Good morning, everyone, and welcome to Encompass Health's Fourth Quarter 2023 Earnings Conference Call. Today's conference call is being recorded. If you have any objections, you may disconnect at this time. I'll 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 fourth quarter 2023 earnings call. Before we begin, if you do not already have a copy, the fourth quarter earnings release, supplemental information, and related Form 8-K filed with the SEC are available on our website at encompasshealth.com. On Page 2 of the supplemental information, you will find the safe harbor statements, which are also set forth in greater detail on the last page of the earnings release. During the call, we will make forward-looking statements, which are subject to 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 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, and the Form 10-K for the year ended December 31, 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. The fourth quarter was a strong finish to a great 2023 for our company. I'll discuss key highlights for the year, and then Doug will provide details about our Q4 results and 2024 guidance. Our 2023 revenue increased 10.4% and was driven by strong volume growth, with total discharges up 8.7%, inclusive of same-store growth of 4.8%. Our strong volume growth continues to provide evidence that our value proposition is resonating with referral sources, payers, and patients. Our 2023 adjusted EBITDA increased 18.5%, driven by revenue growth and prudent expense management. Persistent vigilance on premium labor utilization facilitated a 32.9% decrease in contract labor, plus sign-on and shift bonuses. On a dollar basis, these premium labor expenses decreased $67.3 million from $204.3 million in 2022 to $137 million in 2023. We reduced contract labor FTEs from an average of 547 in 2022 to 425 in 2023, and contract labor FTEs as a percent of total FTEs from an average of 2.2% to 1.6% over the same period. Other operating expenses as a percent of revenue declined by 50 basis points from 15.3% to 14.8%, owing in part to scale efficiencies. The strong growth in adjusted EBITDA facilitated an adjusted free cash flow increase of 54.6% to $525.7 million. We continue to invest in capacity expansion to meet the needs of a significantly underserved and growing market for inpatient rehabilitation services. In 2023, we invested more than $350 million in growth CapEx, opening eight de novos with a total of 395 beds and adding 46 beds to existing hospitals, a net 4.1% increase in licensed beds. We also continue to invest in our facility-based technology through initiatives like our Tablo on-site dialysis rollout. We now offer in-house dialysis capabilities in 83 of our hospitals and we'll continue the rollout to new locations in 2024. We complemented these investments in the growth of our business with a return of approximately $60 million to our shareholders through cash dividends on our common stock. Our strong free cash flow generation allowed us to fund these investments and shareholder distributions with internally generated funds, all while reducing our net leverage to 2.7 times at year-end 2023 from 3.4 times at the end of 2022. Review Choice Demonstration, or RCD, began on August 21 in Alabama. Our company was well prepared to address the administrative requirements of this program. Recall that under RCD, every Medicare claim is reviewed for documentation and medical necessity. The affirmation rate target set by CMS under RCD is 80% of claims submitted during the first six months, and our affirmation rate remains above that level. Turning to objectives for 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 expect to open six de novos in 2024, as well as a 40-bed freestanding hospital licensed as a satellite location on an existing hospital that will be accounted for as a bed addition. To date, we've announced an additional 11 de novos with opening dates beyond 2024. We anticipate adding approximately 150 beds to existing hospitals in 2024, including the aforementioned satellite, and 80 to 120 beds per year from 2025 through 2027. We continue to focus on enhancing patient outcomes by investing resources and clinical innovations. One such innovation is our fall prevention model, which combines predictive modeling with our core clinical practice protocols. Our fall prevention model was initiated in 2021, and we have since seen our fall rates per 1,000 patient days improve by 24%. We have an array of additional clinical innovations and enhancements underway that are intended to advance our ability to consistently produce quality outcomes for medically complex high-acuity patients in need of inpatient rehabilitation care. Now I'll turn it over to Doug.

