Encompass Health Corp (EHC) 2014 Q3 法說會逐字稿

Good morning everyone and welcome to HealthSouth's third-quarter 2014 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. (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 Mary Ann Arico, Chief Investor Relations Officer.

Thank you, Maria, and good morning everyone. Thank you for joining us today for the HealthSouth third-quarter 2014 earnings call. With me on the call in Birmingham today are Jay Grinney, President and Chief Executive Officer; Doug Coltharp, Executive Vice President and Chief Financial Officer; Mark Tarr, Executive Vice President and Chief Operating Officer; John Whittington, Executive Vice President, General Counsel and Corporate Secretary; Andy Price, Chief Accounting Officer; Ed Fay, Treasurer; Julie Duck, Senior Vice President Financial Operations.

Before we begin, if you do not already have a copy, the press release, financial statements, the related 8-K filings with the SEC and the supplemental slides are available on our website at www.HealthSouth.com.

Moving to Slide 2, the Safe Harbor, which is also set forth in greater detail on the last page of the earnings release. During this call, we will make forward-looking statements which are subject to risks and uncertainties, many of which are beyond our control. Certain risks, uncertainties and other factors that could cause actual results to differ materially from management's projections, forecast, estimates and expectations are discussed in the Company's SEC filings, including the Form 10-K for 2013, the Forms 10-Q for first quarter and second quarter and third-quarter 2014 10-Q when filed and previous SEC filings. 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. Statements made throughout this presentation are based on current estimates of future events and speak only as of today. The Company does not undertake a duty to update or correct these forward-looking statements.

Our slide presentation 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 slide presentation or at the end of the related press release, both of which are available on our website and as part of the Form 8-K filed last night with the SEC.

Before I turn it over to Jay, 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 will turn the call over to Jay.

Great. Thank you Mary Ann, and good morning to everyone joining our call this morning.

The third quarter was another solid quarter for HealthSouth. Discharges grew 3.8% against growth of 5.7% in Q3 of 2013, and included the closure of 40 SNP beds at our Harmarville hospital. Normalizing for this closure, total discharge growth was 4.2% while normalized same-store discharge growth was 2.3%. Strong topline growth of 5.8% was driven by this increase in discharges and continued favorable inpatient pricing, offset by a decline in outpatient and other revenues.

Adjusted EBITDA for the quarter came in at $140 million, an increase of 3.3% over prior year. There are two items to take into consideration when evaluating this year-over-year growth. First, as Doug will elaborate later, our adjusted EBITDA was impacted by a $4.8 million negative swing in our insurance reserve adjustments. As reported previously, we've experienced continued improvement in claim trends in our group health, workers comp and GP&L self-insured programs. These improvements have resulted in reductions to our insurance reserves that favorably impacted insurance costs in both years. In the third quarter of 2013, we took a $7.8 million adjustment to these reserves, while this quarter we took a $3 million adjustment. This $4.8 million swing reduced our year-over-year adjusted EBITDA growth by approximately 400 basis points.

The second item was $1.6 million in preopening startup costs associated with the three new hospitals that are scheduled to open in the fourth quarter. Our 50-bed hospital in Altamonte Springs, Florida, our 50 bed hospital in Newnan, Georgia, and our 34 bed hospital in Middleton, Delaware. As a reminder, we are required to treat a minimum of 30 patients at each facility before we can receive Medicare certification, so these patients will be treated without reimbursement.

In addition to these new hospitals, we also made excellent progress on other development projects that will contribute to growth in 2015. We move forward with our joint venture with Mountain States Health Alliance for the 26-bed Quillen rehabilitation hospital in Johnson City, Tennessee, and expect this hospital to be operational by year-end. On August 22, we received final approval from the Tennessee Court of Appeals to proceed with our plans to build a 40-bed hospital in Franklin, Tennessee. We will begin construction on this hospital in the fourth quarter and expect it to be operational by the fourth quarter of 2015. We also moved forward with our plans for a 50-bed hospital in Savannah, Georgia which will be a partnership with Memorial University Medical Center and expect this hospital to come online in the first half of next year.

