Good morning, everyone, and welcome to Encompass Health's Second Quarter 2023 Earnings Conference Call. 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.

Thank you, operator, and good morning, everyone. Thank you for joining Encompass Health's Second Quarter 2023 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. Certain risks and uncertainties, like those relating to regulatory developments as well as volume, bad debt, and labor costs 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, 2022, and the Form 10-Q for the quarter ended June 30, 2023, 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 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.

Thank you, Mark, and good morning, everyone. We are very pleased with our second quarter results, driven by continued strong volume growth and substantial year-over-year improvement in labor costs. Our second quarter revenues increased 11.7% and adjusted EBITDA increased 27.1%. Q2 total discharges increased 9.8% with same-store discharges up 6.2%. Our strong volume growth continues to underscore our value proposition to referral sources, payers, and patients. As anticipated, our patient acuity continued to broaden with more normalized patient flows to the healthcare system. While we continue to show solid growth in stroke discharges, which were up 5.5% year-over-year, knee and hip replacement, fracture of the lower extremity, and other orthopedic discharges each grew approximately 15% year-over-year. Given the strong demand for inpatient rehabilitation services, we have continued to invest in capacity additions. We opened 2 de novos in the second quarter, adding 110 beds. This brings us to 5 de novos and 259 beds added year-to-date. We also added 10 beds to existing hospitals in the second quarter. Over the balance of the year, we plan to open 2 more de novos and add 31 beds to existing hospitals. Three of our bed addition projects originally scheduled for 2023 have shifted to 2024 due to local permitting issues. As a result of this shift, we now expect to add approximately 140 beds to existing hospitals in 2024. We continue to build and maintain an active pipeline of de novo projects, both wholly owned and joint ventures with acute care hospitals. We currently have announced 19 de novos with opening dates beyond 2023. During Q2, we again met the increasing demand for our services while reducing contract labor and sign-on and shift bonus expenditures. Contract labor was down approximately $13 million or 37% from Q2 2022, while sign-on and shift bonuses decreased approximately $8 million or 36% from Q2 of 2022. Our talent acquisition efforts resulted in over 200 net same-store RN hires. This is a very strong hiring quarter. We want to remind you that higher results may vary significantly from quarter to quarter based on seasonality and other factors. Last week, CMS issued the 2024 IRF final rule. This included a net market basket update of 3.4%, which we estimate would result in a 3.3% increase for our IRFs beginning October 1, 2023. Review Choice Demonstration, or RCD, is scheduled to begin August 21 in Alabama. We've been working closely with CMS and Palmetto, the Medicare Administrative Contractor for the State of Alabama to prepare for its implementation. While many details have yet to be finalized, we have prepared for its implementation, and we are focused on pre-claim review as we believe that it will allow for a more iterative process and the potential for real-time adjustments. Moving now to guidance. Based on our first half performance and revised expectations for the balance of the year, we are increasing our 2023 guidance to include net operating revenue of $4.75 billion to $4.81 billion, adjusted EBITDA of $920 million to $950 million, and adjusted earnings per share of $3.31 to $3.53. The key considerations underlying our guidance can be found on Page 12 of the supplemental slides. Finally, I want to remind you that we are hosting an Investor Day in New York City on September 27, 2023. At that meeting, we will provide more detailed insight into key elements of our strategy, including de novo hospitals, clinical technologies, and labor management. If you have not already registered, you may do so on our Investor Relations website or contact Mark Miller. We hope to see you there. Now I'll turn it over to Doug for further color on the quarter.