Thank you, Mark, and good morning, everyone. As Mark stated, Q4 was a strong finish to 2023. Revenue for the quarter increased 9.6% over the prior year, driven primarily by volume growth. Total discharges grew 8.3%, inclusive of 5.3% same-store growth. Volume strength was broad-based across geographies and patient mix and exceeded our expectations. Q4 adjusted EBITDA also increased 9.6% over the prior year, as the contribution from increased volume and favorable operating expenses was partially offset by an incremental bad debt reserve. Our 2023 de novos outperformed in Q4, generating approximately $1 million in adjusted EBITDA compared to our expectation of approximately $2.5 million to $4.5 million of net pre-opening and ramp-up costs. The favorable performance relative to our expectations was driven primarily by the joint venture de novos. For the full year of 2023, our de novo net pre-opening and ramp-up costs were $6.6 million. Within our 2024 guidance considerations, we are anticipating $15 million to $18 million of de novo net pre-opening and ramp-up costs. The year-over-year difference is largely attributable to the timing of new hospital openings and the balance between joint venture and wholly-owned de novos. We continue to see improvement in year-over-year premium labor costs. Q4 contract labor plus sign-on and shift bonuses totaled $30.6 million compared to $35.4 million last year. Within premium labor costs, Q4 contract labor was $17.7 million, and sign-on and shift bonuses were $12.9 million as compared to $19.7 million and $15.7 million in Q4 of 2022. On a sequential basis, premium labor decreased by $2.7 million. Our Q4 adjusted EBITDA included approximately $6.8 million in favorable reserve adjustments for workers' comp and general professional liability insurance. On a full-year basis, 2023 included approximately $11.2 million in favorable reserve adjustments for these self-insured programs. These reserve adjustments are out-of-period, as they relate to claims prior to 2023. Our Q4 adjusted EBITDA also benefited from favorable trends in group medical claims under our self-insured program. Q4 revenue reserves related to bad debt as a percent of revenue increased by 170 basis points to 4.1%, and as a result of an approximately $22 million reserve related to appeals pending before the Departmental Appeals Board in various federal district courts. These appeals relate to claims denied primarily prior to 2018 and under review programs that are different from TPE and RCD. We now have a full year of experience at the Departmental Appeals Board and have updated our reserve assumptions given our experience to date. After giving effect to minority interest, the Q4 adjusted EBITDA impact of this incremental bad debt reserve was approximately $16 million. Adjusted free cash flow for the quarter increased 103.3% to $93.5 million due to higher adjusted EBITDA, lower maintenance CapEx, and favorable changes in working capital. Moving on to guidance. Our 2024 guidance includes net operating revenue of $5.2 billion to $5.3 billion, adjusted EBITDA of $1.015 billion to $1.055 billion, and adjusted earnings per share of $3.77 to $4.06. The key considerations underlying our guidance can be found on Page 13 of the supplemental slides. With that, we'll open the line for Q&A.

And we'll take our first question today from Kevin Fischbeck with Bank of America.

Actually, this is Joanna filling in for Kevin today. There are so many things happening at once, so we have to approach it this way. My question is about volumes, as you mentioned they exceeded your internal expectations and showed strong year-over-year growth. Is that growth sustainable? What are your assumptions for same-store volume growth in your 2024 guidance? I understand you noted that the strength was widespread geographically, but could you elaborate on whether any specific category stood out or if there were any notable factors related to payers or seasonal impacts in Q4? Thank you.

Joanna, this is Mark. I'll take a shot at this first. As you know, we saw nice volume growth across all eight of our geographic regions. I think there's a number of things. One, we continue to see where we have taken market share from nursing homes. I think that going back the last two years or three years, we've proven ourselves very capable of taking a higher acuity patient and achieving great outcomes with them. So that has been a primary driver for us. I think that it's no secret that the acute care hospitals have seemed to have strong volumes, which we get the downstream impact from that. Relative to program mix, it was another quarter of continued growth in our stroke program and other neurological conditions. We did see some pickup on a small base in our orthopedic categories. Nonetheless, we did see a percentage increase in lower extremity drug placements and other orthopedic as well. So, it was very broad-based in terms of our overall growth, and we're confident that we're building a good foundation.

Just to add a couple of other things to round out your question. In terms of the expectations for volume growth in 2024, if you parse through the guidance considerations, you get a range of discharge growth that is kind of in line with our longer-term target of 6% to 8%, obviously coming off a number of strong years. The low end of the range would be slightly above that, while the rest of the range is solidly within that. In terms of the breakdown between same-store and new store, we obviously have the eight units that we opened this year that will be a new store. And it's worth recognizing that if you look at the four-year CAGR in same-store growth that extends from 2019 to 2023, that's north of 5%. So, we continue to demonstrate very positive numbers there. But it's not to suggest that we're going to be in a position to generate 5% same-store growth on a year-over-year basis. There will be some fluctuations from year to year. The patient mix was broad-based, as Mark mentioned. We did continue to see outsized growth in some of the smaller categories like ortho, but saw in excess of 5% growth in neurological and just about 5% growth in stroke. So those are good numbers. And finally, as it relates to payer mix on a year-over-year basis, we saw the Medicare Advantage payer mix increase by 90 basis points. Importantly, about 50 basis points of that growth came from general managed care, and another 20 to 30 basis points came from Medicaid. So those were both representing a positive trade out of our lowest reimbursement categories into a higher reimbursement category.

