Encompass Health Corporation Common Stock 2026 Q3 Earnings Call

Thank you, Operator, and good morning, everyone. Thank you for joining Encompass Health's third quarter 2026 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 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, 2025, and the Form 10-Q for the quarters ended March 31, 2026, June 30, 2026, and September 30, 2026, 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 President and Chief Executive Officer, Mark Tarr.

Mark, thank you, and good morning, everyone. We are very pleased with our third quarter results. As revenue grew 8.9%, adjusted EBITDA increased 15.5%, and adjusted EPS increased 23.6%. For the first 9 months of 2026, revenue rose 9.2%, adjusted EBITDA increased 11.9%, and adjusted EPS was up 17%. Based primarily on our Q3 results, we are again raising our guidance for 2026. We achieved these results while once again delivering outstanding patient outcomes. Our Q3 discharge-to-community rate was 84.7%. Discharge to acute rate was 8.4%, and discharge to SNF rate was 6.2%. Our performance on each of these quality metrics continues to exceed industry averages. Our hospitals continue to be recognized for the outstanding clinical care we provide. Newsweek recently named Encompass Health as America's Most Awarded Leader in Inpatient Rehabilitation for the seventh consecutive year.

Also, NRC Health, a leading provider of patient experience data, recognized Encompass Health with the 2026 NRC Health Excellence in Patient Experience Award for the second consecutive year, placing us among the top 3 large health systems nationwide for patient experience. Our investments in professional growth and development programs for our clinicians continue to enhance our abilities to serve high acuity, medically complex patients. Encompass Health holds 408 Joint Commission disease-specific certifications, including 150 Joint Commission stroke certifications. This represents approximately 65% of total stroke certifications among all providers. In August 2026, the American Heart Association and American Stroke Association reaffirmed the importance of inpatient rehabilitation facilities in their updated 2026 stroke rehabilitation guideline recommending IRF care over skilled nursing facilities for eligible stroke patients when both settings are available.

The recommendation is supported by evidence showing greater functional improvement and higher rates of discharge back to the community following IRF care. We treat more stroke patients than any other inpatient rehabilitation provider. Through the first 3 quarters of 2026, we treated 37,620 patients recovering from a stroke, comprising approximately 18% of our patient mix. We will continue to put our resources to work to help stroke and other vulnerable patients regain their independence and return to the activities that matter most to them. Demand for inpatient rehabilitation services remains strong and is growing. We continue to invest in capacity additions to help address this underserved market. In Q3, we opened a new 50-bed hospital in Norristown, Pennsylvania, and added 31 beds to existing hospitals. Through the third quarter, we opened 4 hospitals with a total of 189 beds and added 85 beds to existing hospitals.

Earlier this month, we opened 2 additional 50-bed hospitals, one in Bangor, Maine and one in San Antonio, Texas, and added 60 beds to existing hospitals. Over the balance of the year, we intend to open 2 more hospitals with a total of 100 beds and add up to 45 beds to existing hospitals. We maintain an active pipeline of new hospital development projects while also executing on bed expansion opportunities as warranted by occupancy trends and market dynamics. Our pipeline of announced new hospital projects with opening dates beyond 2026 currently consists of 15 hospitals with 654 beds. This includes our first 2 small format hospitals, Conroe, Texas, and Richmond, Texas, both of which will be additive to our Houston market presence and serve as an exemplar of the hub and spoke strategy we have previously discussed.

We anticipate additional projects will be announced over the balance of the year. We also continue to expect to add 150 to 200 beds to existing hospitals in 2027. On October 1st, North Carolina's repeal of its Certificate of Need law became effective. As we have previously discussed, North Carolina has highly favorable population growth and demographic characteristics, and our assessment indicates a large underserved market for IRF services. We currently operate one hospital in North Carolina and have thus far prioritized 15 markets for development. We currently have six real estate parcels under contract. Now I'll turn it over to Doug.

Thank you, Mark, and good morning everyone. The Q3 revenue increase of 8.9% was driven by 5.7% discharge growth and a 4% increase in net revenue per discharge. Net revenue per discharge again benefited from higher patient acuity. Bad debt expense in Q3 was 2.7%. The increase over last year is primarily due to a billing and collection disruption issue following a system conversion in Q2 of 2026. This was a one-off issue, and we expect bad debt expense as a percent of revenue in Q4 to normalize in the recent historical range of 2%-2.5%. Q3 Medicaid supplemental payments decreased by $10 million from Q3 2025. Recall that Q3 2025 included $10.8 million of net provider tax revenue, owing largely to retroactive Medicaid supplemental payments.

In Q3 2026, we reversed $9.2 million of previously accrued supplemental payments within our other revenue category related to the anticipated approval by CMS of the Florida fiscal year 2026 Medicaid state-directed payment program. The Florida fiscal year 2026 program is still pending approval from CMS, and as the fiscal year ended September 30th, we deemed it appropriate to make this adjustment. We also reversed $3.4 million of accrued provider tax expense within our other operating expenses related to the 2026 Florida program. Q3 adjusted EBITDA increased 15.5% to $346.6 million, even as we absorbed an $11.5 million year-over-year decrease in net provider tax contribution. Through the first three quarters of 2026, the adjusted EBITDA contribution from net provider taxes was $600,000, and that compares to $18.1 million for the comparable 2025 period.

In our Q2 update, we had revised our expectation for the 2026 net provider taxes contribution to our adjusted EBITDA to approximately $10 million. This was based primarily on the Florida fiscal year 2025 Medicaid state-directed payment program, approved by CMS in May of 2026. Given the pending status of the fiscal year 2026 program and the related adjustments to our accruals, which I just reviewed, we now expect the 2026 net contribution to adjusted EBITDA to be approximately $3 million. Q3 SWB per FTE increased 3.8%, in part driven by increased participation in our career ladder programs, partially offset by declines in premium labor and medical plan costs. Premium labor costs comprised of contract labor and sign-on and shift bonuses declined $3.9 million from Q3 2025 to $23.1 million.

This marks 16 consecutive quarters of year-over-year reductions in premium labor spend, even as capacity and patient volumes have grown substantially. Contract labor FTEs as a percent of total FTEs was 0.9%, an improvement of 30 basis points from Q3 2025 and our lowest level since Q4 of 2020. Q3 net pre-opening and ramp-up costs were $4.9 million, flat from Q3 2025, and were $15.8 million on a year-to-date basis, compared to $11 million through Q3 2025. Based on the incurrence to date and our projection for the balance of the year, we now expect net pre-opening and ramp-up cost of $20 million to $24 million for 2026. Adjusted free cash flow for the first nine months of 2026 was $634.2 million, an 8.9% increase from the comparable period in 2025.

During Q3, we repurchased approximately 495,000 shares of our common stock for a total of $57.9 million, bringing our year-to-date total share repurchase to approximately 1.91 million shares and $203.7 million. We also declared a cash dividend of $0.21 per share, which was paid earlier this month. During Q3, we issued an incremental $100 million of senior notes as an add-on to our 5.875% notes due in 2034, bringing the total amount of that note series to $600 million. Our leverage and liquidity remained very favorable. Net leverage at quarter end was 1.8 times, and we ended the quarter with approximately $870 million available on our $1 billion revolving credit facility.