Thank you, Mark, and good morning, everyone. I'm going to hit just a few highlights, and then we'll open up the floor for questions. As Mark stated, we are very pleased with our Q2 results. We continue to make significant improvement in year-over-year labor costs. Our Q2 contract labor plus sign-on shift bonuses of $36.1 million was comprised of $22.1 million in contract labor and $14 million in sign-on and shift bonuses. Contract labor expense in Q2 declined approximately $13 million or 37% from Q2 2022. Agency rates declined year-over-year and were relatively flat sequentially. Our Q2 2023 agency rate per FTE was $186,000 down from $223,000 in Q2 2022. Utilization also declined year-over-year and remained essentially level sequentially. Q2 2023 contract labor FTEs 476 represented a 25% decline from Q2 2022. Contract labor FTEs as a percent of total FTEs was 1.8%, an 80 basis point decline from Q2 of last year and flat sequentially. We expect contract labor FTEs as a percent of total FTEs to remain relatively consistent. We will continue to see improvement. Sign-on and shift bonuses decreased $7.8 million or 36% from Q2 2022 and decreased by $2.3 million or 14% sequentially. The improvements we are experiencing in sign-on and shift bonuses are the result of the processes we have implemented and we believe an easing in market conditions. Revenue reserves related to bad debt decreased 30 basis points to 1.9%. Supplemental medical review contractor or SMERC audit results trended favorably in Q2 compared to our previously established reserves. Our aging-based reserves also benefited from strong collections in the quarter. EPOB for the quarter was 3.38, an increase from 3.37 in Q2 of last year and from 3.32 in Q1 of this year. Our guidance assumes EPOB to be approximately 3.40 for Q3 and Q4. Q2 de novo net preopening and ramp-up costs totaled $4.3 million, bringing the year-to-date total to $8.5 million. We continue to expect $10 million to $12 million of these costs for the full year. Finally, we ended Q2 with a net leverage ratio of 2.9, down from 3.1 at the end of Q1 of this year and from 3.4 at the end of 2022. And with that, we'll open the lines for Q&A.

Your first question comes from Kevin Fischbeck of Bank of America.

To start off on the labor side, we've made some progress in several areas. I'm curious about the expectation for contract labor to remain relatively stable sequentially. Why do you think progress has leveled off? What do you need to see to make further advancements?

Yes. So Kevin, this is Doug, and I think it's relatively consistent with the comments we made at the end of the first quarter, where we felt like we had hit what at least for now is a run rate, both in terms of the rates per FTE and the percentage of our total FTEs made up of contract labor. The rate is stabilized in the mid-180s and as a percentage of total FTEs, we're hovering around that 1.8%, and that compares to roughly 0.9% pre-pandemic. We don't know that this represents a permanent level, and we're anticipating that there will be further improvements perhaps as we move into 2024; there are signs on the horizon that the labor market for skilled clinicians is getting a little bit better, but we continue to see it move around in pockets. Our contract labor in the second quarter was still fairly concentrated. It was less concentrated than it was in Q1, but we still had 20 of our hospitals comprise more than 50% of the spend during the quarter, and it's not consistent in terms of which hospitals are experiencing those kinds of trends. So until we get greater visibility, we think it's prudent to anticipate relatively consistent spend based on those factors from quarter to quarter for the balance of the year. Again, that doesn't suggest that we're not continuing our efforts as you saw evidenced in our recruitment of more than 200 RNs during the quarter to reduce the reliance on this premium labor.

Kevin, one point I would add, and this is Mark. We've guided our operators that if they have the volume, they need to just go out and get the labor even if it's contract labor. So we've been very fortunate to continue to grow our volumes, and they've been accommodating in certain marketplaces because of the availability of contract labor.

That brings me to my second question regarding volume. There has been considerable discussion about the strong volume in the industry at the beginning of the year. I would like to hear your insights, especially since your volumes exceeded our expectations. Do you believe this surge in utilization might be something temporary that could decrease in the future, or should we view this as a solid base for growth going forward?

Well, this is Mark. I mean we obviously are very pleased with the volume we saw in the second quarter. We think that our value proposition with our outcomes continues to help us to grow our volumes. And clearly, I think referral sources and patients and payers are recognizing the differences and the various post-acute settings. So I think there's a lot of momentum behind our volume gains that are sustainable and our ability to continue to perform.