Finally, in addition to these new hospitals, we expect to add 51 beds to existing hospitals by year-end, which will contribute a total of 211 new beds to our portfolio prior to January 2015.

As a result of our solid year-to-date performance, we are tightening our full-year adjusted EBITDA range to $575 million to $580 million. Full-year EPS guidance is now between $2.24 and $2.27 per share. Our EPS guidance is being impacted by an approximately $13 million or $0.08 per diluted share loss on early extinguishment of debt that we expect to record in the fourth quarter of 2014, due to our recent debt transactions.

I'll now turn the agenda over to Doug for a more thorough review of the quarter's results.

Thank you Jay, and good morning everyone. As Jay indicated, Q3 was a solid quarter for our Company. Revenue for Q3 increased by 5.8% over the prior-year period, driven by inpatient revenue growth of 6.6% with 200 basis points of this growth attributable to the consolidation of our Fairlawn hospital. Please recall that, in the second quarter, we acquired an incremental equity interest in our Fairlawn hospital, and as a result, Fairlawn is now treated as a consolidated entity for accounting purposes.

The inpatient revenue growth was comprised of a 3.8% increase in discharges, and a 2.7% increase in revenue per discharge. The discharge growth was split evenly between same-store and new store, with the new store growth attributable to Fairlawn. The increase in revenue per discharge resulted primarily from Medicare and managed-care price adjustments.

Outpatient and other revenues declined by $2 million in Q3 of 2014 versus Q3 last year. We ended the quarter with 16 outpatient clinics as compared to 21 at the end of Q3 2013. There was one clinic closure during the quarter.

Bad debt expense for Q3 was 1.4% of revenue, in line with our expectations, and reflecting the continuation of prepayment medical necessity claims reviews predominantly arising from one Medicare fiscal intermediary as well as the extensive backlog in the adjudication process for previously denied claims.

In his comments just a moment ago, Jay mentioned the reductions in our self-insurance reserves in both Q3 this year and Q3 last year. You may recall that, in our conference call to discuss second-quarter results, I provided a reminder that the second half of 2013 included approximately $13 million in favorable self-insurance accruable adjustments, including approximately $6.7 million related to the lowering of our statistical confidence interval which we will anniversary in Q4 of this year. Those adjustments impact the comparability of certain year-over-year financial metrics, and I'll attempt to highlight this impact as we continue through the Q3 results.

SWB of 48.6% increased by 80 basis points over Q3 last year. Approximately 60 basis points of that increase was attributable to the year-over-year change in our insurance reserves. Due to favorable trends in claims, our reserves for group medical and workers compensation were reduced by approximately $3 million in Q3 2014 and approximately $6.3 million in Q3 of 2013. The balance of the SWB delevering was attributable to the startup costs of our new hospitals coming online in Q4. Jay mentioned in his remarks the startup costs related to those new hospitals was $1.6 million. Approximately $1 million of that was in SWB.

The anticipated incurrence of these startup costs was also discussed in our conference call last quarter. Our continued emphasis on labor productivity was evident in our EPOB of 3.48 for Q3, flat with the same period last year.

Hospital related expenses as a percent of revenue for Q3 were flat with the same period last year at 20.7%. During Q3, the ongoing benefit of lower occupancy costs stemming from our purchases of leased properties was offset by a $1.5 million reduction in general and professional liability reserves in Q3 of last year, a favorable adjustment that was not repeated this year. The reduction in those reserves last year was also attributable to favorable claims trends. The balance of $600,000 of the $1.6 million in hospital startup costs was included in hospital related expenses for the quarter.

