Good morning, everyone, and welcome to Encompass Health's Third 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 speakers' remarks, there will be a question-and-answer period. 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.

Thank you, operator, and good morning, everyone. Thank you for joining Encompass Health's third quarter 2024 earnings call. Before we begin, if you do not already have a copy, the third 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, the Form 10-K for the year ended December 31st, 2023, and the Form 10-Q for the quarters ended, March 31st, 2024, June 30th, 2024, and September 30th, 2024, 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 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're very pleased with our third quarter performance, highlighted by an increase of 11.9% in revenue and 13.4% in adjusted EBITDA. Q3 total discharges increased 8.8%, including 6.8% in same-store. Once again, discharge growth was broad-based across geographies, payers, and patient types. Neurological and stroke, our two most common primary conditions treated, grew 9% and 9.7% respectively. Within our payer mix, Medicare discharges increased 8.8% for the quarter, while Medicare Advantage discharges grew 12.6%. Going largely to our Q3 results, we are again increasing our 2024 guidance. Doug will cover the details of the quarter and guidance in his comments. The demand for inpatient rehabilitation care is underserved and growing. For more than a decade, the age cohort most in need of these services has grown at a 4% to 5% CAGR, while the total supply of licensed IRF beds has been essentially static. It is estimated that by 2030, one in five Americans, more than 70 million people, will be aged 65 or older. Older adults disproportionately experience chronic health conditions, which is likely to continue to drive strong demand for inpatient rehabilitation services. We are continuing to invest in capacity additions to meet the needs of patients requiring such services. During Q3, we added 99 beds to our capacity, comprised of two de novo hospitals with a total of 89 beds and the addition of 10 beds to existing hospitals. We expect to open one additional de novo in 2024, a 61-bed hospital in Houston that will be our first fully prefabricated hospital and add approximately 22 more beds to existing hospitals. The Houston project marks an important milestone in our de novo construction strategy. Full prefabrication will facilitate lower costs and shorter design and construction times, but the process is not without complexities. Together with our primary prefab partner BLOX, we have learned a great deal on the Houston project, paving the way for efficiencies on future de novos. These efficiencies are starting to materialize on our Athens, Georgia de novo scheduled to open in the first quarter of 2025. We currently anticipate that at least two de novos per annum will be built with full prefabrication. With 15 development projects beyond 2024, already announced and underway, our pipeline remains robust and balanced between wholly-owned and joint ventures. Many areas in the Southeast and Mid-Atlantic regions of the US were significantly impacted by Hurricanes Helene and Milton. We operate numerous hospitals within these geographies. We are very proud of our leadership and how they prepared for and performed during and in the aftermath of these Hurricanes. And we are humbled by the resiliency of our dedicated employees, some of whom experienced damage to their homes and personal property as well as electricity and water outages. Given our presence in hurricane-prone markets, we have well-defined protocols for dealing with large storms. These protocols prioritize the safety and well-being of our patients and employees. Our physical plants withstood the Hurricanes very well. 25 of our hospitals, including 10 that incorporated at least one element of prefabrication as part of the initial build or bed addition or in some way impacted by the hurricanes, yet in total experienced only relatively minor damage. This is a testament to the quality and strength of our hospitals. We are still gathering estimates on required repairs, which we currently believe will amount to less than $1 million of expenses to be incurred in Q4. For the safety of our patients and staff, we chose to evacuate our Largo and Cape Coral, Florida hospitals ahead of Hurricane Milton with our Largo hospital closing for five days and Cape Coral for six days. Many patients from these two hospitals were evacuated safely to other Encompass Health hospitals and were accompanied by members of our clinical staff as needed. Again, a testament to our hospital staff. Four additional Florida locations did not admit patients prior to and immediately after Hurricane Milton passed through Florida on October 9th and 10th. By Saturday, October 12, all of our hospitals had resumed normal operations and were admitting patients. Although our operations are back to normal, some of the communities we serve are still in recovery mode. Disruptions to the healthcare systems in those communities may impact our volumes and length of stay in Q4, and we have attempted to account for that as well as the aforementioned facility repairs in our updated guidance. Now, I'll turn it over to Doug.