The volume growth was robust across almost all categories. Specifically, regarding patient mix, our top acuity categories showed good performance, with stroke increasing by about 5.5% and neurological growth at approximately 2.5%. We are still witnessing growth in these areas, along with normalized flows and increased market share across the healthcare system, which contributed to double-digit growth in all other major RIC categories for the quarter. The patient mix performed strongly, even with a year-over-year decrease of about 43% in the number of COVID patients treated. The payer mix also showed strength, with fee-for-service up about 9.5% year-over-year, and Medicare Advantage up 20%. We observed the anticipated expansion in patient mix within our Medicare Advantage book of business. Geographically, performance was also strong, as 78% of the 35 states plus Puerto Rico included in our same-store calculation experienced same-store growth greater than 5% during the quarter. Year-to-date, our discharges have increased by 9.5% and same-store growth is approximately 6%. However, we are uncertain about maintaining volume growth at these levels in the second half of the year due to more challenging comparisons. Consequently, our guidance includes a moderate expectation for volume growth in the latter half of the year, which reflects a prudent planning approach for the business.

Your next question comes from Andrew Mok of UBS.

With the recent positive indicators around the early de novo performance, I was hoping you could provide updated views on total start-up losses incurred in year 1 and time it takes to reach breakeven and mature EBITDA margins?

Yes. So we haven't changed our estimate for what the ramp-up and start-up costs will be for this year. But remember, even as those new doors come online, it takes them for a while to ramp up, which I think is an appropriate segue into your second question. Generally speaking, we're seeing most of our new units start ahead of maturity levels somewhere between year 3 and year 4, but they're getting to positive 4-wall EBITDA typically within a 9- to 18-month time period, and that's been relatively consistent.

And then I just wanted to follow up on some of the volume discussion. You called out orthopedic procedures. I think you said up 15%, driving incremental volume strength in the quarter. As you speak to your referral partners in July, August, what's your sense of the durability of the elevated orthopedic procedures for the balance of the year?

It certainly feels like maybe some of this is a result of pent-up demand. As we've talked about before, we do believe that over the intermediate or long run, the conditions that are treated in our facilities are nondiscretionary in nature. But there was the ability for some of these orthopedic conditions to be deferred for a period of time. And so that's part of the reason that's contributing to our expectation that volumes might moderate a little bit in the second half. Having said that, again, seeing the strength that we are across geographies, across the payer mix and so forth, we feel like some of it is sustainable and is attributable to market share gains.

And one final comment on the orthopedic mix that we see. Just a reminder, these patients are typically in their late 70s and have multiple comorbidities. All of our patients still have to meet the medical necessity threshold, so in many cases, they aren't your typical knee replacement patient.

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

Hi, everybody. The first question is about the 202 new hires on a same-store basis, which appears to be the highest in years, occurring alongside a decrease in sign-on bonuses. This suggests that there might be a more abundant supply of nurses or therapists available. I wonder what that number could potentially be. Do you still have a lot of open positions that might lead to further hiring, or are you currently hiring most of the people you need and want? It seems this quarter is quite different from the previous ones.

As I noted, A.J., in my comments, there's quite a bit of variability from quarter to quarter; some of it's affected by seasonality and other points. I think that, a, we are seeing some nurses come back into the marketplace. I think that there's starting to be some softening in the markets in general. But I also think we've just gotten better too in terms of our own strategies and tactics that we use to recruit. Two years ago, we centralized the talent acquisition functions around our nursing recruitment, which has really paid dividends for us. And then we've just looked at everything that we could to make ourselves a better employer, particularly for nurses, whether that is through scholarships to support nurses that may want to go back in for their RN degree. We've been reviewing opportunities for improvement on our clinical ladders. We've taken a real strong look at our orientation process, clinical education, and flexible scheduling. So I think it's the combination of marketplaces externally and internally, things we've done to make sure that we are an attractive opportunity for RNs and also to retain our RNs once we get them.

