Encompass Health Corporation (EHC) Q4 2018 Earnings Conference Call Transcript

Now, let's move on to our financial results. Doug will cover the fourth quarter in his comments I'm going to comment on the full year. During 2018, our company increased consolidated revenues by 9.3% and consolidated adjusted EBITDA by 9.5%. This growth was driven by strong organic volume growth in both of our business segments. Same-store discharge growth in our inpatient rehabilitation segment was 2.8% and the same-store admission growth in our Home Health was 5.6%.

The growth in adjusted EBITDA, along with favorable working capital changes, resulting in primarily from improved collections of accounts receivable yielded $538.1 million in adjusted free cash flow for the full year, an increase of 14.8%. We used our free cash flow to fund growth opportunities in both of our business segments and to invest in our strategic initiatives.

Relative to growth, we opened four new hospitals and expanded our existing hospitals by 26 beds. The 26 number was less than our target of 100 beds, but remember that we added 166 beds in 2017 and we expect to add 150 or more beds in 2019 to our existing hospitals. We also added 23 home health locations and 22 hospice locations, with the majority of those coming from the acquisition of Camellia Healthcare in May.

In terms of our strategic initiatives, in 2018 we completed our rebranding and name change, advanced our use of data analytics, continued the development of post-acute solutions and increased clinical collaboration between our two segments. Our clinic collaboration rate for 2018 was 34%, an increase of 450 basis points over 2017 and the number of Encompass Health IRF patients to receive the benefits of clinical collaboration increased 20%. Remember the primary objectives of clinical collaboration are to improve the patient experience and outcomes and to reduce the total cost-of-care across a post-acute episode.

We continue to see increasing evidence these objectives are being achieved. Coordination between our IRF and home health teams is resulting in lower discharges to skilled nursing facilities and higher discharges to home in overlap markets. And within our overlap markets, patient satisfaction scores are increasing, while hospital readmission rates are decreasing.

Our priorities for 2019, build on momentum carrying over from 2018. In 2019, we continue to be focused on growth. We have four new hospitals scheduled to open in 2019, including one in Boise Idaho, which is a new state for us. We also have $50 million to $100 million earmarked for home health and hospice acquisitions.

We will also focus on continuing to build our stroke market share. In 2019, we're excited to officially launch our three-year strategic sponsorship with the American Heart Association/American Stroke Association. This sponsorship allows us to bolster stroke awareness through provider, patient and community education, highlighting the 2016 AHA/ASA guidelines that strongly recommend stroke patients be treated in an inpatient rehabilitation hospital rather than a skilled nursing facility.

With 112 of our inpatient rehabilitation hospitals holding stroke-specific certifications from the Joint Commission, we believe we are well positioned to continue to build market share in stroke. We will use data analytics to determine where stroke patients are being discharged in each of our markets and we will present patient outcome data for those patients to providers and payors to demonstrate our value proposition.

Another area of focus in 2019 is our continued development of post-acute solutions. Our post-acute solutions leverage our clinical expertise, large post-acute data sets, EMR technology, and strategic partnerships to drive improved patient outcomes at a lower cost of care across the entire episode care. In 2018, we developed a 90-day post-acute readmission prediction model and began piloting it at two of our hospitals. In 2019, we will continue to refine the model and deploy to additional EHC hospitals. These enhanced capabilities are facilitated by the investments we've made in the IT platforms in both of our business segments as well as our strategic relationships with Cerner and MetaLogics.

With these growth and operational initiatives under way, we are reaffirming our 2019 guidance as communicated last month. Full year 2019 guidance for net operating revenue is between $4.5 billion and $4.6 billion while full year guidance for adjusted EBITDA is between $925 million and $945 million. Full year adjusted EPS guidance is a range of $3.71 to $3.85 per share.

2019 will also include a focus on reimbursement payment model changes scheduled to become effective in 2020 for both of our business segments. As we've discussed previously beginning October 1, 2019, CMS will remove the functional independent measure or FIM tool from the IRF patient assessment instrument. FIM tool will be replaced by a new patient assessment tool called the CARE tool. This new patient assessment tool has been used concurrently with the established functional independent measure since the CMS fiscal year 2017. Guidance from CMS on a new functional assessment tool continues to be released as questions from the industry are brought forward.

Our efforts in 2019 to prepare for the implementation of the new payment system will include improving the documentation that captures each patients' functional abilities. One of the ways we will do this is by using data analytics to compare the functional status of patients measured using the FIM tool to patients using the CARE tool. We will measure the correlation between our hospitals as they use the CARE tool to ensure consistent patient assessments across our staff for inter-rater reliability. All this data can be shared with CMS to address implementation concerns and could be used to refine our education efforts on specific hospitals.

Our primary area of concern with the new payment system is the accuracy and completeness of the data used to build the new payment system as it is likely to require CMS to make substantial changes with the case mix groups or CMGs, relative weights and average length of stay values or the IRF-PPS.

We expect to know more about the changes to case mix groups and the new systems impact on our pricing once the fiscal year 2020 proposed rule for IRFs is released in late April or early May.

In home health, CMS is replacing the current home health perspective payment system with the patient-driven groupings model or PDGM. Among other changes, this system will revise the current 60-day episodic payment to 30-day payment periods.

Reimbursement under this new system also relies more heavily on a patients' clinical characteristics and eliminates therapy service-use thresholds. In addition, to achieve budget neutrality, CMS assumes behavioral changes will offset a 6.4% reduction in the base rate.

We will spend 2019 preparing ourselves for these changes. Our preparation will include the continued use of technology to generate objective, evidence-based care plans and to drive incremental efficiencies in administrative support functions.

We don't expect to have any additional updates regarding PDGM until the calendar year 2020 proposed rule for home health is released in late June or early July. We will continue to work individually and as part of our trade associations to provide feedback to CMS and Congress on both new payment systems, but we assume these payment system will go in place as is and are preparing now.

If these systems go in effect as currently designed their implementation could make 2020, a little bumpy for providers. However, that does not change the long-term outlook for our company, which is predicated on demographic trend driving increasing demand for the services we provide.

We believe we are well-positioned as a company to work through these changes and we have a proven track record of being able to do so. We have successfully managed through an economic recessions, regulatory changes, sequestration and Medicare payment freezes and cuts, growing adjusted EBITDA in 39 of the last 40 quarters. We provide necessary services to an aging population and consistently produce high quality patient outcomes in a cost effective manner.

As the population continues to age the demand for our facility and home-based services will grow and we will meet that demand with enhanced capabilities and expanded capacity.

With that, I'll now turn it over to Doug.

Doug Coltharp -- Chief Financial Officer

Thank you, Mark, and good morning, everyone. Q4 was another strong quarter with regard to our operating financial results. Our Q4 consolidated revenues increased 8.6%. Adjusted EBITDA increased 6.5% and adjusted EPS increased 14.3%.