Earnings Call Transcript - EHC Q2 2025

Operator, Operator

Good morning, everyone, and welcome to Encompass Health's Second Quarter 2025 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 Investment Relations Officer.

Mark Miller, Chief Investment Relations Officer

Thank you, operator, and good morning, everyone. Thank you for joining Encompass Health's Second Quarter 2025 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 such as guidance and growth projections, 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 cost trends that could cause actual results to differ materially from our projections, estimates and expectations are discussed in the company's SEC filings, including the earnings release and related Form 8-K, the Form 10-K for the year ended December 31, 2024, the Form 10-Q for the quarter ended March 31, 2025, and the Form 10-Q for the quarter ended June 30, 2025, 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, reconciliations 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 1 question and 1 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 President and Chief Executive Officer, Mark Tarr.

Mark J. Tarr, President and CEO

Mark, thank you, and good morning, everyone. Our discharge growth in the second quarter facilitated an increase of 12% in revenue and 17.2% in adjusted EBITDA. Total discharges for Q2 increased 7.2%, including 4.7% in same-store. Our discharge growth was again broad-based across geographies, payers and patient types. Our focus remains on successfully treating patients with complex medical conditions. Neurological conditions and stroke for which we have extensive clinical expertise grew 12% and 6.7%, respectively, in the quarter. Our dedicated and highly competent clinical teams continue to deliver outstanding patient outcomes. Our Q2 discharge community rate was our discharge to acute rate was 8.5% and our discharge to SNF rate was 5.8%. Our performance on each of these quality metrics is favorable compared to the industry average. In Q2, we opened a new 60-bed hospital in Fort Myers, Florida. We also added 26 beds to an existing hospital. In July, we opened a new 50-bed hospital in Daytona Beach, Florida and added 20 beds to an existing hospital. Over the balance of the year, we plan to open 5 additional hospitals, 4 for de novos with a total of 190 beds and a 50-bed freestanding satellite hospital and add another 30 to 50 beds to existing hospitals. Due in large part to our Q2 results, we are again increasing our 2025 guidance. The demand for inpatient rehabilitation services remains considerably underserved and continues to grow as the U.S. population ages. The Medicare beneficiary population is the fastest-growing segment of the U.S. population. It is estimated that by 2030, 1 in 5 Americans more than 70 million people will be aged 65 or older. The 65-or-older population has been growing consistently at a CAGR of approximately 3%. The average age of our Medicare beneficiary patient is 77 years old, and the aged 75-plus population is growing at approximately 4%, yet the supply of licensed IRF beds in the U.S. has increased only nominally. As a result, the demand for treatment of complex medical conditions such as stroke, necessitating acute care intensity, is significantly underserved. We treat more patients with IRF appropriate conditions than any other provider. This allows us to develop and refine best-in-class clinical protocols which are then extrapolated across our hospitals via our continuous best practice initiatives. The identification, development and implementation of these clinical protocols is enhanced by our state-of-the-art information systems, including our IRF specific electronic medical record. In addition to our strong performance on discharge community rate, we outperform industry averages on many quality, patient safety and patient satisfaction measures, including patients' mobility at discharge, their ability to care for themselves at discharge, medication management, and pressure injuries that are new or worsened, along with patient Net Promoter Score. Referring hospitals know they can reliably send complex patients to our hospitals for post-acute services. Our attractiveness as a partner to acute care hospitals is further evidenced by the fact that 67 of our 169 hospitals are operated as joint ventures. Finally, on August 1, 2025, CMS released the 2026 IRF final rule. This included a net market basket update of 2.6% which we estimate would result in approximately a 2.7% increase in net revenue per discharge for our Medicare patients beginning October 1, 2025, based on our current patient mix. With that, I'll turn it over to Doug.

