Encompass Health Q2 2024 Earnings Report

Encompass Health EPS Results

• Actual EPS: $1.11
• Consensus EPS: $1.01
• Beat/Miss: Beat by +$0.10
• One Year Ago EPS: $0.95

Encompass Health Revenue Results

• Actual Revenue: $1.30 billion
• Expected Revenue: $1.30 billion
• Beat/Miss: Missed by -$290.00 thousand
• YoY Revenue Growth: +9.60%

Encompass Health Announcement Details

• Quarter: Q2 2024
• Date: 8/5/2024
• Time: After Market Closes
• Conference Call Date: Tuesday, August 6, 2024
• Conference Call Time: 10:00AM ET

Encompass Health (NYSE:EHC) is a leading provider of post‐acute healthcare services in the United States, operating a comprehensive network of inpatient rehabilitation hospitals and home health and hospice agencies. Its inpatient rehabilitation hospitals offer intensive therapy programs for patients recovering from conditions such as stroke, brain injury, spinal cord injury, cardiac and pulmonary disorders, and orthopedic procedures. Through its home health segment, Encompass Health delivers skilled nursing, physical therapy, occupational therapy and speech therapy to patients in the comfort of their homes, while its hospice services provide end‐of‐life care focused on symptom management and emotional support for patients and families.

Founded in 1984 as HealthSouth Corporation and rebranded as Encompass Health in 2018, the company has grown organically and through acquisitions to serve patients across more than 30 states. Headquartered in Birmingham, Alabama, Encompass Health has built a reputation for integrating clinical expertise with data‐driven care models, collaborating with referring physicians, hospitals and payers to optimize patient outcomes and manage overall costs. Its multidisciplinary approach emphasizes early discharge planning, community reintegration and ongoing continuity of care.

Under the leadership of President and Chief Executive Officer Mark Tarr and Chief Financial Officer William Wellman, Encompass Health continues to invest in facility expansion, telehealth initiatives and digital health platforms to enhance care coordination and patient engagement. The company’s strategic priorities include strengthening partnerships with acute‐care providers, expanding its home health footprint and leveraging clinical analytics to streamline operations and improve quality metrics. With a focus on innovation and evidence‐based practices, Encompass Health aims to address the growing demand for rehabilitation and home‐based services driven by an aging population and evolving payment models.

Encompass Health Q2 2024 Earnings Call Transcript

Key Takeaways

• Q2 revenue rose 9.6% and adjusted EBITDA increased 8.9%, driven by 6.7% discharge growth (4.8% same-store) across geographies and key conditions like stroke and neurological care.
• 2024 guidance was raised to $5.275–5.350 billion in net operating revenue, $1.040–1.075 billion in adjusted EBITDA, and $3.97–4.22 in adjusted EPS, reflecting strong volume trends and a 3.3% IRF pricing update.
• Added 194 beds in Q2—including new hospitals in Rhode Island—and now have 15 development projects underway, with six hospitals in joint venture with Piedmont to meet growing inpatient rehab demand.
• Bad debt expense climbed to 2.9% of revenue due to a surge in medical necessity claim reviews and TPE audits by Medicare’s primary MAC, prompting additional reserves against unprocessed claims.
• Initiated a major ERP conversion to Oracle Fusion (≈$2.5 million H2 2024), resumed share repurchases (~$17 million) and boosted the quarterly dividend by 13% to $0.17 per share, with Fusion go-live expected in late 2025.

Presentation

[Operator]

Good morning, everyone, and welcome to Encompass Health's Second Quarter 2024 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 speaker's remarks, there will be a question-and-answer period. If you would like to ask a question during this time, please press star one on your telephone keypad. You will be limited to one question and one follow-up. Today's conference call is being recorded. If you have any objections, you may disconnect at this time. I will now turn the call over to Mark Miller, Encompass Health's Chief Investor Relations Officer. Please go ahead.

[Mark Miller, Chief Investor Relations Officer at Encompass Health]

Thank you, operator, and good morning, everyone. Thank you for joining Encompass Health's second quarter 2024 earnings call. Before we begin, if you do not already have a copy, the second quarter earnings release, supplemental information, and related Form 8-K filed with the SEC are available on our website at encompasshealth.com. On page 2 of the supplemental information, you will find the safe harbor statements, which are also set forth in greater detail on the last page of the earnings release. During the call, we will make forward-looking statements which are subject to risks and uncertainties, many of which are beyond our control.

[Mark Miller, Chief Investor Relations Officer at Encompass Health]

Certain risks and uncertainties, like those relating to regulatory developments, as well as volume, bad debt, and labor cost trends that could cause actual results to differ materially from our projections, estimates, and expectations are discussed in the company's SEC filings, including the earnings release and related Form 8-K, the Form 10-K for the year ended December 31, 2023, the Form 10-Q for the quarter ended March 31, 2024, and the Form 10-Q for the quarter ended June 30, 2024, when 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 to today. We do not undertake a duty to update these forward-looking statements.