Adjusted EBITDA for Q3 of $140 million increased 3.3% over the same period in 2013. As Jay stated in his comments, the year-over-year delta in the magnitude of favorable self-insurance reserves negatively impacted the adjusted EBITDA growth rate by approximately 400 basis points for the quarter. Adjusted EBITDA for Q3 benefited by approximately $2 million from the Fairlawn consolidation with this benefit largely offset by approximately $1.6 million in the startup cost for the new hospitals coming online in Q4. Adjusted EBITDA for the first nine months of 2014 of $436.8 million increased by 6.7% over the same period in 2013, even after the approximately $8 million impact from sequestration absorbed in Q1 of this year.

As anticipated, both interest expense and D&A increased in Q3 2014 over Q3 2013. The increase in interest expense resulted from the exchange of the 2% convertible senior subordinated notes for shares of our 6.5% convertible preferred stock completed in Q4 of 2013. As a reminder, although the exchange results in an increase in reported interest expense, it reduces our preferred dividend, creating an annualized cash flow benefit of approximately $10 million. The increased D&A relates to continued investments in our business, including the clinical information system which is now installed in 56 of our hospitals, and the purchase of previously leased properties which generates the ongoing benefit to occupancy cost I referenced earlier.

Diluted earnings per share of $0.53 for Q3 benefited from a lower effective tax rate resulting from a nontaxable gain on the Fairlawn transaction and our election to claim certain tax credits. Q3 2013 diluted EPS of $0.59 included a $0.13 per share gain in government class-action and related settlements.

The strong cash flow generation of our Company was evidenced again in Q3 with adjusted free cash flow of $103.3 million. For the first nine months of 2014, adjusted free cash flow was $265.9 million compared to $264.6 million in the first nine months of 2013. Please be reminded that maintenance CapEx of $65.9 million for the first nine months of 2014 includes approximately $12 million related to equipment purchases made in Q4 2013 that were paid for in Q1 of 2014.

Adjusted free cash flow for the current year also reflects an increase in Accounts Receivable related to the continuing Medicare medical necessity claims denials primarily from a single fiscal intermediary and the lengthy delays in the adjudication process. We have incorporated the growth in Accounts Receivable into our revised working capital assumption appearing on Slide 19 of the supplemental slides included with our earnings release. As noted on Slide 19, even with the aforementioned $12 million timing issue on maintenance CapEx and the anticipated growth in Accounts Receivable, we expect adjusted free cash flow for 2014 to increase over the $331 million generated in 2013.

The cash we generated in the first nine months of 2014 supported $80.6 million in discretionary CapEx, $43.1 million in common stock repurchases, $47.4 million in cash dividends on our common stock, and the purchase of our increased equity ownership in Fairlawn.

Moving to the balance sheet, we continued our strategy of proactively and opportunistically managing our capital structure to reduce cost and enhance flexibility. During Q3, we amended our credit facility to add a $150 million term loan commitment to our existing $600 million revolver and extend the maturity date to Q3 2019. We also issued an additional $175 million of our 5.75% senior notes due in 2024 with the add-on notes priced at a premium to par. On October 1, we used the proceeds from the additional notes together with a $75 million draw on our term loan commitment and cash on hand to fund the redemption of all of our $271 million of 7.25% senior notes due in 2018. This refinancing will lower our quarterly interest payments by approximately $2 million. Because the redemption on the 2018 senior notes was not completed until October 1, it remained on our balance sheet at the end of Q3, effectively overstating our leverage. A pro forma view of our debt capital structure incorporating the credit facility amendment and senior notes issuance redemption may be found on Slides 24 and 25 of the supplemental slides.

Please also note that we have updated our full-year 2014 EPS guidance to incorporate the $0.08 per share loss on early extinguishment of debt incurred in Q4 with our debt transactions.

And now we will open the line for questions.

(Operator Instructions). Darren Lehrich, Deutsche Bank.