Douglas E. Coltharp, CFO

Thank you, Mark, and good morning, everyone. Revenue for the second quarter increased 12% to $1.46 billion and adjusted EBITDA increased 17.2% to $308.6 million. The revenue increase was comprised of 7.2% discharge growth and a 4.2% increase in net revenue per discharge. Q2 net revenue per discharge benefited from a decrease of 90 basis points in bad debt expense to 2%. Recall that Q2 '24 bad debt expense included reserves associated with a significant increase in prepayment claims reviews under TPE. Q2 FWB per FTE increased 4%. Salaries and wages per FTE, excluding contract labor and sign-on and shift bonuses, increased 3.4%. Contract labor and sign-on bonuses declined by $4.9 million or 15.1%. Contract labor FTEs represented 1.3% of total FTEs. Q2 benefit expense per FTE increased by 18%, and benefits expense growth continues to be driven by an increase in the frequency of high-dollar medical claims. We expect group medical expense growth to moderate in the second half of the year as we anniversary the increase we experienced in 2024. Net pre-opening and ramp-up costs were $4 million in Q2, bringing the first half total to $6.1 million. We expect these costs for the full year to be in a range of $18 million to $22 million. Q2 adjusted free cash flow increased 30.5% to approximately $186 million, bringing year-to-date adjusted free cash flow to approximately $408 million, a 31.7% increase from the first half of 2024. Based on our strong Q2 performance and the tax benefit of additional bonus depreciation resulting from recent legislation, we now expect 2025 adjusted free cash flow of $705 million to $795 million. Our leverage and liquidity remain very favorable. Net leverage at quarter-end was 2x. We ended the quarter with approximately $100 million in unrestricted cash and in excess of $950 million available on our $1 billion revolving credit facility. During the second quarter, we repurchased approximately 232,000 shares of our common stock for $24.7 million. We recently announced an increase in our quarterly dividend, next payable in October to $0.19 per share. As can be seen on Page 13 of our supplemental materials, we have again increased our anticipated growth CapEx estimate for 2025. Following Q1, we raised our estimated 2025 spend by $15 million to $20 million to pull forward a number of bed expansions in response to our increasing occupancy rates. We are now further increasing our 2025 estimated spend on bed expansion by $25 million, predominantly related to our recently announced CON approval for a freestanding hospital in Cleveland, Tennessee, which we intend to operate as a satellite of an existing hospital. Production of this fully prefabricated hospital will commence shortly. We also added $5 million to our anticipated 2025 de novo spend as we have elected to accelerate the land purchase for a future period de novo. Moving on to guidance, we are raising our 2025 guidance as follows: net operating revenue of $5.88 billion to $5.98 billion, adjusted EBITDA of $1.22 billion to $1.25 billion, and adjusted earnings per share of $5.12 to $5.34. The key considerations underlying our guidance can be found on Page 11 of the supplemental slides. And with that, we'll now open the lines for questions.

Operator, Operator

We'll take our first question from Andrew Mok of Barclays.

Andrew Mok, Analyst

Occupancy rates have increased more than 200 basis points year-over-year through the first half of the year. I think some of that has benefited from a shift to single bed rooms. But if you just look purely at your single bedroom facilities, like where is mature occupancy? And what levels are you comfortable operating at?

Douglas E. Coltharp, CFO

Yes. So it varies pretty widely across the portfolio, really depending on the maturity of the hospital itself. First, to begin and give some specifics, the numbers that you're looking at, Andrew. At the end of 2020, 41% of the beds in our portfolio were private. At the end of the second quarter, we were at 56%. To your point, occupancy in Q2 was 76.6%, and that's up 210 basis points over the second quarter of last year. When looking at an all-private room facility, when occupancy starts to stabilize north of 80%, we start putting it on a list and start thinking about a future period bed expansion. Now the capacity in those facilities can run into the mid- to high 90s because you're not facing issues of gender or germ compatibility. It's lower than that for the hospitals that are still semi-private rooms. Recall, as we move into the back half of the year, based on the opening schedule that Mark highlighted during his comments, you're going to see a little bit of a downward pressure on occupancy because we've got that new capacity coming on board.