So A.J., obviously, we're very pleased by the more than 200 net RN hires during the quarter to maybe get to your question about how far do you have to go, what kind of openings you have out there, you can kind of triangulate on it using a number of data points. First, we referenced the 476 contract labor FTEs that are out there. So that suggests if you were going to go to 0 usage of contract labor, you've got roughly 476 FTEs that would need to be replaced in the existing system. In addition to that, our RN turnover has been improving on a year-to-date basis and it's currently running at about 22%. So you've got at any point in time, 22% that needs to be backfilled. And then finally, not included in that 200 because that's a same-store basis, but we are utilizing our recruiting efforts for the de novos as well. And I'll remind you that a 50-bed de novo has stabilized staffing at about 97 FTEs. It typically opens kind of 12 less than that and that you're going to have somewhere, I think, about 35% of those FTEs are going to be in nursing. So it's all those pieces together, and that's what our recruitment team is attempting to tackle on a quarter-by-quarter basis. And not only did they do that with an improvement year-over-year in sign-on shift bonuses in Q1, but we did it with a reduction in our overall recruiting and related marketing costs, and that is because we have standardized procedures for using sign-on and shift bonuses and we have also really honed and gained efficiencies in our recruiting and related marketing efforts.

Maybe if I could get my follow-up. You're calling out 2% to 3% managed care contracting rate increases. That seems pretty consistent. We hear a lot from the MCOs about wanting to shore up their post-acute networks, etc. I wonder if any of that activity on the value-based side is creating any incremental opportunities for you that you're looking at?

We're not really seeing any movement to say, risk-bearing or value-based contracts. As we've suggested before, we actually think we're well positioned to do that. And we've had some discussions with some of the major managed care companies. And for whatever reason, it just hasn't been a priority for them. What we have seen is that we continue to be able to increase the percentage of our contracts that are paid on a case rate basis versus a per diem basis. And that tends to move up to a payment rate that is very close to the fee-for-service rate. If you look and get into the details, the discount from fee-for-service to Medicare Advantage expanded a little bit in Q2. And again, that was expected and something that we foreshadowed previously. That was related not to our contracting efforts, but specifically to the broadening of acuity within the MA book of business, which as I alluded to earlier, grew 20% on a year-over-year basis.

Your next question comes from Brian Tanquilut of Jefferies. Your line is open.

I guess, Mark, as I think about it, I mean, you've obviously got a lot of success and you're still adding beds, de novos, and additions to existing facilities. As we look forward, I mean, I've seen more announcements about JVs. Maybe anything you can share with us in terms of what those conversations are like and what that pipeline is like with hospitals versus doing your stand-alone de novo builds?

Yes. So our pipeline is a nice complement of both wholly owned and JV opportunities. I think kind of the themes that we hear back from potential joint venture partners in our existing joint venture partners is that we bring something relative to the knowledge of running and operating an IRF that they don't have in-house particularly around all the regulatory and the processes that are different from the acute care hospitals. They're looking at opportunities to grow their IRF business. Typically, these units that they may have are in a less than desirable portion of their acute care hospital that can't be expanded, and they're looking to grow that with the partner. And then last thing I want to point out is that we've been doing this business model with partnerships now for over 34 years, and so we know how to be a really good partner. And it gives us an opportunity to go out and grow with the acute care hospital systems that are looking to expand their post-acute.

We like having both arrows in our quiver, and we think we use them effectively. And some of what determines whether or not we'll prioritize a JV relationship has to do with the market that we're entering. There are certain states where aligning yourself with an acute care hospital that already has a presence in that state or in that market can be useful in securing companion-wise; in others, where it really doesn't matter as much. If you look at our portfolio today, those hospitals that are already opened were just below 40% in terms of the number of those that are JVs. When we look at our broader pipeline, not just the 19 that have been announced beyond 2023, but the total pipeline of active projects, which is closer to about 50, it's running at about 40% that we currently have identified as potential or likely JV partners. So I think we'll continue to utilize both effectively. And as a result, I wouldn't expect that we'll see a significant change in the composition of our portfolio in terms of JVs versus non-JVs.