[Mark Miller, Chief Investor Relations Officer at Encompass Health]

Our supplemental information and discussion on this call will include certain non-GAAP financial measures. For such measures, reconciliation to the most directly comparable GAAP measure is available at the end of the supplemental information, at the end of the earnings release, and as part of the Form 8-K filed yesterday with the SEC, all of which are available on our website. I would like to remind everyone that we will adhere to the one question and one follow-up question rule to allow everyone to submit a question. If you have additional questions, please feel free to put yourself back in the queue. With that, I'll turn the call over to Mark Tarr, Encompass Health's President and Chief Executive Officer.

[Mark J. Tarr, President and CEO at Encompass Health]

Thank you, Mark, and good morning, everyone. We are pleased with our second quarter performance as strong discharge growth facilitated an increase of 9.6% in revenue and 8.9% in Adjusted EBITDA. Total discharges for Q2 increased 6.7%, including 4.8% in same-store. Our discharge growth continues to be broad-based across geographies, payers, and patient type. Neurological conditions and stroke, our two most common primary conditions treated, grew 6.3% and 6.6%, respectively, while smaller categories, including other orthopedic conditions, major multiple trauma, and knee and hip replacement, experienced double-digit increases. Within our payer mix, Medicare discharges increased 7.2% for the quarter, while Medicare Advantage discharges grew 9.6% for the quarter. Owing largely to our Q2 results, we are again increasing our 2024 guidance.

[Mark J. Tarr, President and CEO at Encompass Health]

Douglas will cover the details of the quarter and increased guidance in his comments. Demand for IRF services remains strong, and we are continuing to invest in capacity additions to meet the needs of patients requiring inpatient rehabilitation services. During Q2, we added 194 beds to our capacity, comprised of three de novo hospitals with a total of 130 beds, one 40-bed satellite hospital, and the addition of 24 beds to existing hospitals. In July, we expanded into a new state for our company as we opened a 50-bed hospital in Johnston, Rhode Island. Over the balance of the year, we expect to open two additional de novos with a total of 100 beds and add approximately 30 more beds to existing hospitals.

[Mark J. Tarr, President and CEO at Encompass Health]

We are continuing the expansion of our joint venture partnership with Piedmont, the leading healthcare system in the state of Georgia. In May, we opened a 40-bed IRF unit within Piedmont's Atlanta hospital. In July, we expanded the relationship further by adding our existing 70-bed hospital in Augusta, Georgia. Our joint venture relationship with Piedmont now includes six open hospitals and the previously announced plans to build hospitals in Athens and Loganville, Georgia. With 15 development projects beyond 2024 already announced and underway, our pipeline remains robust and balanced between wholly owned and joint ventures.... We also recently made the decision to undertake a major ERP conversion from predominantly an Oracle PeopleSoft platform to Oracle Fusion. The conversion is intended to create a highly capable and sustainable cloud-based ERP infrastructure to support the future growth of our company and facilitate our culture of continuous operational improvement.

[Mark J. Tarr, President and CEO at Encompass Health]

Fusion includes specialized supply chain solutions for healthcare organizations that represent an upgrade from the functionality within our current system. Other key Fusion modules include financial and human capital management processes. We are pleased to have identified a solution that allows us to maintain and build upon our strategic relationship with Oracle, and we have engaged a leading consulting firm to assist us with the design and implementation of Fusion. Our efforts in this regard began in earnest in Q2, and we expect to go live sometime late in 2025. During the quarter, we also resumed activity under our share repurchase authorization, buying back approximately 200,000 shares of our common stock for approximately $17 million. In July, we announced an increase in our share repurchase authorization to $500 million.

[Mark J. Tarr, President and CEO at Encompass Health]

We also announced an increase in the company's quarterly dividend, next payable in October, of approximately 13% to $0.17 per share. On July 31, 2024, CMS released the 2025 IRF Final Rule. This included a net market basket update of 3%, which we estimate would result in approximately 3.3% increase for our IRFs beginning October 1, 2024, based on our current patient mix. Across our more than 160 inpatient rehabilitation hospitals, we are providing high-quality, cost-effective care to medically complex patients. Our dedicated clinical teams work collaboratively with physicians to administer this care, producing leading scores in patient satisfaction and quality outcomes. This value proposition increasingly resonates with patients, caregivers, referral sources, and payers. The demand for inpatient rehabilitation services remains considerably underserved and continues to grow as the U.S. population ages.