Next, we'll hear from Pito Chickering with Deutsche Bank.

You've actually got Kieran Ryan on here for Pito, same idea as Joanna earlier, lots of calls. I wanted to ask on margins. It looks like the guidance is implying about year-over-year contraction on your reported 2023 figures, maybe a little bit less than that when adjusting for the reserve, the benefits, and the de novo outperformance. But just broadly, when we think about what could drive margins lower year-over-year. How should we think about these headwinds from labor and the de novos compared to the fixed cost leverage that you should get on this very strong volume growth you're seeing?

Well, Kieran, I think you hit exactly on it, which is we've got all in and assume a 4% to 5% increase in SWB per FTE. So, what's driving that is an assumed 4% to 5% increase in general internal SWB per FTE, and then the benefits of getting some leverage with volume growth across assumed relatively constant premium labor cost is being offset by an increase in benefits cost, which is largely attributable to the fact that we had such a favorable outcome this year. Then, it's a pretty significant swing going from a little over $6 million in net pre-opening costs for 2023 to an assumed $15 million to $18 million in 2024. That has a number of factors implied in it. In 2023, we had a much heavier weighting towards the first half of the year in terms of openings, and we're anticipating for 2024. Five of the eight facilities that opened in 2023 were joint ventures, including a couple of those that were with existing joint venture partners. Those ramped faster than the balance that we're anticipating in 2024. But those are the two primary factors that could create a little bit of rub on the margin. And as we have said repeatedly, we are an EBITDA and an EBITDA growth story. We are not necessarily a margin story. We'll always seek to gain leverage as we're growing volume. But the most important thing that we can do is get out there and provide extremely high-quality care to more patients who are in need of inpatient rehabilitative services, and we continue to believe that the market is underserved.

Appreciate that. And then just a quick follow-up on the labor side. 55 net RN hires in 4Q, solid, obviously, down a bit from the last two quarters where you're up in the 200 range. But should we think about this as kind of the right pace as to what you're targeting heading into '24, given where volumes are running and that you've already cut down contract labor down to that 1.5%, 1.4% of FTEs? Or do you see it accelerating further from here?

We're actually very pleased with that number in Q4. If you look back at the prior year, that was a negative net. If you think about the period of the year, it's extremely difficult to hire new staff around the holidays, particularly in Q4. Our talent acquisition team has been very successful in helping to support the hospitals as well as the new ramp-ups in finding and hiring nurses. We've talked about in past calls that we have a real focus on retention in our hospitals to retain the nurses that we already employ, with a particular focus on those that have been hired in the last year or so. So, we're very pleased with the progress that we've made and are hiring of RNs, and we would expect this year to be another strong year with that.

Yes. We can't necessarily assume the run rate that we saw in new hires in Q4 is going to stay steady across all four quarters in 2024, because there will be some seasonality to that. But as Mark said, we're very pleased. With some specifics on turnover, our RN turnover for all of 2023 was down 500 basis points from 2022, and therapy, which has always been best of class and low from a turnover perspective, was down 130 basis points on a year-over-year basis. So, a combination of new hires and reducing turnover rate is really allowing us to manage those premium labor costs better. Now, frankly, the 1.4% that we saw in terms of contract labor, FTEs as a percentage of total FTEs in the fourth quarter was better than we had anticipated. We assume that we get kind of a stabilization point around 1.5%. As we've noted previously, we had run just below 1% prior to Q3 of 2021 when the spike occurred for the overall industry. We'd like to see continued progress towards that number, but it's just very hard to predict. Embedded in our guidance assumptions for 2024 is that from a total dollar perspective, premium labor cost in 2024 remain relatively consistent with the run rate that we established in Q4, which was down an aggregate of $2.7 million sequentially from Q3.

Our next question will come from Ben Hendricks with RBC Capital Markets.