Andrew Mok, Analyst

Great. As a follow-up, there was discussion about quality ratings in previous CMS rate proposals, but it seems that none of that has progressed yet. I'm interested in your thoughts on these initiatives and whether you support them, as well as your position if those quality initiatives were to be implemented.

Mark J. Tarr, President and CEO

Yes. Andrew, it's Mark. So the quality initiatives, any change in those did not get included in the final rule. They did take out some of the ones around COVID that were COVID specific. When we work with our trade associations, we are fine with looking at and including various quality measurements and think that we would do extremely well on that. We just want to make sure as an industry that we all agree on what those would be and how they would be measured.

Operator, Operator

We'll take our next question from Matthew Gillmor of KeyBanc.

Matthew Dale Gillmor, Analyst

I just wanted to do a quick follow-up on Andrew's question around quality. Can you just remind us how you share your quality results with different stakeholders? I guess I was thinking referral sources and JV partners. And are there any particular areas of quality that are sort of most relevant or important to those stakeholders?

Mark J. Tarr, President and CEO

Yes. So we work closely with the Joint Commission. In fact, they do our Medicare validation surveys for all of our new start-up de novos. Relative to outcome metrics, the ones that we really focus on and share with our joint ventures, although we can go as deep as they want, are discharge community, discharge to acute, discharge to SNF. We always include the patient satisfaction measurement with the Net Promoter Score. Those have all been prioritized by Medicare in the past. I think they are a good representation of the functionality of the patients at the time of discharge. As you heard me in my prepared remarks, those are the ones that we do extremely well on. We perform well in others. There are 16 measurements as part of the CMS care compare. But we're very proud of our outcomes and continue to improve our outcomes. If you look at the discharge community as well as to acute, those were all the highest we've had in recent quarters. So we're very proud of our quality and make it a priority.

Douglas E. Coltharp, CFO

In addition to the acute care hospitals, obviously, another important constituency are the physicians who refer patients to us and many oversee the care of those patients when they come into our facility. They tend to be very data-driven. So we share with them a lot of the patient improvement scores that Mark cited in his comments earlier today. So we're looking at the gains that they have in functional capabilities and the ability to care for themselves and so forth. Again, those are very numerically driven scores that physicians like to see and that they really study very hard.

Matthew Dale Gillmor, Analyst

Great. I appreciate that. And then I wanted to ask a follow-up on payer mix. It seems like the Medicare fee-for-service mix was pretty stable this quarter, but maybe managed care ticked up a little bit. I noticed you increased, I think, your managed care pricing assumption. I was curious if there's a story around that to tell or what's driving that trend? Or perhaps it's just within kind of normal variation of what you'd expect.

Douglas E. Coltharp, CFO

There actually is a bit of a story there, and that has to do specifically with the VA Community Care Network contract. We have been seeing growth in that line of business that's been in the mid-teens, and it now comprises almost 18% of our overall managed care business. Importantly, it pays at the Medicare CMG. So that has been a driver of the growth in managed care and also the improved pricing.

Operator, Operator

We'll take our next question from Pito Chickering of Deutsche Bank.

Philip Chickering, Analyst

Nice quarter. Looking at the EBITDA in the first half of the year for the back half of the year, can you sort of bridge to us sort of what the implied guidance is, how we should be thinking about start-up losses in the back half of the year, changes to employee per occupied bed in the back half of the year or any other changes as we bridge the first half of the year and the back half of the year?