That's awesome. And then Doug, maybe any color you can share with us on early reads on RCD?

As Mark alluded to in his comments, we think we've been having some very productive discussions with both CMS and with Palmetto, who is our MAC for Alabama. We think, not surprisingly, we're ahead of the curve in terms of our competition and even for the administrator. Not all of the details have been provided. We've been asking a lot of probing questions to make sure that there's a practical application when this starts up. We believe, based on our resources and our systems capabilities that we're going to be in a great position to provide all of the appropriate documentation to the MAC to satisfy them that these are appropriate admissions and to proceed with the claims processing. And that's really why we've chosen to go on a pre-claims review as Mark added in his comments, that's going to be an iterative process, and we think we'll be very effective at engaging in that back and forth on any patients where there are questions with Palmetto. So we think that in terms of any kind of impact, could there be some delays in claims processing that would really be more of a working capital issue than a long-term bad debt expense issue? Sitting here today and not knowing what implementation will look like, that's our best guess.

Brian, I have been pleasantly surprised by the level of communication that both CMS and Palmetto have had with the providers. We have been very engaged, including a meeting yesterday in Columbia, South Carolina, where Palmetto is located. This has been a valuable learning experience for both Palmetto, as they receive feedback from providers like us, and for us as we learn from Palmetto and CMS. From that viewpoint, I would say it has gone as well as we anticipated, although there are still some process-oriented questions that need to be addressed.

Your next question comes from Pito Chickering of Deutsche Bank.

Versus your last guidance, you have increased your labor inflation assumptions, which is offset with tailwinds from better Medicare pricing for the fourth quarter. 2Q was very strong, you're still implying 2Q margin expansion relative to Street estimates today despite the increase of inflationary pressures on the labor side. So I was curious if you can talk about OpEx leverage, what you're seeing? Is it getting better than you had assumed for last quarter or at the beginning of the year in order to offset these labor inflationary pressures? And is there any reason why the OpEx leverage shouldn't continue into 2024?

It's a great question, and the answer is both yes and no. If we look closely at some of the expense categories where we experienced significant leverage, there are certain categories that we believe will remain sustainable even if volume growth slows down somewhat. Throughout this year, we've anticipated that as we reach milestones from last year's notable increases and as market conditions begin to stabilize, we would see improvements in areas like daily utilities and daily food expenses. We believe this will occur, contributing additional leverage in the latter half of the year. Earlier, I mentioned that we have made year-over-year improvements in our recruiting and related marketing expenses. We are confident that our updated procedures and the efficiencies we have gained will continue to provide leverage, even as we intensify our efforts to recruit and retain nurses and other clinicians in the second half. However, there are a few considerations to keep in mind. Firstly, our self-insured group medical program performed exceptionally well in the first half of the year, particularly regarding overall utilization rates and the number of high-dollar claims. Based on our experience, we do not expect this level of performance to be sustainable, and we anticipate some margin pressure in the second half, which is reflected in our guidance. Additionally, we had a favorable bad debt experience in the second quarter, largely influenced by the unique circumstances related to targeted audits in the previous quarter. We have now accounted for a more normalized experience moving forward. Lastly, we expect the EPOB to continue trending towards 3.40, and we anticipate an increase in the length of stay from its current level of 12.3 in the second quarter. While there are expense categories we expect to leverage further, we also have some counterbalancing factors to consider in the near term.

And then the follow-up on the 20% growth of Medicare Advantage just hard as you saw in the quarter. I'm just curious if you're seeing any different behavior from Medicare Advantage maybe at the end of the quarter or in July trying to curb the days or be more stringent with prior authorization as you're absorbing that spike of utilization?

We really aren't. And I think the good news with the MA growth is that it also has been brought across geographies. Again, how we deal with MA plans with regard to prior authorization and their admission procedures and so forth can vary pretty significantly from payer to payer. And even within those payers from market to market, but generally speaking, and as evidenced by the 20% growth on a year-over-year basis, it's getting better.