This is Mike Murray on for Ben. So, it sounds like internal SWB per FTE growth is expected to moderate in 2024. After a few years of acceleration, just broadly, can you talk a little bit more about the labor market and what you're seeing for wage inflation? And do you think this will continue to moderate moving forward?

As I said, Mike, we've got the internal SWB per FTE assumption is an increase to 4% to 5%. Frankly, that's probably a point higher on both ends of the range than I was thinking about at the end of Q3. What we're seeing is that although overall labor market conditions are improving, it's important to really stay on top of market adjustments. As we're bringing in these larger number of new hires, if they're coming in at a market rate that is different than what we're paying the previous workforce, we've got to make sure that there's parity across that. Again, across all of the metrics that we've cited, we're seeing improving labor market conditions. We're optimistic that will improve, particularly as we progress into the second half of 2024, but it's difficult to bank on that. So, we went with a set of assumptions that reflect the current environment and no further improvement as we progress through the year.

Mike, we've tried to make sure that our hospitals have stayed at the market in terms of their rates with the market analysis that we have. Once you get behind market, it's awfully difficult to catch up, and it typically costs you more once you get behind than if you had stayed at the market level all along through market adjustments. If you look at the market adjustments we've done in the last year and a half and the new staff that we brought on, there's a pretty high percentage of our overall staff that have had some adjustment or another. So that's part of the logic that we took going into the assumptions for this year.

And I think it's all proving to be a very good trade. I mean you tie together a bunch of these domestic metrics, look at the volume growth. At no point during 2023 did we find ourselves constrained in being able to take volume and to take it safely in the best interest of the patient because of labor constraints. Our turnover rates, as I cited before, are down markedly for both RNs and therapists on a year-over-year basis, and our salaries are competitive enough that we're continuing to have great progress in recruiting new clinicians into our workforce.

One final note on labor. It should be noted that our talent acquisition team has helped us open up the vast majority of the de novos in the last couple of years with zero contract labor at the time of opening. So, it's been a huge support in terms of our ability to take the volume that Doug alluded to and to start off in these new markets on a solid footing.

And the efficacy of the centralized talent recruiting function also comes with an efficiency. To their credit, our HR team has been very creative in looking at the ways that we were expending dollars across the recruiting function to find out where those were having the greatest impact and then concentrating the dollars in those areas. So even with the success we had on new hires during the course of 2023, we actually did that with a year-over-year decrease in recruiting costs.

Okay. That's very helpful. Just shifting gears a little bit. I know you're working at moving more contracts towards case mix. I just wanted to see how this is progressing.

Yes. We continue to make great progress there. We have just about 90% of our MA contracts are on an episodic versus a per diem basis. The rate differential, even as we continue to grow Medicare Advantage at a rate greater than our other payer categories compared to fee-for-service remains at less than 5%.

Our next question will come from Brian Tanquilut with Jefferies.

This is Taji on for Brian. Thank you for taking my question, and congrats on the quarter. So unfortunately, just one more question about labor. Just currently, are you able to fill all the demand that you're seeing in the market? And if not, how much more labor would you need to see you upsize like that volume growth?

Yes. As I just mentioned, at no point in 2023 were we unable to take volume because of labor constraints. We will continue to prioritize, and we are going to serve all of the patients who are in need of inpatient rehabilitative care in the markets in which we operate, even if it means paying for premium labor.

Okay. And then this is a slight follow-up from Joanna's question. I know you had called out differences you're seeing in different condition categories. Just wanted to follow up and see if there are any specialties where you see as an incremental opportunity in terms of volume growth or revenue yield? I know you called out increasing investment and like expansion of your in-house dialysis, but I want to see if there's anything else you're thinking about?

No. So we've put a big focus on the neurological categories as a whole for the past several years. I would call out stroke because we think we have a particularly strong outcome. We feel like there's a huge demand for stroke rehabilitation. We think we do a really good job in getting these patients back to the community, and we've partnered with the American Stroke Association nationally to help promote the need and education for stroke patients. So, we call it stroke specifically. As Doug noted, we had almost a 5% growth in that last year, and it remains one of our top categories in terms of percentage of total discharges. So, between stroke and other neurological, I would call those out as areas that we see continued opportunities to grow.