Thank you, Mark, and good morning, everyone. As Mark stated, Q3 was another strong quarter with revenue increasing 11.9% to $1.35 billion and adjusted EBITDA increasing 13.4% to $269.3 million. Total discharges increased 8.8% and net revenue per discharge increased 2.5%. As we saw in Q2, discharge growth in Q3 was skewed somewhat more towards same-store based primarily on the timing of de novo openings. Revenue growth in Q3 included a $7.9 million increase in provider tax revenues, partially offset by a $4.5 million increase in associated expense, netting to a $3.4 million adjusted EBITDA benefit. Bad debt expense as a percent of revenue was 1.9%, down 30 basis points from Q3 '23 and 100 basis points from Q2 '24. Recall that in Q2, we had a substantial increase in claims requested for review by our primary MAC. Consistent with our historical practice, we established a reserve against those claims in Q2, as the review was still pending. During Q3, a substantial majority of those claims was resolved favorably, contributing to strong collections. We had a relatively small number of new claims selected for review under TPE in Q3. Moving on to Review Choice Demonstration or RCD. As a reminder, Alabama was the first state to implement RCD inclusive of seven Encompass Health hospitals. RCD began with Cycle 1, which ran from August 2023 until February 2024, and had a minimum required affirmation rate of 80%. Cycle 1 participants were given an option of 100% prepayment claims review or 100% post-payment claims review for all Medicare claims. We elected 100% prepayment claims review and all seven of our hospitals completed Cycle 1 with an affirmation rate of approximately 89% exceeding the 80% required threshold. Accordingly, we were given the option for Cycle 2 of remaining on 100% prepayment claims review, changing to 100% post-payment claims review or being subject to a 5% spot audit. Given the processes we had established and the success we had achieved in Cycle 1, we elected to remain on 100% prepayment claims review. Cycle 2 began in May 2024 and concludes on October 31st. The required affirmation rate in Cycle 2 increased from 80% to 85%. We do not expect any of our seven hospitals to achieve that target by October 31st. Many of our RCD non-affirmations are based on the application of improper standards or requirements that directly conflict with the Medicare coverage criteria for inpatient rehabilitation facilities. We are appealing incorrect determinations and we are working directly with CMS to address our concerns related to these improper standards. We are still early in this process, but we believe our approval rates of approximately 90% Cycle 1 better reflect our long-term affirmation rates than the lower initial approval rates we have thus far experienced in Cycle 2. There is no financial penalty for not beating the affirmation rate in Cycle 2. Rather, as we enter Cycle 3, we will remain at 100% prepayment claim review. The required affirmation rate in Cycle 3 increases to 90%. SWB per FTE increased 4.1% in Q3, inclusive of a 3.5% increase in salaries and wages per FTE and a 14% increase in benefits per FTE. The large increase in benefits per FTE in Q3 was driven by group medical costs, which included several large dollar claims and an increase in prescription costs. The occurrence of large claims is sporadic and the frequency of such claims tends to be mean-reverting. Total premium labor expense for Q3 was $32.6 million, down 2% from Q3 '23 and flat sequentially. Q3 contract labor FTEs were 1.5% of total FTEs. These metrics were consistent with our expectations of a stable labor market. Net pre-opening and ramp-up costs were $5.4 million in Q3 '24 as compared to an adjusted EBITDA contribution of $900,000 from the 2023 openings in Q3 '23. We continue to generate significant free cash flow. Adjusted free cash flow increased 27.1% to $189.7 million, bringing our year-to-date total to approximately $0.5 billion. We now expect full-year adjusted free cash flow of $560 million to $620 million. Our leverage and liquidity remained very favorable. Net leverage at quarter-end was 2.3 times compared to 2.7 times at year-end '23. We ended the third quarter with approximately $148 million in unrestricted cash and no amounts drawn on our $1 billion revolving credit facility. On October 22nd, we issued a notice of redemption for an incremental $100 million of our 5.75% senior notes due in September 2025. This redemption will settle next month following which we will have a remaining balance of $100 million on these notes. We are again raising our 2024 guidance. We now assume net operating revenue of $5.325 billion to $5.375 billion, adjusted EBITDA of $1.07 billion to $1.09 billion and adjusted earnings per share of $4.19 to $4.33. The key considerations underlying our guidance can be found on Page 12 of the supplemental slides. There are a number of factors to keep in mind as you contemplate year-over-year comparisons for Q4. Q4 of '23 included a $22 million revenue reserve related to bad debt stemming from the write-off of older claims, predominantly pre-2018. After giving effect to minority interest, the impact of this revenue reserve on Q4 '23 adjusted EBITDA was $16 million. Q4 '23 also included $6.8 million in favorable reserve adjustments for workers' comp and general professional liability insurance. We are anticipating net preopening and ramp-up costs of $3 million to $3.5 million in Q4 '24 as compared to $1 million in adjusted EBITDA contribution from 2023 openings in Q4 '23. And we anticipate a Q4 adjusted EBITDA impact of $3 million to $3.5 million related to the addition of our Augusta hospital to the Piedmont joint venture together with Oracle Fusion implementation costs. With that, we'll open the lines for Q&A.