Your next question comes from Steven Valiquette of Barclays.

You mentioned the patient referral sources earlier, particularly regarding the Medicare Advantage payers who noted higher outpatient utilization compared to inpatient care in the second quarter. I'm curious about your incoming patient flow this quarter and the sources of those referrals. Can you remind us of the proportion of patients referred to you from inpatient settings versus other sources, and whether that mix has shifted during the quarter, showing an increase in patients coming from outside the hospital inpatient setting? I'm trying to align your trends with comments from managed care companies.

So close to 90% of our admissions come directly from an acute care hospital; we didn't see a significant change in that in Q2 from past quarters. So kind of goes back to the point that all of our patients have to meet medical necessity; they typically have multiple comorbidities. They're sick. So outpatient is not really an option for them because they need 24-hour nursing care. So we haven't really seen anything that stood out in the second quarter from our past trends.

Yes. I think the point we're trying to make there is that those patients who are receiving orthopedic surgeries and then ultimately finding their way into our facilities are getting those on an inpatient basis at the acute care level and not on an outpatient basis because of their comorbidities.

Your next question comes from Matt Larew of William Blair.

Last quarter, you touched briefly on occupancy rate, long-term target, reflecting the higher skew towards private rooms. Occupancy rates again were very high this quarter. So perhaps less thinking about that theoretical long-term target. Maybe could you help us think about some more near or medium-term targets as to how you expect occupancy rate to trend over the next year or 2 given the shift of de novo builds towards private rooms.

Yes. It's a very fair question. And to be honest, Matt, I haven't mapped it out, but we would expect it to continue to increase. In the near term, I think it's fair to say that it will move from the low 70s up into the mid-70s; I think that's reasonable. I don't know how I would define the near term. And you've got a little bit of this push-me-pull-me that goes on as well, because as we see the occupancy increase in recently opened facilities or bed additions that are all private room, you're getting downward pressure on the occupancy rate from the de novo activity and the more recent bed expansions. But if we stay at kind of the current build level that we've been at, which is roughly call it, 850-bed de novos per year and some call it 100 beds, so adding 600 beds to a larger base. That should start to result in opportunities for company-wide occupancy levels to trend up. Where the theoretical limit gets, it really depends on that ongoing ratio between new capacity coming on in any particular year against the base. To the extent that new capacity becomes an increasingly smaller part of the base, then I think you have continued upward opportunity within occupancy. It will take a while just because of the legacy base, even where we're addressing that remodels to try to create more private rooms, it's going to take a while to get it north of 80%, but definitely see upside.

Occupancy rate has historically remained around 70% company-wide. I'm interested in how an increase might impact margins. I assume that you've structured your staffing around that 70% level. Do you have any experience with facilities in your network that consistently operate at higher rates, and do you have a plan for adjusting staffing and management as the acuity level increases over time?

The benefits from EPOB arise from increased efficiency when operating at high staffing levels. This can lead to margin expansion. If a facility is currently operating in the low 70s and increases to about 90%, there are opportunities for margin improvements throughout this process. I'm not considering the pricing environment for now. However, once you exceed 90% capacity and if that facility is fully utilized without potential for bed expansion, you will likely experience margin pressure. This occurs because, in many cases, your volume growth will be constrained. Consequently, your annual revenue growth will depend primarily on price increases, and you might face inflationary pressures and other costs that rise more than the annual price adjustments.

Your next question comes from Scott Fidel of Stephens. Your line is open.

I wanted to revisit the Medicare Advantage conversation. I'm interested in where the MA reimbursement rates stand in comparison to fee-for-service, if you have updated figures on that. Additionally, I’d like to know how you anticipate those trends will develop for the remainder of the year and into 2024. Specifically, I'm curious about the interplay between some shifts and the expanding utilization backdrop that may be impacting this. At the same time, you've mentioned increasing your market share, which I assume could have a positive effect as well. I'm trying to understand how these factors balance out against each other.