I think the other one that I would point to and perhaps one that we don't count enough and maybe don't get enough credit for in a forum like this is dealing with brain injury patients. So, brain injury typically runs between 10% and 12% of our overall patient mix, and it was up 10.5% in the quarter. Obviously, that's a very medically complex patient, and so they can't be treated effectively in too many settings.

We'll now hear from Jared Haase with William Blair.

Good morning. Appreciate all the detailed commentary thus far. Maybe I'll just take a step back and ask a bigger picture question. I'm curious to hear your perspective just around the outlook for Medicare Advantage environment in general. Obviously, there's been a lot of focus lately just around rates for the plans and the broader utilization that those plans are experiencing. I would just love to get your perspective on the group in a general sense and then how you're sort of thinking about maybe potential leverage in terms of rate negotiations or just your general value proposition in partnering with MA plans?

Yes. So again, we think there continues to be significant upside in Medicare Advantage for us. Although the growth rate over the last several years has been very impressive. If you look again at the four-year CAGR same-store CAGR for Medicare Advantage extending from 2019, and I picked 2019 specifically to go back before COVID and run that through 2023. Our Medicare Advantage same-store is up 15.2%. It's our fastest-growing category. But we've been able to grow that while maintaining or increasing the number of those contracts that are paid on a case rate basis versus a per diem and keeping that narrowing the payment differential versus fee-for-service at less than 5%. I think the real opportunity is that we continue to see conversion rates in Medicare Advantage, which means the number of admits as a percentage of referrals is lower, significantly lower than Medicare fee for service. Some pressures or some of the focus that you're now seeing from CMS on the MA plan are about denial of access to care and utilizing internal metrics and algorithms to authorize care for Medicare Advantage patients, which is not necessarily directing those patients to the place where they can expect the best outcome. We think that those trends will bode well for us in the future just based on the quality of outcomes that we're producing and the complexity of the patients that we're able to treat effectively.

Got it. That makes a lot of sense. And then maybe I'll just ask a quick follow-up, thinking about specifically any priorities you guys would call out in 2024, just around technology investments or other workflow improvements. I think you alluded to some of the things around predictive analytics and obviously, you have the dialysis technology that you're rolling out as well. But just really curious to hear if anything new or incremental on the roadmap this year that's focused on driving clinical or operational improvements?

You've named a couple of them. We always look at innovations that are out there. Whether that is through the utilization of this huge amount of data that we've been able to collect from our clinical information system over the years and working with our clinical team on predictive analytics and driving our clinical outcomes. We look at new technologies that are out there, particularly on the clinical aspects, either for nursing or therapies that will help us assist in treating our patients. There are a number of them that we’re working on this year around dysphagia, helping the patients with their swallowing difficulties, which is a common issue with stroke patients. We have wage-assisted devices in our gyms that can help our patients in ambulation around. So, on any given year, including 2024, we take access to innovation in a number of different studies, particularly if it enables our staff to get better outcomes or helps them become more efficient.

We believe our competitive advantage in this regard is self-perpetuating, providing that we operate under a philosophy of continuous improvement. By that, I mean, if you look at the common conditions that are treated in the IRF setting, just based on our scale and our market share, we see far more of those patients than any of our competitors by a very wide margin. We utilize the data that comes from seeing that vast number of patients to get smarter about the clinical protocols and the outcomes that they produce. Our clinical leaders have been focused. They never rest on their laurels, and they're focused on just continuously getting better at what we do, analyzing the data that comes through on almost every patient saying, how do we refine our models, how do we refine the protocols that we're using to become even more effective in treating these patients.

Our next question will come from Scott Fidel with Stephens.

We'd say Scott, but we don't want to be presumptive.

Hi, good morning. It's actually Scott here for the real...

Which is not in any way to express disappointment regarding any of the others.

Understood. I want to ask you just about balance sheet capacity here, just given how you did end up with leverage down below the long-term target range. Obviously, a high-interest rate environment, so that's not necessarily a terrible thing. But does seem like you still have a lot of capacity incrementally here. And just how you're thinking about that for 2024 and whether that would influence thinking about potentially ramping up capital returns such as the buyback more or further accelerating some of your growth investments? Or are you just comfortable keeping leverage below target here just given the cost of capital environment?