Hi, good morning. This is Dana Nentin in for Darren. One of the questions I had, we've seen and heard a lot about how patients are being managed differently on a postacute basis, especially around the readmission rules. With the new DRGs that were recently added to the readmission rule, do you expect to see any change in behavior, whether good or bad, as it relates to the DRGs, and whether it may impact compliance levels under the 60% rule?

This is Mark Tarr. I'll tell you that all of our hospitals are very focused on making sure that the quality of our care delivered to our patients ends up with the vast majority of our patients going home or back to the community. So we paid a lot of attention to our ability to discharge home successfully, and ultimately reduce the number of readmissions back to the acute care hospitals. So, I think we will fare very well in the future as acute care hospitals are reviewing their postacute discharges, and how many of those patients return back to those acute care hospitals.

That does play into what we have said all along we think is a differentiator for us relative to skilled nursing facilities. And that is that our goal has always been and our track record has demonstrated that we execute against that in getting patients back into their homes. And so I think it's reflective of the shift in our delivery system to what is commonly referred to as more value-based purchasing. And I think everybody recognizes that historically the focus has been exclusively on per diem costs, and now we are seeing the system move slowly towards looking at things like readmission rates, and total cost of care per episode, not just on a per day basis. So, I think this is early stages, but we definitely think that it sets us up very nicely for continued market share gains and continue to be attractive to discharge planners at the acute care hospitals.

Okay great. Thanks a lot.

Matthew Gilmore, Robert Baird.

Good morning everyone. Can you give us an update on Teamworks and Beacon and are there any new areas of focus for both of those initiatives?

This is Mark. Our current Teamworks initiative right now, which those of you that aren't familiar with Teamworks, that is our standardization process of which we will take a focus area in operations, and then roll it out across our entire portfolio of hospitals. Right now, our focus is on the patient experience. We are working collaboratively with our patient satisfaction vendor, Press Ganey, and rolling out standardized practices and protocols across our portfolio to make sure that we are maximizing our opportunities on the patient experience. The current rollout will be completed to all our hospitals by year-end, and leading into expectations next year that we will continue to see increases across our portfolio on total patient satisfaction scores.

Okay, great. And then second question, Doug mentioned the increase in the backlog for medical necessity denials. Is there an opportunity to potentially accelerate that review process as the acute hospitals have settled, or will settle a lot of those claims, or is there an opportunity for the postacute providers to enter into a similar settlement?

I don't know if we will be successful, but we certainly are pushing for that. And again, we just don't know at this point. We would certainly hope that there would be an opportunity, but it's not anything that we can count on.

Okay, great. Thanks a lot.

Gary Lieberman, Wells Fargo.

Good morning. Thanks for taking my question. There's been a fair amount of acquisitions in the postacute space and in other perhaps acute sectors. Can you just update us on your thinking in terms of how you feel about your positioning in the broader postacute space, and any changes and thoughts on potential other areas that you might want to get into?

Sure. And our thinking hasn't changed. And just to summarize it, number one, we believe that we are very well positioned to continue to grow in the inpatient rehabilitation sector. We think that there's a lot of additional growth that is possible there, primarily driven by the aging of the population and the fact that we believe there are a lot of joint venture opportunities, based on our development pipeline, joint venture opportunities for us to exploit. Having said that, we continue to believe that, as the delivery system evolves into one characterized by more coordination of care, potentially more risk taking on behalf of the providers, that there may be some benefit in expanding our service line offerings to include other postacute services. Within that context, we think the service line that makes the most sense would be home health or home care. And the reason we believe that is if we look far enough down the road in this evolving delivery system, we believe that a need will be there for patients who are being discharged from acute care hospitals to receive facility-based postacute services where there would be 24-hour, seven day a week nursing care and a higher level of care similar to what we provide in our rehabilitation hospitals but not limited to what we provide in the rehabilitation hospitals. In that new world order, we think that facility-based services would encompass services that are even today included in some of the skilled nursing, some of the higher needs orthopedic patients. So, that would be one part of that continuum. And then we believe that in order to manage the patient's care in the most optimal way, having a facility-based presence in those markets -- excuse me, a home-based presence in those markets would complement the facility base and would round out our ability to be attractive to the ACOs or other providers who might be participating in shared risk or coordinated care kind of models.