Thank you. At this time, the floor is now open for your questions. We'll go first to the line of Joanna Gajuk with Bank of America Securities. Please go ahead.

Good morning, Joanna.

Hi. This is Christian Porter on the line for Joanna. Thank you guys so much for taking our question. I was wondering because same-store volumes were very strong and accelerated quarter-over-quarter. Just wondering what drove that strength and how much of this was from the addition of new beds. Thank you.

Christian, this is Mark Tarr. As I noted in my comments, it was very broad across geographies. All of our eight geographic operating regions had nice growth. We saw nice growth in our stroke and other neurological categories. We saw the continued ramp-up of the facilities we brought on for the past couple of years. So we believe that we continue to take market share. We believe that our value proposition continues to be out there relative to the quality outcomes that we're able to achieve and is recognized as our ability to get patients back home and not readmitted back to the acute care hospitals.

I do think the bed additions had a favorable impact. Prior to Q3, on a year-to-date basis, we had added 115 beds, including 40 beds in the satellite location. And so those are counted in same-store. It's also the case that in the first half of the year, the 23 de novo openings were rolling into same-store, and those are still in ramp-up mode. So that provides a little bit of a tailwind to the same-store number as well.

And we'll hear next from Andrew Mok with Barclays. Please go ahead.

Good morning, Andrew.

Hi, good morning. Total FTEs have been up about 7% to 8% for the last year or so. Should we expect that to continue to increase in that ballpark to keep up with the discharge growth or should we expect that to moderate as we distance ourselves from some of the severe labor issues of '21 and 2022? And then relatedly, it sounded like there are some additional group medical expenses hitting the SWB line in the quarter. What was the underlying wage inflation and what's the outlook for that going forward? Thanks.

Yeah, I'll take the second part of the question first. And SWB per FTE or SW per FTE was up 3.5%, so pretty consistent with what we saw in Q1 and Q2. With regard to the total FTEs, we're pretty much at a stabilized EPOB of about 3.4% now. You'll have some noise from quarter-to-quarter based on the timing of new openings. But generally speaking, we would expect that the growth in total FTEs will be pretty highly correlated to discharge growth.

And as we've noted in the past, at this EPOB level, we feel like it's at a level that is conducive to us being able to continue to retain staff and also produce the outstanding outcomes. So we have put a lot of focus on that in the past couple of years as well.

And we do believe that we are seeing tangible evidence of the impact of EPOB as well as a number of the other initiatives we've been pursuing on our turnover rates. The Q3 annualized turnover rate for RNs was 20.7% and for therapists 7.6%, and those are very strong numbers.

