Encompass Health Corporation (EHC) Earnings

Management highlights

### Clinical Quality & Workforce Development - Patient quality outcomes outperformed industry averages: 84.7% discharge to community, 8.4% discharge to acute care, and 6.1% discharge to skilled nursing facilities. - Participation in clinical staff professional growth and career ladder programs increased, driving improved retention and lower premium labor spend. Annualized nursing turnover hit 19% (a 12-year low), while therapy turnover fell to just above 7% (a 5-year low). Turnover for ladder-participating RNs is only 5%, compared to 25% for non-participating RNs. The number of certified nurses has increased 21% year-over-year and 60% since 2023, allowing the firm to serve more high-acuity, medically complex patients. ### Capacity Expansion & Development Pipeline - Opened two new hospitals (50-bed in Concordville, PA; 40-bed in Loganville, GA, the eighth joint venture with Piedmont) and added 10 beds to existing facilities in Q2. Through the first half of 2026, three new hospitals with 139 total beds have opened, and 54 beds have been added to existing facilities. - Plans to open five more new hospitals with 250 total beds and add 100-150 beds to existing facilities in the second half of 2026. The announced post-2026 development pipeline includes 13 new hospitals with 606 total beds, with additional small-format hospital projects expected to be announced by year-end. - Lowered the occupancy threshold for evaluating bed additions to 70-75% (from 80-85% historically) to add capacity faster to meet demand in high-occupancy facilities. - New de novo hospitals consistently reach four-wall positive EBITDA by month 6 and 70% occupancy by month 10, with improved ramp-up speeds due to refined opening processes, even in new markets where the brand is not well-established. ### Regulatory & Market Expansion - North Carolina repealed its certificate of need (CON) law for inpatient rehabilitation, effective October 1, 2026. The state has favorable demographics and a large underserved market; Encompass currently operates one hospital there and has identified 15 initial target markets, with three real estate parcels under contract for new facilities, with the first opening expected in late 2028 or early 2029. The firm plans to use a mix of traditional de novo and small-format hospitals in a hub-and-spoke strategy, likely pushing annual de novo growth to the high end of the 6-10 per year target. - The 2027 Inpatient Rehabilitation Facility (IRF) final rule released by CMS will result in an estimated 2.3% increase in net revenue per discharge for Medicare patients starting October 1, 2026. ### Capital Structure - Issued $500 million of 5.875% senior notes due 2034 in Q2, and used most proceeds to redeem $400 million of 4.5% senior notes due 2028. Net leverage at quarter-end was 1.9x, with strong liquidity and balance sheet position. - Increased the quarterly dividend to 21 cents per share (payable October 2026) and increased the common stock repurchase authorization to $1 billion. Repurchased 704,000 shares for $74.2 million in Q2, bringing year-to-date repurchases to 1.412 million shares for $145.8 million. ### Program Growth - The VA patient initiative grew 33% year-over-year in Q2, now accounting for just under 23% of total managed care volume, with substantial remaining runway: the firm is on pace to treat ~10,000 veterans annually by year-end, out of a total population of 8 million veterans over age 65 in the U.S.

Guidance

- Management raised full-year 2026 guidance for the second time, driven by stronger-than-expected Q2 results. New guidance is: net operating revenue of $6.41 to $6.49 billion, adjusted EBITDA of $1.365 to $1.395 billion, and adjusted EPS of $6.02 to $6.25. - Updated full-year 2026 assumptions reflect the 2.3% Q4 2026 Medicare pricing increase from the final IRF rule. Salary, wages, and benefits (SWB) per FTE growth guidance is revised to 3.5% to 4%, up from prior guidance, to account for higher expected participation in career ladder programs that pay certified staff a wage premium. - Full-year 2026 net pre-opening and ramp-up costs are still expected to be $18 to $22 million. Net provider tax benefit to 2026 adjusted EBITDA is now expected to be ~$10 million, down from the prior expectation of ~$21 million, due to the retroactive Florida Medicaid accrual adjustment recorded in Q2.