[Mark J. Tarr, President and CEO at Encompass Health]

We intend to continue to expand our capacity and capabilities to help meet this need. Now I'll turn it over to Douglas.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

Thanks, Mark, and good morning, everyone. We are pleased to report another really solid quarter, with Q2 revenue increasing 9.6%, driving 8.9% Adjusted EBITDA growth. The revenue increase resulted primarily from discharge growth of 6.7%, including 4.8% same-store growth. I'll note this marks 8 consecutive quarters of same-store discharge growth exceeding 4%. New store growth in Q2 was impacted by the timing of de novo openings. Specifically, we had 2 openings in Q1 of 2023, which therefore rolled into same store beginning in Q2 2024, and our first de novo openings this year did not occur until mid-Q2. Revenue growth in Q2 also included a $10.3 million increase in provider tax revenues.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

Our net revenue per discharge in Q2 increased 2%, lower than anticipated, primarily due to an increase in bad debt expense as a percent of revenue to 2.9%. The largest factor leading to the increase in bad debt expense was an increase in medical necessity claim review audits. To elaborate, we had experienced a low level of TPE audits from our primary MAC, Palmetto, from Q3 2023 through Q1 2024. The TPE audits by Palmetto ramped up significantly in Q2, and our practice is to establish reserves when a claim is submitted for review. The increase in medical necessity claim review audits in Q2 also includes initial appeals of non-affirmed claims under RCD. We are still early in the stages of RCD, and few of the appealed claims have yet to be resolved.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

Adjusted EBITDA in Q2 increased 8.9% to approximately $272 million, inclusive of an approximately $5 million benefit from net provider tax revenues. Total premium labor expense for Q2 was $32.6 million, and contract labor FTEs were 1.6% of total. These metrics are consistent with our expectations of a stabilizing labor market. We continue to generate significant free cash flow. Adjusted free cash flow increased 14.7% to $142.5 million, bringing our year-to-date total to $310.1 million. We expect full year adjusted free cash flow of $495 million-$580 million. Our leverage and liquidity remained very favorable. Net leverage at quarter end was 2.5x, compared to 2.7x at year end.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

We ended the second quarter with $154.4 million in unrestricted cash, and with no amounts drawn on our $1 billion revolving credit facility. In July, reflective of the strength and consistency in our performance, Moody's upgraded our corporate family rating from Ba3 to Ba2, and our unsecured notes rating from B1 to Ba2. We also issued notice for the redemption of $150 million of our 5.75% senior notes due 2025, with a settlement date of August fifteenth. As Mark mentioned, during Q2, we resumed activity under our share repurchase authorization, repurchasing 198,708 shares for $16.8 million. In July, we increased our share repurchase authorization to $500 million, and declared a cash dividend of $0.17 per share.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

We are again raising our 2024 guidance. We now assume net operating revenue with a range of $5.275 billion-$5.35 billion, adjusted EBITDA in a range of $1.04 billion-$1.075 billion, and adjusted earnings per share of $3.97-$4.22. The key considerations underlying our guidance can be found on page 12 of the supplemental slides, and I want to take a moment to note several updates. We have updated our Medicare pricing assumption for Q4, reflecting the IRF final rule released last week, and now expect a 3.3% Medicare pricing increase.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

Our assumption for full year 2024 bad debt reserves has increased to 2.4%-2.6% of revenue, primarily due to the increase in medical necessity claim review audits experienced in Q2. We continue to anticipate $15 million-$18 million of de novo net pre-opening and ramp-up costs for 2024. Q2 net pre-opening and ramp-up costs were $6.9 million, bringing our year-to-date cost to $8.7 million. Oracle Fusion conversion costs in the second half of 2024 are expected to approximate $2.5 million. The addition of our existing Augusta, Georgia, hospital to the joint venture with Piedmont is expected to increase income attributable to non-controlling interest, or NCI, in the second half of 2024 by approximately $3.5 million.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

With that, we'll open the lines for Q&A.

[Operator]

At this time, if you would like to ask a question, please press star one on your telephone keypad. You may remove yourself from the queue at any time by pressing star two. We ask that you please limit yourself to one question and one follow-up. Once again, that is star one to ask a question. We'll take our first question from Whit Mayo with Leerink Partners.

[Mark J. Tarr, President and CEO at Encompass Health]

Good morning, Whit.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

Morning, Whit.

[Whit Mayo, Senior Managing Director and Senior Research Analyst at Leerink Partners]

Morning, guys. Maybe just first on the Doug, on the higher bad debt, how was that versus expectations, thoughts on the back half, and how you've incorporated that into the guide on maybe a dollar basis, just given the higher audits, and are these higher audits actually higher than what you expected? Thanks.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

Yeah, it's, it's a little hard to predict the activity under TPE. The single largest factor here were the TPE audits with Palmetto. And, as I tried to outline in my comments, those tend to be a little bit lumpy. So after several quarters where there wasn't much activity there, Palmetto selected, which they were entitled to do, 20 claims from each of the hospitals within their jurisdiction. And because our practice is to establish a reserve immediately when the claim is selected for review and before it's been processed, Q2, you saw the accumulation of the reserve for all of those claims selected by Palmetto, although very few of them had been processed. Now, what we've witnessed since the end of the second quarter is that more of those claims are getting processed with a favorable resolution, and new claims have not been selected.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

That really kind of informs our outlook for the balance of the year.