Douglas E. Coltharp, CFO

Yes, absolutely. As we move into the back half of the year, we do expect to incur the lion's share of the pre-opening and ramp-up costs. Again, if you're at the midpoint of the $18 million to $22 million for the year and you subtract out the $6 million in the first half, you're looking at about a $14 million number. We ran at a 2% bad debt number for the first half of the year. We hope that continues. But in our guidance assumptions, we've assumed some resumption of TPE activity, which would cause that number to go higher. So pick your point for the second half of the year between 2% and 2.5%, and you would see an increase there. It's a smaller number, but we had favorable insurance adjustments of about $4 million in the first half of the year. We're not necessarily anticipating that those would continue. Even though it was down on a year-over-year basis, the net EBITDA impact from provider taxes was about $7 million. There's no guarantee that, that continues in the second half of the year. The item that you suggested is we ran at a 3.34 EPOB in the first half of the year. We expect that to be closer to 3.40, particularly given the new capacity coming on board in the second half of the year. Going the other way is the Q4 pricing update, at least a portion of which will be offset by our annual merit cycle. I think those are most of the pieces, Pito. I hope that was responsive to your question.

Philip Chickering, Analyst

Can you provide details on the premium labor in the first quarter compared to the second quarter? The contract employees appear to be relatively flat sequentially. Did you see a decrease in overtime as more employees were hired in the second quarter? Also, could you share your thoughts on the current ease of hiring versus turnover for full-time employees?

Douglas E. Coltharp, CFO

Yes. So sign-on and shift bonuses from Q1 to Q2, in Q1, it was $12.2 million. It was $10.9 million in Q2. In terms of the shift bonus component, it was $10.7 million in Q1 and $8.4 million in Q2, so nice improvement there. Regarding contract labor, we went from 16.4% in Q1, up just slightly to 16.7% in Q2. Contract labor FTEs moved slightly from 375 to 379.

Mark J. Tarr, President and CEO

Peter, I'm going to ask Pat Tuer to weigh in on what he's seeing in terms of labor. He and the operations team have been working real hard, specifically on recruitment and retention, as we've mentioned in past calls.

Patrick W. Tuer, COO

Thanks, Mark. We continue to see strong hiring. You may recall, a few years ago, we centralized our talent acquisition function, so we have 83 full-time employees that do nothing but focus on bringing people into our organization, encompassing both recruiters as well as the recruitment and marketing function. We continue to see net hires up. We had 71 net hires in Q2, which is another strong quarter for us. From a turnover perspective, we are hovering around pre-pandemic levels, just at 21%. That's up slightly from Q1, but it is well below the turnover rates that we saw during the pandemic. Our local teams are focused on ensuring that employees in their markets are paid competitively. We've also created several career ladders and we're focused on enrolling as many folks who qualify for those into those ladders. We have shown that if we can get an employee, specifically a nurse, onto the clinical ladder, they're turning over about a quarter of the rate of our non-laddered nurses. Additionally, we have put effort into workflow analysis to ensure that we're reducing the burden on our clinical employees and making their workday as efficient as possible. The centralized talent acquisition function allows our local HR folks to focus more on engagement, which has also helped retention.

Mark J. Tarr, President and CEO

A few of those turnover numbers were specific to nursing, which has obviously been a huge focus for us. But we are also focused on therapy openings and making sure we retain our therapists as well. I feel like we're making continued progress here in what continues to be a challenging market out there.

Operator, Operator

We'll take our next question from Whit Mayo of Leerink Partners.

Benjamin Whitman Mayo, Analyst

Maybe just a follow-up on the hiring efforts. I was just thinking that we never talked about the physiatrist market, only nurses and therapists. How does that market look like today? And maybe talk about how you find bringing doctors into new markets?

Mark J. Tarr, President and CEO

Whit, I'm going to ask Pat to address that. I will say before he gets into specifics, we have a physician recruitment team here at Encompass, and that is somewhat centralized, but we've also had to use market and regional recruiters as well. Overall, the physiatry market is challenging but has been fairly stable over the last 2 to 3 years. I'll let Pat give you some specifics.