Great. Thanks for all the color.

Next we'll hear from the line of Ben Hendrix with RBC Capital Markets. Please go ahead.

Hello, Ben.

Good morning.

Hi. This is Mike Murray on for Ben. Congrats on the quarter. And I appreciate all the commentary you gave on the hurricanes. Just given your expectations for lower volumes, could you provide a ballpark estimate for revenue impact in the fourth quarter?

Yeah. We really can't because, as we said, our hospitals resumed normal operations very quickly. So the impact of discharge growth into revenue from those disruptions would have been relatively minor. What we're still evaluating is whether or not the systems in the communities in which we operate hospitals have been impacted in any way that might cause us, for instance, to see a longer length of stay because there aren't available places for patients, who have been treated in our facilities to be discharged. We are confident that the updated guidance ranges for revenue and adjusted EBITDA incorporate any impact that we're going to see from the hurricanes, whether it's the volume, whether it's the length of stay or making the repairs to the facilities that will be expensed in Q4.

Okay. And just a follow-on. So you had some de novos in development in areas that were impacted by the hurricanes. And sorry if I missed this, but are you expecting any delays in construction as a result? Thanks.

We are not expecting delays. We are scheduled to open five hospitals in Florida next year, and all those sites were secured prior to the storm and performed well. Any minor disruptions we may have encountered there can be managed, and we believe we will adhere to the projected timeline outlined in the supplemental slides.

Awesome. Thank you.

And now we'll turn to the line of Brian Tanquilut with Jefferies. Please go ahead.

Good morning.

Good morning, Brian.

Good morning, guys. This is Meghan Holtz on for Brian. Congrats on the quarter.

Thank you.

Just going back to your bad debt really quick. We noticed that you're guiding 4Q bad debt reserves to a midpoint of Q2 '25. Is that a step up from Q3? Is that just conservatism or is that attributed to the small new audit claims that you guys mentioned in 3Q?

Before Q3, there was some variability in the performance in Q2 and Q3. That was the baseline we were experiencing, and we don't believe it's indicative of anything beyond what we consider a normalized level of activity. In Q3, we experienced a benefit from a reduction in our aging-based reserve, which was partly due to processing some previously denied claims.

Got it. Thank you so much.

And next we'll hear from the line of Pito Chickering with Deutsche Bank. Please go ahead.

Hey, Pito.

Hey, good morning, everyone. This is Kieran Ryan on for Pito. Thanks for taking the question. It looks like 4Q EBITDA margin guidance, it's maybe down somewhere about 50 bps from 3Q, excluding the provider taxes. I don't think there's any negative seasonality from 3Q to 4Q on margins or EBITDA dollars. So just wanted to confirm, is that kind of just the opening costs and any potential impact from hurricane headwinds, or is there anything else we should be thinking about sequentially?

Yeah, I think it's really that series of year-over-year considerations that I reviewed at the end of my prepared comments, and those are laid out in the guidance considerations.

Okay. And then on free cash flow, it looks like the working capital tailwind came down pretty significantly, but you still raised your guidance quite a bit free cash flow dynamics in the quarter, and if there's anything we should pay attention to there for 2025? Thanks.

Yes. I think probably the most significant item in Q3 was just the strong collections of AR we had, a lot of that was moving through that bulbous of claims that had been selected for review under TPE at the end of Q2.

Thanks.

And next we'll go to the line of Scott Field with Stephens. Please go ahead.

Good morning.

Well, good morning. Well, fine, but close enough. Good morning. I wanted to first question just ask about just an understanding that you're not providing guidance at this point, but do you wanted to maybe frame the key headwinds and tailwinds for 2025? And just from, I guess, the bigger picture, any modeling considerations at this vantage point that you think it is important to call out for analysts and investors?