[Whit Mayo, Senior Managing Director and Senior Research Analyst at Leerink Partners]

Okay. Maybe just to follow up, and we can talk about that offline. But, just, Doug, buybacks, you presumed a little bit more activity, maybe not a question on the quarter or the year, but just how you think about buybacks becoming a larger part of the uses of cash in the future. It wasn't a large amount in the quarter with something. I know the authorization was nudged up to $500 million. Just want to kind of think how you're sort of evaluating buybacks on a, on a go-forward basis. Thanks.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

... Yeah, we think, you know, as we had talked about previously, we really kind of crossed a Rubicon with regard to cash flow in 2023, where we began generating free cash flow above the level that is required to fund all of our discretionary CapEx. And at the same time, our leverage has been coming down predominantly based on the year-over-year increases in EBITDA. So that gives us capacity to allocate free cash flow to other uses. And, you know, we've stated pretty consistently that we think that the best additional use beyond capacity expansion is shareholder distributions. We have tended to like a balanced approach between share repurchase activity and an increase in the dividend.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

I think you saw the initial moves in that direction in Q2, and with the increased authorization, we would expect to see kind of that become a more stable utilization of our, or allocation of our free cash flow. We don't have a specific time frame in mind over which we intend to use that authorization, but it was put in place for us to utilize.

[Mark J. Tarr, President and CEO at Encompass Health]

Yeah, Whit, this is Mark. I mean, this is a common and frequent discussion from our board in terms of how to use this free cash and how best to recognize with our shareholders.

[Operator]

Our next question comes from A.J. Rice with UBS.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

Morning, AJ.

[Mark J. Tarr, President and CEO at Encompass Health]

Morning, AJ.

[A.J. Rice, Managing Director and Senior Health Care Equity Research Analyst at UBS]

Hi, everybody. Maybe just... I know you reiterated your cost figures for SWB per FTE up 4%-5%. I'm seeing contract labor up sequentially a little bit. I mean, we're not seeing that, you know, from the acute guys and all of that, but maybe that's due to your incremental bed capacity and bridging to get permanent people, or what's going on there? And anything else to call out on labor?

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

You know, I think with regard to the premium labor, it's, it's consistent with the story we've told the last several quarters, which we felt like we were at a roughly stabilized level. I do think it is important to note that we're keeping the dollars level at the same time that our volume continues to grow, not just in the new stores, but with that same store growth. Again, eight consecutive quarters of same store discharge growth exceeding 4%. So we don't necessarily think that there'll be much near-term leverage against those, although we continue to focus on trying to bring that down. We seem to have stabilized at roughly 1.5%-1.6% of FTEs.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

I think in the, in terms of the assumption of, SWB being up 4%-5% a year, we were up 3.5% for the first half of the year, so that would suggest we'd have to be up kind of in the higher end of that 4%-5% range to get the full year there. And so there may be some conservatism built into that assumption, but we think just, just given some of the uncertainty with regard to labor market conditions and the fact that it can change, particularly on a geographic market by market, basis, that it was prudent to leave the assumption there.

[Mark J. Tarr, President and CEO at Encompass Health]

A.J., that contract labor, so 50% of the spend was within 13 hospitals for Q2. So it's within a small percentage of our hospitals and just some of those marketplaces that remain still a bit of a challenge.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

You know,

[A.J. Rice, Managing Director and Senior Health Care Equity Research Analyst at UBS]

Okay

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

... with regard to the philosophy around being proactive with regard to market adjustments, again, that, that really has served us well. Our turnover levels for both nursing and therapy were again, very favorable in Q2, and we continue to have great success at net new RN hires. So, you know, that's the trade-off against a somewhat higher inflation level on SWB. We think it's probably a good one.

[A.J. Rice, Managing Director and Senior Health Care Equity Research Analyst at UBS]

Okay, I noticed you continue to see growth at about 0.5 percentage point on your revenue mix in Medicare Advantage, and what you call traditional Medicare is a little down, about 0.5%. Otherwise, pretty stable. Anything to call out there? I mean, I know we got underlying growth in Medicare Advantage enrollment. Is that basically what's driving that, or anything contracting-wise or to call out?

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

No, you know, I think it really is just kind of tracking the overall market growth. We do feel like we continue to make good inroads with Medicare Advantage plans. 90% of our contracted Medicare Advantage revenue is on an episodic versus a per diem basis. And once again, we were just at about a 3% discount in the overall book of Medicare Advantage to Medicare from a pricing perspective. So feel good about what's happening there and about the way our value proposition is resonating with that payer class.

[Mark J. Tarr, President and CEO at Encompass Health]

A.J., as we've said before, you know, a large percentage of the cases that we see through Medicare Advantage are stroke programs and those programs that are more medically complex patients, which is really an area that we feel we've developed as a sweet spot in our ability to provide that value proposition to get those patients back to the communities.