Patrick W. Tuer, COO

Thanks, Whit. From market to market, this can vary, but I would say the supply has stabilized, as Mark has alluded. In a number of our markets, we partner with or have established residency programs with universities that have helped with recruitment. We also have a strong component of internal medicine physicians who have also worked to become rehab physicians in markets that may be challenging to get a PM&R physician. We have been able to fill all the needs that we currently have. We have a pretty strong recruitment team that focuses solely on this.

Mark J. Tarr, President and CEO

It remains challenged. However, over the last decade, we've seen a pleasant trend in what used to be a lot of physiatrists primarily wanting to do outpatient and, in some cases, pain management. We've seen a nice trend in the last couple of years where these physiatrists are now very interested in inpatient settings and treating complex patients. So that's been a nice trend as we've gone out to recruit doctors.

Benjamin Whitman Mayo, Analyst

Okay. My follow-up is, I'm looking at my model here, and it's got leverage now below 2x. Are we not at a floor where you should look to maybe hold it steady and take that excess capital and prioritize larger buybacks? I appreciate the increase in the growth CapEx, but it seems like you can probably balance both.

Douglas E. Coltharp, CFO

Yes. The short answer is yes. As we think about capital allocation, the top priority will continue to be towards capacity expansions. As we noted in our comments, we have increased this year the allotment to both bed expansions and to de novos. We expect it to be at an elevated level for the next several years given the opportunity that exists to meet some of that rising demand. We do get a benefit this year, it’s almost $50 million, and we will have an ongoing benefit related to bonus depreciation. So even as we increase our capital expenditures, we're getting favorable cash flow from the tax benefit as well. The likely place to go is going to be with more share repurchase activity.

Operator, Operator

We'll take our next question from Joanna Gajuk of Bank of America.

Joanna Sylvia Gajuk, Analyst

I guess, maybe first, the follow-up on the last discussion around the capital deployment priorities such as likely more share repurchase. Any considerations around acquisitions? I think I've asked you this before. It sounds like you believe when it comes to your core business, the inpatient, that you believe de novos and bed additions will prefer those because of the returns over deals. But any consideration around looking outside of the inpatient rehab? I just want to ask just in case.

Douglas E. Coltharp, CFO

Right now, we have not identified any particular service lines or capabilities that are important to our key constituencies that we don't currently provide. There are no adjacencies that are on our radar screen to move into. We would consider those only to the extent some of those key constituencies, whether it was referral sources or payers, came to us and said we could be meaningfully more valuable to them as a partner if, in addition to IRF services, we could provide this additional service. That has not arisen in any of our discussions yet. Regarding acquisitions within the IRF space, we continue to use the model as part of our business development effort where we will acquire a unit in an existing hospital and have it folded into a new de novo as a market entrant strategy. That will continue to be an option for us. As we’ve mentioned before, some portfolios of freestanding IRFs predominantly sponsored by private equity have experienced attractive growth and have favorable operating characteristics. As those become available, we would evaluate those, but the return hurdle is quite high to surpass the returns we’re getting from our de novo activity. Thus, the real focus of our cash flow and capital allocation in terms of capacity expansion will remain on our own de novo activity and then bed expansions at existing hospitals.

Joanna Sylvia Gajuk, Analyst

My question about the same-store volumes were up very nicely in the quarter. Can you talk about the metrics by specialty? Sometimes you give us these metrics, so just curious about whether there's any outlier or if every category is going similarly?

Douglas E. Coltharp, CFO

Yes. We can provide you with some of that. Neurological was very strong, up 12.5%. We saw another good quarter of stroke growth, which was up 6.7%. Brain injury is smaller but still a significant category, which was up over 12%. There was good growth in a lot of those areas where we focused on treating more medically complex, higher acuity patients. That's been a portion of our differentiation strategy for more than a decade now.

Operator, Operator

Our next question is from Ann Hynes of Mizuho Securities.

Ann Kathleen Hynes, Analyst

I know there are a few CON states that might relax the CONs, maybe North Carolina, South Carolina, and Tennessee. Can you just give us the update on the status of those and maybe how you view de novo activity in those states once the CONs are lifted?

