pre-ops assisted in 2020. We saw admissions here in 2020 that perhaps, in previous years, would not have been sent to us due to various reasons. Some of that was due to the waivers, and others were because skilled nursing facilities were unable to accept patients due to COVID outbreaks or other limitations. We now have more data on the outcomes of those patients, which will assist us as we continue discussions, particularly with the Medical Directors of these MA plans. This helps us talk about our value proposition as it relates to their patients.

Okay, thank you.

Your next question comes from the line of Kevin Fischbeck of Bank of America.

Good morning Kevin.

Hey, good morning. Actually, this is Joanna Gajuk filling in for Kevin. Thanks for taking the questions. Could you provide a follow-up on the discussion about the long-term growth targets? Would you describe those targets as implying higher revenue but maybe slightly lower EBITDA? Is there any particular area where you would point to in terms of the lower margins in either segment or something around PPE costs?

I think you are reading a degree of precision into the five-year CAGR that simply doesn't exist. These CAGRs reflect the fact that the base for 2020 is lower than we anticipated last March, and that delta is attributed 100% to COVID. We anticipate that will fully dissipate through 2021. Beyond that, you’ve got a 200 basis point spread on five-year CAGRs and you allow for some rounding. The base is lower, and we believe our growth plans on top of that have not changed. We continue to discuss the targets we have put out there. We are going to arrive at a similar endpoint in 2025. If the margin is 10 or 15 basis points lower or higher, so be it. There are multiple ways we can get from here to there. But the targets we are shooting for in 2025 are effectively unchanged from those we discussed in March of last year.

Okay, great. That's what I was trying to confirm. Thank you for that. If I may, just a follow-up on something mentioned in your introductory remarks around a 'Smith at Home' program. Could you talk about this opportunity for Encompass to participate in any extended benefits? Are you adequately covering your markets with these personal care services?

Yes, so we don't have personal care services as part of our organization. It's critical for us to create key partnerships with private duty focused companies that have a national presence, enabling us to respond in the same timely fashion that some of our competitors can. We feel like we have those relationships in place and are beginning to leverage those when we have family structures that can support that service line. We hope that there will be a version of Smith at Home that will make it into legislation and become a payer source for those private duty services. We believe we can provide care for certain patients at home for less compared to facility care, but it will take more than the average $50 we would receive today from Medicare to provide that care. We are looking forward to that program evolving, and we are exploring ways to execute on it even before funding legislation is in place.

Okay, thank you.

Your next question comes from the line of Frank Morgan of RBC Capital Markets.

Hello Frank.

Good morning Frank.

Good morning, I hopped on late so I apologize. I think April was just at the point of making some comments about volumes in December. Can you comment on what you are seeing so far in the first quarter, both in home healthcare and rehabilitation, and I apologize if you discussed this before I hopped on?

Frank, I’ll cover where we are at this point. As you know, we typically have a seasonal rebound after the holidays, and we've seen a strong demand for services in both operating segments, which is a testament to the confidence we have going forward. We are challenged in certain markets with quarantined staff. The positive news is that both segments have seen a decrease in the number of quarantined staff over the last week and a half, which is trending more positively. When we get more staff back, we will have fewer markets impacted by staffing restrictions. We also have certain markets where hospitals have a higher number of semi-private rooms, and we've had to enforce isolation requirements temporarily, but demand is strong, supporting our thoughts that any uncertainty we have is near-term uncertainty tied to COVID. The opportunities we have to get on the other side of this pandemic appear to be promising.

Got you. And what percentage of your staff have been vaccinated against COVID?

We have a total of 68,100 employees who have been vaccinated, with a small portion having received their second doses. Nearly 70% of our total staff have indicated that they would like to receive the vaccine. We will continue that distribution process. There is a lot of volatility from state to state in terms of how effectively vaccines are being distributed, but we keep seeing progress.

Got you. And just last question, I know April made the comment about the nursing shortage, but are you seeing similar pressure on the therapy side? Is there anything event-driven related to COVID affecting that as well?

I’ll ask April how we are seeing on the therapy side.

On the therapy side, the challenge has primarily been restrictions related to staff being in quarantine. I think we've seen some of our older therapists choose not to be in the workforce due to fear and anxiety about COVID. The good news is that we are hearing from some of those individuals saying they want to return once the vaccines are available. So we expect to see more of them coming back unfortunately, we are experiencing wider healthcare challenges, which was driven by the numbers of COVID patients and the uncertain duration of the pandemic. This uncertainty caused stress across the entire workforce; not just our clinicians but also the industry as a whole. The vaccine brings hope and a clear endpoint clinicians can look forward to.

Your next question comes from the line of Andrew Mok of Barclays.

Good morning, Andrew.