[Operator]

We'll take our next question from Andrew Mok with Barclays. Please go ahead.

[Mark J. Tarr, President and CEO at Encompass Health]

Morning, Andrew.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

Morning, Andrew.

[Andrew Mok, Director and Senior Equity Research Analyst at Barclays]

Hi, good morning. First, can you just clarify what the startup cost number was in the quarter? And then I wanted to follow up on the guidance components. Looks like there's an implied deceleration in the back half, even though the bad debt increase is largely impacting 2Q, and it looks like SWB per FTE is tracking below the low end of your guidance in the first half. So any other items that we need to consider in the back half for guidance? Thanks.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

... Okay, so first on the pre-opening and ramp-up costs, in the quarter, $6.9 million. Year to date, $8.7 million. Full year assumption, unchanged at $15 million-$18 million. You know, I think in the second half, I think the things that we would call out are the Oracle Fusion conversion costs, the NCI impact from adding our Augusta Hospital to the Piedmont Joint Venture. And then we do, based on that 4%-5% SWB increase for the full year, and the fact that we ran at 3.5% for the first half of the year, that would suggest a potentially higher rate of inflation in the second half.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

We don't know if that'll come to fruition, and that's why I mentioned earlier, there may be some conservatism to that assumption, but we think it's prudent to leave it there at this point.

[Andrew Mok, Director and Senior Equity Research Analyst at Barclays]

Great. And if I could just follow up, this is the second quarter in a row that we've seen some provider tax revenue flowing through the outpatient and other side of the business. Can you help us understand your exposure to these programs more broadly, and whether or not you have exposure on the inpatient side? Thanks.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

It's very volatile and very difficult to predict. Most states have some form of program that's out there. You don't get a lot of visibility into what your participation is going to be. There tends to be a time lag based on the state's fiscal year, which doesn't, in most instances, align with our fiscal year, so it can be really lumpy. If you look at last year, you know, in the first two quarters, it was negligible. So some of this is out of period, some of it is in period. It's kind of a long-winded way of saying that it's just really hard to predict, and it's, as a result, very difficult for us to incorporate it into any of our guidance.

[Operator]

Our next question comes from Pito Chickering with Deutsche Bank.

[Pito Chickering, Director and Senior Equity Research Analyst at Deutsche Bank]

Good morning, guys. So looking at the changes from the previous guidance versus the updated guidance, I estimate about $23 million of headwinds coming from Oracle, the JV sale and bad debt, about $8 million of tailwinds coming from Medicare pricing and provider tax EBITDA. So if I think about you're raising our guidance by $24 million, with a $14 million negative impact from the headwinds, the net headwinds, is that a good way to think about your guidance change?

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

Yeah. So I'll give you the math kind of the way that I'm thinking about it, Pito. And so I'm now focused on the EBITDA guidance at the midpoint, for lack of a better starting point. And so from our initial guidance, it's up $22.5 million. But to your point, there have been tailwinds and headwinds that were not included in that initial guidance. So in terms of the tailwinds, we've had provider tax impact on EBITDA for the first half of $10 million. We also had positive insurance accrual adjustments that weren't factored into our initial guidance of $6 million, so that's $16 million. Offsetting that, if you go to the midpoint on the revised bad debt range, it's about a $16 million impact, and then the Piedmont and Fusion together are $5 million, so that's $21 million.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

So a net headwind of $5 million, which would suggest the midpoint of the EBITDA guide has gone up by $27.5 million or $28 million. And really, all of that has been attributable to the strength and volume that we saw in the first half of the year.

[Pito Chickering, Director and Senior Equity Research Analyst at Deutsche Bank]

Okay, got it. And then, looking at the back half of the year, with your, you know, revenue guidance not changing that much, I guess, where are you seeing sort of better core margin leverage versus your previous leverage? Thanks.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

I'm sorry, I didn't... Pito, could you give me that last question again? I didn't quite get that.

[Pito Chickering, Director and Senior Equity Research Analyst at Deutsche Bank]

Oh, so apologies. I guess, you know, I guess, so back to sort of the, the guidance question. You're not changing your revenue guidance that much, so implying you're seeing better core margin, in the back half of the year as your previous guidance. I guess, you know, is that how we should be thinking about just better margins versus your revenue is not going up that much in the back half of the year?

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

I'm sorry, Pito, I kinda had trouble following that again. I might be a little slow this morning.

[Pito Chickering, Director and Senior Equity Research Analyst at Deutsche Bank]

Oh, I think, apologies, actually. So when I skipped that one and changed that one to-

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

Okay. Thank you.