Mark J. Tarr, President and CEO

Yes, we have a presence, as you know, in South Carolina, up to and all around the Charlotte marketplace. Their CON will subside January 1, 2027. A lot of discussions among many within the decision-makers in the state of North Carolina. We have one hospital now in the state of North Carolina in Winston-Salem and believe that that state, with its growth and demographics, and its shortage of rehab beds, would be a state that would look not dissimilar to what Florida has looked for us in terms of our ability to be a first mover in the state and have significant attractive markets in which to pursue.

Ann Kathleen Hynes, Analyst

Perfect. A big theme this quarter with the payers is just increased coding and maybe more of the use of AI with documentation. How is Encompass using AI to code and document better?

Douglas E. Coltharp, CFO

Yes. We've mentioned previously that we do have a partnership with Palantir, and what we're really looking to do is utilize AI to reduce the administrative burden on our staff and improve the consistency with which we're presenting information. It allows us, for instance, when we get a medical record on a patient who is transferring to us from an acute care hospital, it is voluminous. It is very taxing on our staff to have to process that record and ensure that we're pulling forward the most pertinent information into our own documentation, and AI can facilitate that process. Nothing that we're doing with AI is overriding individual clinical judgment. We make sure that there is a stringent manual review of these processes as well. But it is a tool that ultimately we think can reduce administrative burden, improve accuracy, and in so doing, also increase the job satisfaction of our staff.

Mark J. Tarr, President and CEO

One specific application of that has been used by our nurse liaison to conduct patient evaluations, which can take a lot of time and many of these patients don't turn into admissions. Anything we can do to help these nurse liaisons become more efficient has been accomplished with Palantir as they use their iPads to do the assessment and all the documentation around that. We've been able to reduce the time for documentation of that assessment by 20 minutes, and when you start multiplying that out by all the liaisons that we have and the patients that are being evaluated, you can see a significant gain in efficiency. It's also a boost in job satisfaction for those liaisons; that's just one specific application of how we're applying AI and working specifically with Palantir and Oracle in some cases.

Douglas E. Coltharp, CFO

Ultimately, it benefits both the acute care hospital as the referral source and the patient. It allows us to be more responsive and respond faster, which has the potential to free up beds in the acute care hospital. It also means that if we can make a faster decision, and the patient comes into our facility, they’re going to start their therapy regime earlier, which has substantial clinical benefits.

Patrick W. Tuer, COO

Ann, I was just going to add this is Pat. We also use predictive analytics and modeling to help us with our fall risk model. Since 2020, when we implemented this model, our fall rate has improved by 30%. That model looks at 50 different clinical elements, consolidates those into a risk score, and informs our clinicians of the patients with enhanced fall risk. The other is on acute care transfers. Back in 2015, we developed a REACT model, which continues to be refined, and that has led to a rate improvement of 24% since 2020. There are two other examples of where we're using predictive analytics within our systems to help improve quality in the clinical process.

Operator, Operator

We'll take our next question from A.J. Rice of UBS.

Albert J. William Rice, Analyst

Just on the managed care contracting, any insight from a couple of other questions. Is there any pressure that they're experiencing changes in the dynamics, terms, discussions and rate updates you're seeing?

Douglas E. Coltharp, CFO

A.J., you were a little bit garbled there. I think your question was specifically around managed care contracting. As we go through some of the renewals, are we seeing anything that is significantly different from recent historical norms? I mentioned earlier because it's contained within the managed care bucket for us on payer mix, the impact of the VA work in the community care network that has been very favorable, which has led to the higher-than-anticipated price increase there. Other than that, I'd say it has been fairly standard in terms of annual price increases, generally in the 2.5% to 3% range, and volume growth is not all that significant.

Albert J. William Rice, Analyst

Okay. Another one: your pacing on de novo new deals, partnerships, etc. has been very steady, if not improving a little bit. But I always want to be aware of the pipeline and what you're seeing out there. Have the discussions with acute care partners and potentials on JVs changed at all or in the depth of the potential backlog that you see? Anything to call out there?