So the thinking hasn't really changed and it's predicated on the delivery system continuing to evolve, which we think it will, and in that evolving delivery system having a facility-based postacute presence and a home-based postacute presence makes the most sense.

Thanks. Maybe as a follow-up, have you seen any impact on the business from healthcare reform? Obviously no real direct benefit like acute care hospitals, but have you seen anything tangential?

The only thing that's been tangential has been an increase, a slight increase in our Medicaid patients. We have seen in some states with the expansion of Medicaid and the increased number of lives included in Medicaid, we are seeing some more Medicaid patients in those markets, in, say, South Florida, we are seeing more Medicaid patients coming in as a result of Florida Medicaid going to a managed care product, and we have contracts with many of those payors. So we are seeing that benefit, if you will, and I think that that is a trend that we'll continue to see. I don't expect it to ever be a huge part of our business, but we are seeing a slight uptick in our Medicaid revenues.

Great, thanks a lot.

Chad Vanacore, Stifel.

Good morning. So it looks like you continue to generate a significant amount of free cash flow. Aside from the expansions and investments you've already laid out, what would be your preference for cash flow use? Would that be deleveraging, share repurchase, increased dividend, or something else?

It's Doug. I think the story of the free cash flow utilization really hasn't changed from our previous discussions this year, and that is, one, on the delevering side, we certainly don't feel the need to delever any further. As we've suggested, we think that the appropriate run rate in terms of leverage for this business is at or below 3 times when you adjust our third-quarter balance sheet for that timing difference I referenced in my remarks, just the fact that we had raised some debt and then used it to pay off the 18%s on the first day of the quarter, we are well within our leverage target. And given the structure of our debt capital, we don't feel the need to proactively reduce the leverage. And so that means we will continue to look at the array of opportunities that we have thus far in terms of deployment of free cash flow.

The highest priority is given to the high-quality growth opportunities that exist within the ERF space. As Jay mentioned just a moment ago, based on demographic trends and what we are seeing in our development pipeline, we feel good about that. I think the fruits of our labor are coming to bear in the fourth quarter when you look at the significant capacity expansions that are coming online and we're opportunistic -- or we are excited about the continued growth opportunities in 2015 and beyond.

We did increase our common dividend effective with the payment made in the third quarter, so continuing to look at the appropriate yield that the dividend represents on our common stock is a consideration. And we've opportunistically repurchased some shares during the course of the year as well. All of those things will continue to remain on the table.

All right. That's it for me. Thanks.

Frank Morgan, RBC Capital Markets.

Good morning. Jay, just hoping you could give us some comments and thoughts about what you're paying attention to in DC from a regulatory, from a payment standpoint. Are there any particular issues out there right now that you are most acutely attentive to?

There is nothing new. With the passage of the Impact Act, I think a marker is out there for moving postacute payments to something that is I guess more site-neutral in nature, although I think the timing of that and what that looks like is still up in the air. I don't think that's going to be anything that will impact our business anytime soon. However, as we have said in the past, we believe that is an opportunity for us because we do believe that we can provide a wide range of services, rehabilitative services on an inpatient basis to (technical difficulty) and today we are limited by the 60% rule and other regulatory constraints. And presumably, in a more site-neutral payment environment, many of those constraints would be eliminated or obviated. And that is something we are paying attention to and we are looking at, frankly, quite favorably.

Beyond that, there really isn't anything that we are hearing that is percolating at the moment. I think it's clear that the midterm elections will dictate what kind of effort next year will be directed towards the debt ceiling. There will be the doc fix, and I think all providers will need to be attentive to that process. Whether or not anything ultimately comes of it of course is a function of what can be passed through Congress and then ultimately what could be signed by the President. So nothing new at this point. It's really a lot of the same issues that have always been out there.