[Pito Chickering, Director and Senior Equity Research Analyst at Deutsche Bank]

De novo. So I guess, what's the cost to build a new facility in 2024 versus sort of 2023, I guess? Has the ROIC for building de novos gotten better as inflationary pressures have come down in the last year? Thanks.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

Yeah, and so, you know, you're always looking forward about three years to get a first time an idea about a new de novo pops into our head to the time it gets open is roughly a 2.5 to 3-year time horizon. Right now, we've seen costs really hang in there pretty well at that $1.2 million per bed that we've been talking about for a while. That's for de novo activity. Bed expansions are more in the $700,000, and those have been relatively stable. Some of that is a result of the slowing down of inflation in the market. A lot of it has to do with our use of prefabrication, and then just also some supply chain efficiencies.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

In terms of the ROIC, with the cost per bed staying relatively stable, we are still seeing pro formas that generate attractive ROICs, which is why we continue to push forward with new capacity additions.

[Operator]

Our next question comes from Kevin Fishbeck with Bank of America.

[Mark J. Tarr, President and CEO at Encompass Health]

Morning, Kevin. Morning, Kevin.

[Kevin Fishbeck, Managing Director and Senior Equity Research Analyst at BofA Securities]

Hey, guys. So I guess a couple of questions. First one, on the guidance components in the back half of the year, it wasn't 100% clear to me how we should think about, these headwinds as we think about 2025. I guess we just kinda, with Piedmont, it seems like we just double it and say it's a full year impact next year. But is the bad debt number, should we be thinking about the annual number as the right number? Should we be thinking about the second half run rate as the right number? And then the fusion costs, are there gonna be additional costs in 2025 that we have to think about, or is that all gonna be wrapped up this year?

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

Yeah. So I think, for an initial estimate on Piedmont and Fusion, take the numbers for the second half of this year, multiply by 2, maybe plus or minus a little bit, just based on growth at Piedmont and based on, you know, not knowing the full range of activity that we're gonna make on Fusion through the progress of 2025 when we intend to go live. The bad debt, it's too early for us to formulate an estimate for, 2025, although I don't think sitting here today, that I would pencil anything that is markedly different from kind of the history we've had over the last 2 or 3 years. I think what we saw-

[Kevin Fishbeck, Managing Director and Senior Equity Research Analyst at BofA Securities]

Okay

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

... in Q2 was a bit of a spike, and that's why we expect it to normalize some in the second half of the year. We'll just have to see how much and how fast.

[Kevin Fishbeck, Managing Director and Senior Equity Research Analyst at BofA Securities]

Okay, that's helpful. And then I guess, you know, with joint ventures, like, I'm kinda used to seeing facilities being thrown into a joint venture once you create them. But with Piedmont, I guess you've been involved with them already. So what benefit do you get by adding an additional facility into a joint venture versus just kinda keeping all of the economics yourself?

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

And so we've had a couple of existing facilities that have been added into the Piedmont joint venture, one in Newnan, Georgia, and this one in Augusta, Georgia. Augusta, Georgia, was added specifically. We had an existing hospital there that we've had for better than 10 years. Piedmont did not historically have a presence in that market, and they acquired an acute care hospital, so it was consistent in terms of how we're approaching the entire state of Georgia in markets where we overlap to be partnered together.

[Operator]

Our next question comes from Scott Fidel with Stephens.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

Hello, Scott.

[Mark J. Tarr, President and CEO at Encompass Health]

Morning, Scott.

[Scott Fidel, Managing Director and Senior Research Analyst at Stephens Inc.]

Hi, thanks. Good morning. First question, so just thinking about what you were just talking about on the 8 consecutive quarters now of at least 4% same-store discharge growth and the fact that you're, you know, being opportunistic on investing in wages to sustain that clinical capacity. As we think about the updated guidance for the full year, should we be thinking about you looking to target delivering at least that 4% same-store discharge growth in both the third and fourth quarters implied in the guidance?

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

You know, we don't provide specific quarterly guidance around volume growth or any other metrics. What we have said before, and I think what we continue to adhere to, is that we expect a discharge growth CAGR of 6%-8%, and we've been consistently delivering within that range or above that range. Demand for services, as Mark cited in his comments, remains good. Our hospitals have the capability to serve those patients well, and staffing has not been a constraint, nor do we foresee it being a constraint in terms of being able to meet the volume demands for our facilities.

[Scott Fidel, Managing Director and Senior Research Analyst at Stephens Inc.]

Okay, got it. And then follow-up question, just, just interested as, you know, sort of the latest, I guess, contracting, interactions, with the, with the managed care, payers, just as it relates to, obviously, it's been a challenging backdrop for, for MA in, in 2024 and, and 2025, the reimbursement pressure will continue. So, you know, just curious, has there been any change in the contracting posture from, MA plans and, because of that? And then also, just from I, I guess, you know, sort of the utilization management and, and sort of, medical management side of things as well, from, from the managed, from the Medicare Advantage plans, whether you've seen any sort of tightening behaviors just because of some of the financial pressures that they're facing. Thanks.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

So in terms of the contracting, no, there really hasn't been any change in the nature of the discussions between the two. I'll remind you that, particularly prior to this year, there were a number of years where the MA plans had very significant annual increases, and they did not feel compelled to share that largesse with us during that time frame. So, you know, you can't have it both ways. With regard to the actual relationship, once those plans are in place, I would say that it is improving and becoming more constructive, but there is no doubt that the pre-authorization policies and the screening that gets done by the MA plans remains a challenge in a lot of our markets.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

We have very talented people at all of our hospitals who work very hard to make sure that those patients in need of inpatient rehabilitation care have an opportunity to come to one of our hospitals so they can go get well, and that's true for MA patients, as well.