Douglas E. Coltharp, CFO

No. We included in the supplemental slides the development activity that has been announced, and there are 18 projects, including those that have already opened up this year. Consistent with what we've said before, we maintain an active dialogue or an active pipeline of right at about 50 projects, and it's stayed pretty steady at about that level. So I feel good about the visibility to continue at this level of growth for the next several years.

Mark J. Tarr, President and CEO

A.J., I think one thing that's notable on this development list is the fact that we're growing not only in states where we already have a presence, such as Pennsylvania or Georgia, but we also have some new states that we're entering, and we'll open up our first hospital in Danbury, Connecticut, here in Q3. In the outer years, we'll be looking at adding hospitals in Utah and Nevada. We’re looking at where we have market density as well as opportunities to open up in new states.

Operator, Operator

We'll take our next question from Jared Haase of William Blair.

Jared Phillip Haase, Analyst

Maybe I'll ask one around the benefits expense. I think you said that was up 18% in the period. A couple of quick ones. One, can you remind us the split in total SWB spend between wages and benefit costs? And I assume much of that growth is driven by specialty pharmaceuticals, but just wanted to confirm that. With that being the case, assuming specialty pharmaceuticals are a big driver, it doesn't seem like that's going away anytime soon. So I'm wondering if there's anything incremental to sort of your strategy to manage benefits expense going forward?

Douglas E. Coltharp, CFO

Yes. There is a lot to unpack there. So in response to the first question, total benefits run at about 10.5% of the total SWB line, right between 10.5% and 11%, even with the recent increases that we've seen. The double-digit increases we've been experiencing for the last year have been driven predominantly by an increased frequency of high dollar claims, which we typically classify as an individual claim of over $100,000. Some of that is due to overall inflation in the healthcare system. Even if patients are experiencing a similar malady to what they had previously, the cost of treatment may have now increased to over $100,000. It has not really been driven by specialty pharmaceuticals with one exception that I'll go through in a minute. When a lot of folks think of specialty pharmaceuticals, they're thinking of things like the GLP-1s, along with notable drugs like KEYTRUDA. What we’ve seen there is that the rate of increase in our spend on those drugs has been relatively modest, kind of in the mid-single-digit increase, and that’s because rebates have offset the increase. The impact of specialty drugs on our medical claims, however, is more noticeable, especially with some of the inpatient cancer treatments.

Jared Phillip Haase, Analyst

Got it. That's really helpful color. I appreciate all that. And then maybe just as a quick follow-up, I’ll ask on free cash flow. A nice quarter. I think it was up about 31%. If I look at the revised guidance, I think it implies about 9% or so for the full year, 9% growth. I think you clarified some of the bridging items in the second half and sort of the timing of the capital investment. But maybe the question, if I think longer term, what guardrails or parameters would you frame in terms of how we should think about free cash flow growth going forward, either in terms of a total annual growth rate or conversion relative to EBITDA?

Douglas E. Coltharp, CFO

Yes. I think it’s going to be relatively similar. Capital expenditures are going to be roughly similar over the next several years. Obviously, we anticipate further growth in EBITDA. As we mentioned earlier, we've received benefits this year and expect continued benefits over the next several years related to the change in tax legislation regarding bonus depreciation. That should enhance the flow-through.

Operator, Operator

We'll take our next question from Brian Tanquilut of Jefferies.

Brian Gil Tanquilut, Analyst

Congrats on the quarter. Maybe just a question, Doug. As I think about tariffs and I know you're expanding your CapEx budget for the year, are you seeing any changes there that we need to be thinking about as we consider 2026 budgeting for CapEx and construction costs?