Hi, good morning. Wanted to follow up on the home health volumes; your same store home health admissions remained moderately depressed due to continued drags from assisted and independent living facilities and lower elective procedures. Can you comment on how admissions trended in the rest of the portfolio? Do you see a path back to mid-single-digit organic volume growth in 2021 even with some of the lingering COVID headwinds? Thanks.

Yes, thank you for that question. We did see a meaningful decline from the three areas called out, namely admissions from skilled nursing, surgeries, and senior living communities, which accounted for roughly about 3,800 admission declines. In fact, our overall organic growth was down about 2%, but that suggests that if you consider those 3,800 admissions, we would have seen strong performance in the other sectors to make up that difference. I think without those restrictions, you'd be looking at well over 7% improvement. I recognize that I am making a lot of assumptions about what could have been, but the cause of those declines provides us with a strong foundation to move back into a robust growth posture, especially as we see the virus subside in the latter half of the year. We have replaced those referrals and admissions with new sources that can sustain growth. So we believe we can regain what was lost and build on top of it.

Great, thanks. Secondly, looking at the 2021 EBITDA and EPS guidance compared to the initial 2020 guidance, EBITDA is about 1% lower, and EPS is about 5% lower. Can you walk us through some of the assumptions below the EBITDA line driving the spread on EBITDA and EPS growth? Thanks.

I think the single biggest line is interest expense.

So that's driving the entire delta?

Yes, I don’t have that handy, but I believe that's the primary driver.

Your next question comes from the line of Pito Chickering of Deutsche Bank.

Hey, Pito.

Hey, good morning guys. Thanks for taking my questions. April, when I look at the payer mix in 2020, and where you've taken the cost per visit in the fourth quarter, and all the data that you've collected? How should we think about the new cost structure and leverage from analytics, converting into you guys getting more aggressive with MA and commercial contracts? Is this new contract with United a tip of the iceberg for you guys in this area?

Yes, I certainly think that we have a lot of momentum moving in that direction. We have always been discerning about the relationships we want to enter into, focusing on those that ensure reimbursement levels support quality care delivery. Historically we've lagged the industry in non-Medicare relationships because of that. I believe that's beginning to change as we become more efficient and lower our cost base. It creates opportunity for us, and we are seeing payers move in the right direction as well, creating contracts with not only higher reimbursements but more efficiencies relative to authorization requirements or better said, fewer requirements. We are very discerning about the contracts we take. If there is a pre-authorization requirement that becomes burdensome in time and effort, we are saying no. We are focused on those right relationships where we can be trusted partners delivering clinical outcomes, rewarded for those outcomes. Those are the partnerships we want to form, and we are excited about expanding those relationships as the tide continues to move in that direction.

Thanks so much.

Your next question comes from the line of Scott Fidel of Stephens.

Hello Scott.

Hi, thanks. Good morning. I had to hop on late to another earnings conference call, so hopefully, it hasn't been asked. I have two questions for you. The first is if you can provide your initial framework regarding the Home Health and Hospice M&A target of $50 million to $100 million in terms of pipeline activity in those markets and any thoughts as to whether the strategic review would influence that pacing of your M&A plan for 2021?

Yes, Scott. As you know, we can't comment right now on future reviews or the timing for that, but the process is ongoing. I'll ask April to weigh in on her thoughts on the acquisition.

Yes, we definitely saw a resurgence in acquisition activity in the back half of last year. The low experienced at the beginning of the year due to both COVID and transitions is now behind us. We are seeing a lot of activity in the M&A pipeline, and we are encouraged that we will find good options. We consistently focus on three strategies: First, creating more overlap markets with our rehabilitation services produces strong results in clinical collaboration. Second, we like to build scale and density in our markets for margin improvement. Third, we want to create overlap between Home Health and Hospice services for efficiency. Realistically, if an acquisition meets one of those three core criteria, it doesn't matter if it's Home Health or Hospice; we're looking at where we can deploy our capital effectively. Multiples are rising, particularly in the hospice sector, so we continue to be discerning buyers, seeking growth but investing wisely.

Got it. Just a quick follow-up regarding clinician compensation model changes you implemented. It seems this was supportive of the margin profile for home health and hospice in the back half. How flexible is that model for you in 2021? If volumes remain depressed, how can you adapt it? If volumes pick up, how would you ensure adequate staffing?

The good news is that the model is flexible. We lowered base pay and created a bonus incentive structure. Our employees can earn back to or above the previous compensation level by performing beyond the baseline. This has driven efficiency and productivity. We did not reduce our therapy headcount due to this change, which was fortunate. This shift empowers employees and encourages them to maximize productivity under the structure we have in place. We are confident in our capacity to grow in that service as we move into 2021.

I will now turn the call to Crissy Carlisle for closing comments.

If anyone has additional questions, please call me at 205-970-5860. Thank you again for joining today’s call.

Thank you for participating in Encompass Health’s fourth quarter 2020 earnings conference call. You may now disconnect.