[Mark J. Tarr, President and CEO at Encompass Health]

I think one thing we have done, we've gotten very detailed from our clinical approach with our therapists or nurses that may be, or even our medical directors, that may be working to justify the admission of a patient and support the clinical benefits and the potential gains that should be seen by that patient in our hospital. So we've been. We've involved our medical directors and clinicians in that process to a much greater degree than what we had in the past.

[Operator]

As a reminder today, if you'd like to ask a question, please press Star and One. We'll take our next question from Brian Tanquilut with Jefferies.

[Mark J. Tarr, President and CEO at Encompass Health]

Hey, morning, Brian.

[Brian Tanquilut, Senior Equity Research Analyst at Jefferies]

Hey, good morning, guys.

[Mark J. Tarr, President and CEO at Encompass Health]

Good morning, Brian.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

Good morning.

[Brian Tanquilut, Senior Equity Research Analyst at Jefferies]

Maybe just to go back on the audits, maybe, Douglas, is this specific to Palmetto, or is this a broader and more national thing? And then maybe just as I think about the mechanism here, right? So as the claims are processed, is there a reserve release that we should expect or could expect down the road?

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

Yes. So the majority of the activity has been with Palmetto. I'll remind you that they are our largest MAC, by a long shot. And then it works exactly as you said, Brian. When a claim is selected, we immediately establish a reserve, and we had all of those claims had been selected in Q2, and very few had had a decision rendered upon them by Palmetto at the end of Q2. As we have progressed beyond the end of Q2 to this point, more of those claims have been processed. Many are a favorable resolution. They're approved, and as soon as they are approved, we go ahead and release the reserve. Well, actually, they get approved, and then once the cash comes in, we release the reserve.

[Brian Tanquilut, Senior Equity Research Analyst at Jefferies]

Okay, got it. And then maybe, Mark, I noticed that you-

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

As that flows-

[Brian Tanquilut, Senior Equity Research Analyst at Jefferies]

Oh, go ahead.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

As that flows through the quarter, unless there are incremental claims that are selected for review, you would see a reversal of some of the bad debt expense that we experienced in Q2.

[Brian Tanquilut, Senior Equity Research Analyst at Jefferies]

Got it. Yeah, in future periods. That makes sense. Then maybe, Mark, as I think about, you know, seeing that you opened or you've got an announcement for Rhode Island, are there plans? I mean, how are you thinking about new geographies outside your current footprint of states? Are there states that are screaming for you guys as attractive new market entry opportunities that we should be thinking about?

[Mark J. Tarr, President and CEO at Encompass Health]

Yeah, well, you can look on our slides in terms of the development activity. We're very excited about some of the new states, and I mentioned Rhode Island earlier, but if you look at other states, you've got Danbury, Connecticut on there. That'll be a new state for us next year. You also have geographies within existing states that we're excited to pursue. So, we examine literally any MSA that could be a potential marketplace for us. There are certain states that we'll never enter, but we have a broad approach in terms of evaluating different geographies and the opportunities to enter new states.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

And remind you there that if we just look at a proxy for the demand for IRF services as the number of presumptively eligible CMS 13 discharges coming out of acute care hospitals every year that ultimately wind up in an IRF bed, that conversion rate nationwide is only about 14%. So we know that there's a lot of unmet demand out there, and that demand is increasing every year, just given the aging demographic in this country.

[Operator]

Our next question comes from Jared Haase with William Blair. Please go ahead.

[Mark J. Tarr, President and CEO at Encompass Health]

Hey, Jared.

[Jared Haase, Equity Research Associate at William Blair]

Hey, good morning. Thanks for taking the questions. Maybe just a quick one just on the quarter. Occupancy was up nicely again year over year, but it did decline a bit sequentially. Is that typical seasonality, or were there any other nuances that you'd sort of share in terms of how that metric shaped up for the quarter? And then any comments on, you know, what a fair assumption would be for the back half of the year?

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

Yeah. So, Q1 is normally, based on seasonality, a very strong quarter for us from an occupancy perspective. Q2 was also impacted by the fact that in Q1, we did not bring on any new capacity, and in Q2, we added 194 beds, and most of those came on in the second half of the quarter, and so that weighs down on occupancy while you're in the ramp-up phase.