Douglas E. Coltharp, CFO

Not yet. There's still a lot that is in flux. We've talked previously about how we source our materials. We don't have much exposure to concrete, primarily sourced out of Mexico, given the building composition. From a steel perspective, a significant amount of the steel we use is recycled steel that we're able to procure in the U.S. Thus far, we haven't seen a pronounced impact from tariffs on construction cost inflation, but it's obviously something that remains in flux, and we continue to monitor it.

Brian Gil Tanquilut, Analyst

I appreciate that. And then maybe, Mark, I appreciate all the comments on the quality and the discussions you're having with the JV partners. I'm curious if you can share any feedback or discussions since July that you or your staff and your team have had with the referral partners.

Mark J. Tarr, President and CEO

Yes. Brian, we were very transparent and reached out to our partners. We were aware that this article may come out; we didn’t know when or what it would say, but we reached out to all of our partners and said this may be out there. We've always been transparent with our partners relative to our quality outcomes or anything that might be out in terms of changes in regulations or otherwise. Our partners certainly recognize our quality, and as it leads to the outcomes that we achieve regarding return back to the community, Net Promoter Score, or the likelihood of readmission back to the acute care hospitals, that's what they appreciate. We think the article that reviewed only 0.001% of our total discharges for that time period and tried to use that to cast what we would consider to be a mischaracterization across our quality was disappointing.

Operator, Operator

We'll take our next question from Raj Kumar of Stephens.

Raj Kumar, Analyst

Just looking at this is 12 straight quarters of same-store discharge growth above 4%. Balancing insights from upstream acute care hospital providers and how they're seeing moderating volume growth to more normalized levels, there’s also a tougher comp backdrop for Encompass. How do you see same-store growth in the back half? Additionally, there's a lot of new facilities coming online in the back half as well. Can you provide a framing of growth relative to that 6% to 8% target in the back half between same-store and new store?

Douglas E. Coltharp, CFO

I think you've hit on the right factors: more capacity coming on board in the second half will help with new store growth. However, some of that capacity is coming on very late in the year, so it won't impact this year as much as it will benefit next year. Regarding same-store growth, you are correct. We've had 12 consecutive quarters north of 4%, raising the bar in terms of the comp we’re up against. While there could be some correlation with volumes from acute care hospitals, only 5% of patients discharged from acute care hospitals in the U.S. end up going to the IRF setting, and that portion of their volume, as it relates to nondiscretionary illnesses qualifying for treatment in an IRF, is not very volatile. The volatility seen by acute care hospitals is predominantly around discretionary treatments.

Raj Kumar, Analyst

Got it. Separately, on a smaller portion of the business, outpatient visits were up nicely sequentially, although still down year-over-year, and pricing has been going up drastically in that business. What was the driver of growth? Was it a one-time surprise, like what we saw on the fee-for-service and inpatient side in the first quarter, or is there something strategic being done to stabilize that business since pricing has accommodated?

Douglas E. Coltharp, CFO

Is your question more about outpatient revenue or outpatient volume? Because the outpatient revenue increase is largely attributable to the increase in Medicaid supplemental payments. That category is outpatient and other, if you're looking at Page 5 of our supplemental slides.

Raj Kumar, Analyst

Yes, I was more referring to just volumes which were up 8% quarter-over-quarter, which seems much higher than how it has been historically between Q1 and Q2.

Patrick W. Tuer, COO

So outpatient, we have a small number of locations, and we've intentionally lowered that footprint over time, including the closure of three outpatient facilities within the last year. The operations that we still have running have a good book of business; they're well-known in their communities and often specialized from an outpatient therapy perspective that draws volume in. I wouldn't say that it's a nationwide intentional strategy, but rather a very market-specific strategy with our outpatient teams.

Operator, Operator

Thank you. It does appear that we have no further questions at this time. I'd be happy to return the call to Mark Miller for any closing comments.

Mark Miller, Chief Investment Relations Officer

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

Operator, Operator

Thank you. This concludes today's conference. You may now disconnect your lines, and everyone, have a great day.