Segment performance

Encompass Health is a single-segment inpatient rehabilitation healthcare provider, no separate product segment breakdown was provided in the call. Total Q2 2026 revenue grew 9.6% year-over-year, driven by 5.6% discharge growth and a 3.9% increase in net revenue per discharge (fueled by higher patient acuity, particularly for medically complex cases like stroke and brain injury). Adjusted EBITDA increased 9.2% year-over-year to $348 million, after absorbing an $11.5 million year-over-year decrease in net provider tax impact from out-of-period Florida Medicaid accrual adjustments. Bad debt expense was 2.3% of revenue, in line with management expectations. Premium labor costs (contract labor + bonuses) fell to $25 million, a $2.6 million year-over-year decrease, with contract labor FTEs accounting for 1.1% of total FTEs (a 20 basis point improvement year-over-year). Net pre-opening and ramp-up costs were $6.9 million, up $2.9 million year-over-year. System-wide Q2 occupancy hit 77.4%, up 290 basis points year-over-year, and average daily census exceeded 9,000 for the second consecutive quarter, a company first.

Risks & headwinds

- Forward-looking statements (including guidance and growth projections) are subject to risks and uncertainties, including regulatory changes, unexpected volume volatility, bad debt trends, and cost pressures that could cause actual results to differ materially from projections. - Medicare Advantage (MA) preauthorization denials for IRF services remain an ongoing challenge, with a substantial persistent disparity in denial rates between MA plans and Medicare fee-for-service. Denial of appropriate care for beneficiaries increases administrative costs across the healthcare system and creates volume headwinds. - Patient acuity can fluctuate quarter-to-quarter based on referral flow dynamics, creating uncertainty around net revenue per discharge growth sustainability. - Premium labor cost reduction has reached a point of diminishing returns, with smaller future improvements expected compared to the last three years of declines.

Analyst Q&A

• Q: How did you raise full-year EBITDA guidance despite Q4 Medicare pricing that was 10 bps lower than prior assumptions and SWB growth 500 bps higher than expected? What is driving the strength in discharge growth that is expected to hold into the back half of 2026?

  A: Favorable first-half results from stronger-than-expected patient acuity-driven pricing and lower than expected EPOB created upside that offset the higher SWB and lower pricing assumptions. Higher occupancy and lower turnover from career ladder programs have cut unproductive orientation hours, driving EPOB benefits. Easier year-over-year comps in the back half, the dissipation of headwinds from 2025 facility closures, and new capacity coming online (skewed to Q4) will support continued discharge growth.

• Q: What is the overall growth opportunity in North Carolina after CON repeal, and how will it change your annual de novo growth target? What is your experience with the admit-and-appeal strategy for payer denials?

  A: The 15 initial prioritized markets represent a strong initial opportunity, with additional room for growth beyond that. The state will push annual de novo growth to the high end of the 6-10 per year range, with the possibility of exceeding that target, enabled by small-format hospitals that support a hub-and-spoke expansion strategy. For the admit-and-appeal pilot, 89% of adjudicated claims have been successful, so the firm will scale the program first for high-success diagnosis categories (including stroke) and evaluate a full company-wide rollout by the end of 2026.

• Q: What data demonstrates the impact of workforce development investments, and how is the VA initiative performing?

  A: Annualized nursing turnover is 19% (a 12-year low), therapy turnover is just over 7% (a 5-year low). Turnover for RNs participating in career ladders is only 5%, versus 25% for non-participating RNs, and the number of certified nurses is up 21% year-over-year. VA patient volume grew 33% year-over-year in Q2, now makes up nearly 23% of managed care volume, and there is substantial remaining runway with 8 million veterans over age 65 nationwide, and the firm on pace to treat ~10,000 annually by year-end.

• Q: How should we think about the 50 bps increase in SWB growth guidance for 2026? Is this a one-year or permanent change? What is the status of AI/technology investments?

  A: The higher SWB assumption is for 2026 only, reflecting faster-than-expected growth in career ladder participation this year. SWB growth is expected to moderate in 2027 as the firm anniversaries the current round of wage increases. AI initiatives, including the partnership with Palantir, are still mostly ramping, but are already delivering process improvements in clinical workflows, claims processing, pre-screening, and clinical risk monitoring. Upcoming uses include enhanced market analytics to support North Carolina expansion strategy.