As we look towards 2025, our initial expectation, which may evolve over the next quarter, is that we will experience inflation of around 3% to 3.5% for SWB per FTE. We believe this rate is stabilizing. We haven't yet thoroughly assessed the pre-opening and ramp-up costs on a year-over-year basis, but they will likely be similar to this year's impact. Additionally, through Q3, we've recorded a positive EBITDA effect from net provider taxes amounting to $13 million. However, as we've stated before, predicting the future visibility of these provider taxes is challenging due to the variations in state programs and their annual implementations. Out of the $13 million included in year-to-date EBITDA, about $4 million to $5 million pertains to out-of-period figures, which we do not expect to recur in 2025. Nonetheless, some part of the remainder, possibly a significant portion, may continue. These are the key points to consider, Scott.

Okay. Thanks, Doug. That's helpful. And then just my follow-up question. I wanted to circle back just on some of the comments that Mark had made around on the sort of lessons learned on the prefabs, and then starting to see efficiencies realized more on the Athens facility. I was hoping maybe you can sort of frame if there's any type of quantitative figures you can share with us in terms of like maybe in the initial process, how much maybe additional costs you had just as you were sort of working your way through this new format? And then as you sort of move toward the efficiencies, how much you think you could bring down those costs, for example, on the Athens facility and then as you continue to launch more of the prefabs?

We are aiming to achieve two main advantages. The first is to shorten the construction process, as a quicker build allows us to open facilities sooner and start generating cash flow. Looking specifically at our experience in Houston, which served as a learning opportunity with our first fully prefabricated facility, we laid the first module in early June, and we expect to complete all final permitting and inspections by the first week of November. This timeline is notably fast at just over five months, especially compared to conventional construction timelines of 11 to 12 months. We anticipate even faster timelines for Athens. From a cost perspective, Houston was essentially a breakeven situation when compared to conventional costs due to our learning phase. However, as we refine our processes further, we expect future projects to achieve around a 15% cost savings compared to conventional construction. While there are some savings associated with the design phase through project replication, permitting and site work variances will continue to impact costs across different locations. Nonetheless, the improvement in the timeline from the start of module installation to opening the facility is significant.

Scott, this is Mark. So I'll just pitch in there. We've been at this now for a number of years on an incremental basis, first starting with bathrooms and headwalls and then working our way up to the Uber modules. And it has really turned out to be a nice, what we consider to be a competitive advantage in terms of building our hospitals. I also commented on the fact that these have been tested in a number of severe storms in terms of their quality and soundness of construction. So we just couldn't be happier in terms of the success and the way this is working its way through our implementation phase.

And now we'll hear from the line of Jared Haase with William Blair. Please go ahead.

Hey, Jared.

Good morning.

Hey, good morning and congrats on a solid quarter. Maybe just taking a step back and kind of really thinking about sort of the durability of growth. Again, as we look out to 2025, I'm curious, do you feel like the same-store growth trends is that largely reflecting sort of the underlying demand environment for Earth Services? Or do you feel like you are taking, I guess, more than your fair share as you capture market share from other care settings like SNFs, which I know has been kind of a focus area from recent years, so just any thoughts around that?

Hey, Jared, I believe it's a combination of both factors. It’s difficult to determine the exact portion that is due to gaining additional market share versus organic growth from favorable demographics. In some marketplaces, it's clearer where we are gaining share, whether from nursing homes or other providers. However, as I mentioned in my previous comments, the aging population and the rising demand for inpatient rehab services are certainly evident and are reflected in our same-store growth.

We have mentioned several times that measuring market share in the IRF space by looking at our discharges compared to total industry discharges significantly understates the total addressable market for IRF services. One major reason for this is the annual discharges from all acute care hospitals in the US that comply with CMS 13 guidelines. While only 60% of patients treated in any IRF need to be CMS 13 compliant, only 14% of the acute care hospital discharges that are CMS 13 compliant end up in an IRF bed. We understand that this number shouldn’t be 100% due to several factors, including that some of those patients may not meet medical necessity requirements. However, the potential for that number to be significantly higher than 14% exists. It's also important to highlight that the 14% figure includes patients at our existing Encompass Health facilities. In nearly all markets where we operate, we convert more than 14% of CMS 13 eligible discharges into IRF beds. If we exclude our facilities, that percentage on a national scale is likely in the high single digits. In more established markets where we have been operating for some time, it’s common for us to see conversion rates of 30% or more.