Yes. So, Scott, if you go back to 2022, we were running just about $600 million in total CapEx, and we were essentially breakeven from a cash flow perspective. As a matter of fact, I think we funded almost all of that plus the dividend with internally generated funds. I think our debt increased modestly, maybe $25 million or $50 million. As we came into 2023, with a CapEx budget that was in aggregate pretty similar and with an assumption that the dividend would be relatively constant. Based on our initial guidance, we were assuming that we would once again be essentially breakeven in 2023. We didn't necessarily at that time, I think that it would be prudent given that we were starting the year with a 3.4 times net leverage to start deploying capital towards other potential utilizations like further shareholder distributions. Well, through the course of 2023, we underspent a bit mostly based on timing with regard to CapEx. We overperformed with regard to EBITDA and adjusted cash flow. So that number brought the leverage down but created more capacity for us earlier than we had anticipated to start really thinking about some of these additional uses of capital allocation and shareholder distributions is the one that comes immediately to mind once we get beyond funding our discretionary CapEx. So, it is certainly something that the board is going to be considering throughout this year. We frankly got in a position to be able to have that consideration sooner than we had anticipated.

Okay. Great. So, we'll certainly keep an eye out for that. And then just a follow-up question around modeling for seasonality. Is there anything you'd like to highlight regarding EBITDA or cash flow in terms of quarterly modeling progression that would differ from the usual patterns? Or should we expect it to be consistent with typical patterns?

It really feels like after a period of some normalization being required that we've kind of gotten back into our regular seasonal pattern in terms of volume flows. The biggest difference year-over-year is going to be the timing and the impact of the de novos.

Our next question will come from Parker Snure with Raymond James.

Good morning. This is Parker on for John Ransom. I just want to shift over to the 2024 guidance. So, if I look at the guidance or if I just look at your fourth quarter 2023 EBITDA, you did $255 million of EBITDA. If I normalize that for the bad debt charge, that's $271 million. If you annualize that, you get $1.80 billion. Maybe there's some added de novo costs in there. So maybe let's say, $1.65 billion is kind of the run rate. But your guidance is $1.35 billion. So maybe just talk about why there would be a difference. Is there a reason where there are certain items in the fourth quarter that were kind of more one-time in nature? And why wouldn't the fourth quarter run rate be a good kind of jumping off point as we look into 2024?

Yes. So first, you back out of that $9 million in workers' comp and GPL prior period reserve adjustments, then you normalize for a favorable group medical expense. Then as you suggested, the de novos for 2023 contributed $1 million in EBITDA in Q4, while the assumption for all of 2024 is that you're going to have $15 million to $18 million, some portion of that attributable to Q4. So, you've got a swing there. Our core assumption is that you've got a 4% to 5% labor inflation, which is going to delever to some extent against the pricing. On top of that, you've got more nuanced items. We continue to believe that EPOB will normalize towards 3.48; we're pretty close there right now at 3.38 for fiscal year 2023 in aggregate. It's a highly sensitive ratio, so even if you just moved up from 3.38 to 3.34, which is of an impact, that's about a $14 million to $50 million impact on year-over-year EBITDA. I think it's a combination of all those things. And we're here, we're a month into 2024. What we have demonstrated consistently is particularly with regards to guidance; we call balls and strikes very consistently. The guidance that we're providing right now is according to the philosophy that we have consistently applied to the business that's out there, and if the environment is better, we'll deliver better results. But we think this is a reasonable set of assumptions starting the year.

Okay. Yes. That's fair. And if I can just squeeze in one more, just related to the bad debt charge. I know you guys said you changed some of your reserving practices as you move into next year. Is there any chance that there could be another one of these kind of one-off reserve charges? Or is it kind of the expectation that this was a one-off and that shouldn't recur?

It's really the latter. We didn't necessarily change our reserve methodology, because the current methodology specifically focuses on TPE, which had been suspended for a while and has now returned, but the activity is much lower than it was during the widespread probes that halted in 2018. The write-off this quarter had a $16 million EBITDA impact due to older claims, with 97% of them originating before 2018. This situation specifically arose because when we started appealing these cases to the DAB level and then to the Federal District Courts, we lacked any experience to establish a specific reserve methodology. Now that we're a year in, we unfortunately found that the claims denials, which were essentially approved quickly as the ALJ increased the number of judges to reduce the backlog, were influenced by federal court rulings that received similar quick approvals at higher levels. It's frustrating, but we look back at that backlog of claims, which has mostly been resolved. The remaining balance on our balance sheet is essentially fully reserved. We review those claims and believe we acted correctly; we admitted the right patients and treated them effectively, yet we will incur these write-offs and move forward.