Yes, absolutely. So in the first quarter, the rate differential between MA and fee-for-service was 4.7%. That broadened by 120 basis points to 5.9% in the second quarter, and it was really solely attributable to the lowering of acuity, which was based on the patient mix. That's a positive trade-off for us. I mean we like getting that additional volume gain and we like the fact that our value proposition beyond stroke where it's been evident for a long period of time and complex neurological disorders is now resonating with those MA plans. The two countervailing forces that you'll have that will impact that discount on a go-forward basis are what we believe will be the continuing broadening of acuity within MA, which we believe will continue in aggregate to grow faster than fee-for-service, but at the same time, our success in contracting with those MA plans to move more and more of those, we've already added about 80% of the revenues into a per diem basis. Put all of that into the mix and our assumption is that, that gap that existed in the second quarter widens a bit in the second half of the year.

Your next question comes from John Ransom of Raymond James.

So this is an unfair question, but is there any indication at all that CMS is unhappy with the current payment structure? It just strikes us that they're not happy with home health ever. They are not happy with hospice length of stay, but they've left you guys alone since the 60% rule. It used to be the 70% rule. But is there any kind of inkling on the horizon they may look to tweak how you pay?

John, first of all, we might challenge on, we've been left alone since the 60% rule. We've had sequestration along with everybody else, and we've had Section GG and more quality indicators and all of that other kind of stuff that have not always been easy to digest.

Well, there is a significant structural change, but in light of this change, we want to compensate you hourly, divided into approximately 12-minute increments. Do you believe the current structure will remain?

We're not hearing anything to the contrary, John. As a matter of fact, if you look at the combined rhetoric out there between CMS and MedPAC and then even some of the things that have been considered through, for instance, the residue of the IMPACT Act, it seems to be going the other way, which is a recognition that significant improvement has been made in areas like quality reporting and so forth, and that trying to make a more substantive revision would have very significant complexities to it without necessarily accomplishing anything.

So I think the impact indicates the direction they wanted to take years ago in creating this common assessment tool. Now, they've recognized the complexities of analyzing different post-acute settings and presented their prototype as required. However, everyone agreed it wasn't ready for practical use and would be very challenging to implement. To answer your initial question, we're not noticing any significant structural changes indicated or suggested at this time from CMS or any other regulatory body.

John, we have enough hubris that we feel like we're immune to it, but we're not aware of anything on the horizon.

And so my follow-up would be, I think you just said 80% of your MA rates are per day, right?

Yes, 88% of our current MA revenues are on a case rate basis.

Okay. Got you. So if you could be Nostradamus, again, do you think any indication as you talk to these MA payers, they want to change how you're paid? Or do you think that will also stay in place?

I think we're making progress pushing that 88% up north, so it's a ground game. So it's small increments. But right now, I think the trend line suggests that we're going to be able to not only grow our MA revenues significantly but continue to push the percentage of those revenues that are on an attractive case rate basis north.

Your next question comes from Ben Hendricks of RBC Capital Markets.

I just wanted to follow up on John's first question there, specifically pertaining to the final rule for Medicare. It looks like your rate update is kind of in line with the industry. But is there anything else, any other observations to call out from the final rule, whether they be with the quality reporting program or specifically any implications from the rebasing of the market basket given that it's kind of rebased to a COVID late year?

There's really no major takeaways that we saw. We thought it was a pretty benign final rule. It was very much in line with the initial rule that came out. And yes, they continue to have quality reporting and we're in full compliance with that. So we're not seeing anything major that indicated in the final rule that would change our thoughts on that.

To some extent, it may be the case that CMS was cognizant of the fact that we do have RCD rolling out this month and didn't want to overly complicate things for either the MAC by injecting something into the payment system or for the providers as well. But as Mark said, the final rule was really consistent almost wholly with the proposed rule, which is a good thing.

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

This does conclude today's conference.