The only thing that I think has been taken off the table with respect to any immediate issue or concern would be the site neutral payment. Again, I see that more playing out over the next several years, probably five years at least, with the passage of the Impact Act. And again, we see that as a positive move.

Okay, thanks. One more and I'll hop. Obviously, a really good job (technical difficulty) very consistent volume growth and you have been able to leverage that into your margins. Given where we are with volume growth today, are there any other remaining drivers or incremental drivers to cost efficiencies that you're looking at, or do you feel like you've pretty much got the business tuned as efficiently as you can? Thanks.

There are always opportunities, as we bring on incremental volume, to do that in a disciplined way. I think, as we look down the road, there may be a need for, frankly, adding additional cost to our operating platform. And a lot of that is going to be driven by regulatory requirements. For example, I think, as everybody knows, with the final rule for 2015, inpatient rehabilitation hospitals are now going to be held accountable for accuracy and completeness of recording the various quality metrics, and there is a penalty associated with that. So that's new for us. We haven't seen that in the past. We haven't had to deal with that in the past, so there may be some incremental expenses at the hospital level that we will actually choose to invest in in order to ensure that the compliance is accurate and complete. But the real issue, Frank, is going to be continuing to grow market share, and to do that in a highly disciplined manner.

Okay, thanks.

Kevin Fischbeck, Bank of America.

Good morning. Actually this is Joanna Gajuk filling in for Kevin today. Thank you for taking the questions. Good morning. Just quickly I guess on the comment you made about closing investment spreads, that impact on volumes, so can you just expand on the reason for the closure, and also whether you have more sort of beds that you plan to close that are still in your portfolio?

No, we don't have any other SNP beds to close. Those were the final ones, and it was really just a matter of economics. We were not making money on those SNP beds, and we just felt that it made more sense to close them. We did so, and as I think we have reported over the last couple of years, we've had, I think at one point we had over 100 SNP beds in our portfolio, and over the years we've been closing them as we could, and we closed the last ones then in June.

Great. And then on the clinical information systems, I guess a comment was made now that the implementation is complete in 56 hospitals, so I guess just moving on there, and is there any color you can give us in terms of any operational benefits you've already sort of seen from implementation of the system there, or do you expect going forward maybe?

First of all, the implementation has gone extremely smooth. As Doug noted, it's now in 56 of our hospitals. I think it's a little bit early to start determining whether or not we are getting measurable benefits. We would expect benefits in the future as we get it out to a larger percentage of our portfolio. We are scheduled right now to have the rollout completed the first half of 2017. Ultimately, we should be able to start drawing from all the data that we can capture electronically from the system and begin to apply that to best practices and clinical protocols. But at this point, it would be a bit premature to start talking about the trends that we are seeing, if any.

Thank you.

(Operator Instructions). [Marelli Dunphy], Citigroup.

Hi, good morning. So a quick question. You provided a lot of detail on your debt transactions, and I just have a specific question. With your announcement yesterday of the redemption of 10% of the outstanding amount of the 7 3/4%, the 22%, is that the final redemption you can make at 103 prior to the first call next year assuming you're going to exercise the call or could you do another 10% redemption next calendar year?

No, that's the last 10% option.

That is. Okay, thank you.

And then the notes will be fully callable next year.

Next year, correct, 9-15. Okay, thank you.

I'm showing there are no further questions at this time. I would now like to turn the floor back over to Mary Ann Arico for any closing remarks.

Thank you Maria. As a reminder, we will be filing the updated investor reference book in mid-November. If you have additional questions, please feel free to call me later today at 205-969-6175. Thank you. That concludes our call.

Thank you. This concludes today's conference call. You may now disconnect and have a wonderful day.