I think that's very helpful. I'd like to ask a follow-up about the quarter. It seems that the growth in Medicare Advantage discharges was strong, running a couple of points higher than traditional Medicare discharges. However, I noticed that the revenue from Medicare Advantage dropped slightly as a percentage of total revenue compared to the previous period. I assume this might be due to a mix of conditions treated during the quarter. Is there anything else we should consider regarding the revenue mix?

No, as Mark cited, the growth has been broad-based across the payers. So if you look at Q3 specifically, Medicare up 8.8%, Medicare Advantage 12.6%, and Managed Care saw solid growth at 9.1%. On a year-to-date basis through Q3, Medicare up 9.3%, Medicare Advantage 11.1% and Managed Care of 8.5%. Looking at a three-year CAGR from 2022 to 2023, again, it reflects very balanced growth. Medicare over that period of time, up 7.4%, Medicare Advantage 8.9%, and Managed Care 11.3%. I think what this really demonstrates is that our value proposition really extends well across all payer classes. We ought to talk the case that we create more value for our referral sources when we're not trying to cherry-pick patients between payers.

Absolutely. Makes sense and thanks for all the color.

We'll turn to the line of Matthew Gilmore with KeyBanc. Please go ahead.

Good morning.

Hey, good morning, guys. This is Zach Haggerty on for Matt. I appreciate you taking our question. So we've been getting questions on election implications for hospitals, especially on the exchange subsidies and Medicaid supplemental payments. I guess, could you remind us maybe what your exposure is to these programs? Or if you see any other election-related items that we should be aware of.

Yeah, I think, from our perspective, the program that seems to be getting the most airplay because of its size is Tennessee. And it's really not a factor for us in the State of Tennessee. So we've talked quite a bit about our net provider tax numbers. For us, the numbers are substantially smaller than they are in other states. So we've talked quite a bit about our net provider tax numbers. For us, the numbers are substantially smaller than they are on a state-by-state basis, this year, it's been $13 million, $4 million to $5 million of that relates to out-of-period. So as I stated in my earlier comments, is it reasonable to believe that some amount of that continues into 2025? Yeah, I think it probably is. We just don't have a good estimate because of the lack of visibility.

And relative to your question just around the whole Presidential Election and if there's one preference over another, we really don't see a threat from either one. And if you look back historically, whether it's been Republican or Democrat, it doesn't seem to have had a significant impact one way or the other.

Okay. That's helpful. And then just as my follow-up, as you guys continue to reduce leverage in the business, is there a leverage ratio that you guys are targeting?

There's not. We're very comfortable in the current range. We previously indicated that a run-rate leverage of about three times was appropriate, and we’re currently below that level. It appears the market is now considering 2.5 as the new 3.0 due to various macro factors. We acknowledge that if we go much lower than our current leverage level, it could lead to inefficiencies regarding cost of capital. We continue to see good opportunities for investing in capacity expansions, which remains our top priority. Additionally, our Board of Directors indicated other possible uses of cash through the dividend increase in Q2 and the boost in our share repurchase authorization.

Great. Appreciate the time guys.

As there are no further questions in queue at this time, I'd like to turn the floor back over to Mr. Mark Miller for any additional and closing comments.

Thank you, operator. If anyone has additional questions, please call me at 205-9705-860. Thank you again for joining today's call.

Ladies and gentlemen, that will conclude the Encompass Health's Third Quarter 2024 Earnings Conference Call. Thank you for your participation. You may disconnect at this time and have a wonderful day.