[Jared Haase, Equity Research Associate at William Blair]

Okay, that makes sense. And then wanted to ask another one just on the labor inflation trends, and I know it's early, but specifically, I was wondering if there's any color you can share in terms of just expectation for 2025. I'm sure some of that will maybe be informed by how things shape up in the second half of the year. Obviously, you guys typically try to lead the market on inflation trends, so maybe any thoughts you'd share in terms of broader expectations for the industry?

[Mark J. Tarr, President and CEO at Encompass Health]

Just, so Jared, Mark, I mean, we can comment on what we're seeing right now, and that is certainly a normalization of some of the marketplaces. We've put a lot of effort into our recruitment and talent acquisition function. We're seeing some nice trends in our ability to retain our nurses and our therapists. If you look at our turnover rates, they are equal to, if not better, than pre-pandemic. So, you know, if these trends were to continue in the future, which we fully expect, then we'll certainly be well-positioned to continue to be able to service the growth that we have out there and continue to grow as a company.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

Obviously, a lot of volatility out there right now in the overall macroeconomic picture, as we've all witnessed this week.... So it's a little hard to predict what's going to happen next year, but, you know, it kind of feels, and maybe what we hope for, is that we see things settle down into that level of overall, labor inflation that we saw in the first half of roughly 3.5%.

[Operator]

Our next question comes from John Ransom with Raymond James.

[Mark J. Tarr, President and CEO at Encompass Health]

From John.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

Hey, good morning, John.

[John Ransom, Managing Director and Senior Healthcare Services Analyst at Raymond James]

Hey there. Sorry, I have all kinds of timers going off here right as you—why don't you have me pick up? My question is a broader one. If we look at the post-acute landscape, you know, there's been a lot of changes, but do you think where we are now is that the referral patterns to yourself, to home health, to SNFs, do you think those have stabilized? Has the role of conveners diminished? So other than, you know, MA looking for, do you see—do you think that, you know, we've kind of settled out in where the referrals are gonna go, or are you still going to have a knife fight over all this?

[Mark J. Tarr, President and CEO at Encompass Health]

So John, it's Mark.

[Mark J. Tarr, President and CEO at Encompass Health]

I think that certainly during COVID and immediately post-COVID, the different settings in post-acute and the capabilities or lack thereof, because of staffing and other resources, played out in the favor of IRFs, and certainly we took advantage of that in terms of our ability to handle a medically complex patient. I do think-

[John Ransom, Managing Director and Senior Healthcare Services Analyst at Raymond James]

Mm-hmm

[Mark J. Tarr, President and CEO at Encompass Health]

... that we continue to take market share from nursing homes, the majority of which reason I just stated in terms of our ability to show that we can get better outcomes because we have more resources, can handle more medically complex patients. So I think there's still some settling to be had out there, but I think that there has been a fair amount of settling, certainly since post-COVID.

[Mark J. Tarr, President and CEO at Encompass Health]

In terms of the conveners, you know, whenever we've seen them enter a marketplace, there might be some real aggressive actions there that could impact us in the short run, but in the long run, the outcomes play out, and any impact in terms of the referral patterns that might be changed on a short-term basis worked our favor in the long run.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

They do seem to be popping up much less frequently than they were, say, from 2015 to 2020, which was kind of that period where they were most popular.

[John Ransom, Managing Director and Senior Healthcare Services Analyst at Raymond James]

Yeah. I mean, I saw naviHealth with the layoffs, and I just wonder if their day has sort of come and gone.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

I think so.

[John Ransom, Managing Director and Senior Healthcare Services Analyst at Raymond James]

Yeah. Okay. Thank you.

[Douglas E. Coltharp, EVP and CFO at Encompass Health]

Thank you.

[Operator]

This does conclude today's question and answer period. I will now turn the call back over to Mr. Mark Miller for any additional or closing remarks.

[Mark Miller, Chief Investor Relations Officer at Encompass Health]

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

[Operator]

This does conclude today's program. Thank you for your participation. You may disconnect at any time.

Participants

Executives

• Douglas E. Coltharp, EVP and CFO
• Mark J. Tarr, President and CEO
• Mark Miller, Chief Investor Relations Officer

Analysts

• A.J. Rice, Managing Director and Senior Health Care Equity Research Analyst at UBS
• Andrew Mok, Director and Senior Equity Research Analyst at Barclays
• Brian Tanquilut, Senior Equity Research Analyst at Jefferies
• Jared Haase, Equity Research Associate at William Blair
• John Ransom, Managing Director and Senior Healthcare Services Analyst at Raymond James
• Kevin Fishbeck, Managing Director and Senior Equity Research Analyst at BofA Securities
• Pito Chickering, Director and Senior Equity Research Analyst at Deutsche Bank
• Scott Fidel, Managing Director and Senior Research Analyst at Stephens Inc.
• Whit Mayo, Senior Managing Director and Senior Research Analyst at Leerink Partners