We have a follow-up question from Kevin Fischbeck with Bank of America.

This is Joanna. So, I guess a little bit of a different topic, but I guess the proposed regulation cycle is also keeping up on us, so kind of your expectations for 2025 proposed rule, what you expect there when it comes to rate updates or anything else? And I guess, specifically, the Home Health Trust for policy change that I guess was slack prior to '24 cycles. So, do we expect this to show up in '25? Or would you expect this to kind of die down? Because I guess when you think about it, you would be here at like, why should be? It seems just do this because I guess the hospitals have the same transit policy, so why would that be different? But any thoughts in terms of expectations for that?

Joanna, this is Mark. Let me take the latter point. We've not heard any feedback relative to the Home Health transfer rule anymore from CMS other than what was discussed last year as they did the RFI. I think at that time, the industry made a pretty good case why the home health transfer rule is a little bit different when you think about IRFs, and the primary point being that a home health or an IRF patient is not a substitution of care. It's actually a normal progression of care for a rehabilitation patient. I think it was also pointed out that the average length of stay for IRF patients across CMG has been remarkably consistent. In other words, they have not seen it from a perspective that there was a financial motive to reduce average length of stay. Those are all different aspects than if you looked at other sectors in healthcare, where there have been a transfer rule. So, we've not heard anything. If there is information or an act included within the proposed rule or make it through the final rule, we'll do what we've done with all the other regulatory changes in our history. We'll evaluate it, we'll digest the new rule, we'll understand it, and we believe we'll adjust accordingly, just like we've done historically with other major changes.

Yes. Not to beat our chest, but I don't know that you can point to another provider that over its history has demonstrated greater adeptness and agility at responding to regulatory changes. Underlying all of this is the fact that the demand for inpatient rehabilitative services in this country is currently underserved and is only going to continue to grow based on the underlying demographic. Those patients need to be treated by somebody, and we are the most effective at treating those patients in providing those services and expanding the capacity to do that. Regardless of what comes down the pipe from a regulatory perspective, we will adjust to it with alacrity and we will continue to grow our business.

Our final question will come from A.J. Rice with UBS.

Hi, good morning. A couple of quick things here. I know you were saying in the deck that you're looking for a 2% to 3% increase in your managed care, and that's a small piece of the overall business. But I was curious if any updated commentary or discussions about value-based arrangement, incentive type of programs, any discussion along those lines?

A.J., I understand this may sound repetitive to what we've mentioned before. We don't really see much engagement with the MA plan. Firstly, it's complex, and within their overall business framework, we remain relatively minor. However, if we do receive inquiries from an MA plan regarding our interest and capability to engage in such models, we express a strong desire to participate. Most discussions typically focus on the effectiveness of our outcomes, our overall value proposition, and the advantages for everyone involved in transitioning to a case rate structure that allows us to manage MA patients for optimal clinical efficiency.

Okay. And then I know you said your affirmation rates on the demonstration project are hitting above the 80%, which is the target. I think that was supposed to be a six-month project, if I have it right. Any sense of where we go from here if the major players are hitting the targets? Does it just get dropped? Do you think they’re going to make a change on any of this? Do we have any idea?

A.J., it's Mark. As it's laid out now, the initial six months will end at the end of February. It's projected to go from 80% to 85% and then ultimately up to 90%. We would expect it to go up to 85%. I think certainly, given the affirmation rate that the industry has seen and CMS is seeing, we'll see where that goes from here. As noted, the five-year demonstration. So, if they take the entire five years, we're not sure. But as you note, if the entire industry is performing quite well, you'd wonder why they would continue on with it.

They have identified several states they plan to expand into after starting in Alabama, Pennsylvania, Texas, and potentially Florida, which makes sense given the activity in those states. It is our understanding that CMS has informed the MAC Novitas about beginning this project, although a specific date for the demonstration in Pennsylvania has not been provided. We operate nine hospitals in Pennsylvania, but they are all with a different MAC, which is Palmetto. As it currently stands, our hospitals in Pennsylvania will not be included in the extension of that demonstration into the state.

That will conclude the question-and-answer session. I will now turn the call over to Mark Miller for any additional or closing remarks.

Thank you, operator. If anyone has additional questions, please call me at (205) 970-5860.