Encompass Health Corporation Q4 FY2025 earnings call

• 2025 performance was strong with revenue and EBITDA growth, and excellent quality metrics. Full year discharge to community rate was 84.6%, discharge to acute care was 8.6% and discharge to SNF rate was 6.1%, all favorable vs industry average.
• Added 517 beds in 2025, with plans to use small-format hospitals starting in 2027 as a third modality for capacity expansion to facilitate a hub and spoke strategy.
• Converted enterprise resource planning system to Oracle Fusion in October 2025 without significant disruptions.
• Addressed IRF industry regulatory changes, including RCD and TEAM model. In Alabama, 7 hospitals had an aggregate average affirmation rate of approximately 93% for cycle 4. Prepared for RCD expansion in other states and TEAM model implementation which began on January 1, with 89 hospitals in initial team markets.
• Strategic relationship with Palantir continued to bear fruit, with initiatives to streamline admission documentation and enhance claim denial responses, and agreement extended and expanded.
• In 2025, allocated $158 million to share repurchases and returned over $70 million in cash dividends, maintaining a strong balance sheet with year-end net financial leverage of 1.9x.

2025 revenue increased 10.5%, driven by 6% discharge growth and pricing growth. 2025 EBITDA grew 14.9%. In 2025, 517 beds were added, 390 via 8 new hospitals and 127 through addition to existing hospitals. Q4 revenue was $1.5 billion, up 9.9%, and adjusted EBITDA was $335.6 million, up 15.9%. 2025 full year free cash flow was $818 million, an increase of 18.5% from 2024. Q4 adjusted free cash flow increased 23.6% to $235.4 million. Revenue increase in Q4 was comprised of 5.3% discharge growth and a 4.1% increase in net revenue per discharge. Bad debt expense for the quarter was 2.1%, flat year-over-year. Premium labor costs declined $5.8 million from Q4 '24 to $23.8 million. Net reopening and ramp-up costs were $2.9 million in Q4 '25, with full year total at $13.9 million.

2026 guidance includes net operating revenue of $6.365 billion to $6.465 billion, adjusted EBITDA of $1.34 billion to $1.38 billion and adjusted earnings per share of $5.81 to $6.10. Key considerations underlying the guidance can be found on Page 11 of the supplemental slides.

• Regulatory developments risk: IRF industry regulatory changes, such as extension of RCD and initiation of TEAM model, could impact results. For example, concerns around MA plan conversion rates and non-compliance with Medicare coverage requirements.
• Volume risk: Challenges with MA plans, including conversion rate drops and potential volume loss if not addressed properly.
• Labor cost and related risks: While labor costs improved in the quarter, softening labor markets and potential issues in certain markets could still pose risks.

Q: I thought I might ask a couple of questions on the volume front. The way volumes evolve this year was stronger in the first half and then moderate a little bit in the back half. I think there were some comp issues you talked about last call. I was curious if you could sort of flesh those out and then help us think through any comp issues we should be thinking about during 2026, especially the dynamic of the de novos rolling into the same-store base and that timing issue?

A: Yes. So certainly, in the back half of the year, we were up against some pretty challenging comps. Q3 '24 total discharges were up 8.8% and 6.8% of that was in same-store. And then in a similar fashion, when you moved into Q4 of last year, we were up 8.3% in terms of total discharges and 5.8% of that was in same-store. It was also the case that with regard to contributions from new stores, we were more skewed towards the back end of this year with new hospitals coming on board. You may recall that we had 1 hospital that opened in the last week of the third quarter and then 3 hospitals that opened in the fourth quarter, 1 in each month. And then there was the issue of the unit consolidations and closures that we talked about last quarter. And so as a reminder, we had 2 units, 1 in Sewickley, Pennsylvania, and 1 in Cincinnati, Ohio. Those were spaces that were leased from a host acute care hospital. For various reasons, we terminated the lease, and we anticipate that we'll consolidate that volume into another hospital in the market, but there's a period of time in which that's not happening. We estimated that, that was a headwind of about 30 basis points to total and same-store discharge in Q3. Cincinnati actually closed relatively late in Q3, so we had a full quarter impact in Q4. And so the impact in Q4 was probably closer to 45 basis points.

Q: Can you tell us just like how these pilots usually play out? Like I know the team pilots 5 years, 2032, what typically happens after that pilot program? Like do most of these pilots just kind of die out or are they implemented nationally? If you can give us some examples, that would be great?

A: No. Ann, if you go back and even back to 2016, 2015, with the plans I mentioned, the CJR, there was a little bit of both in terms of people required to do it or voluntarily got into it. You saw some people really go into it strong, kind of what I would refer to on the bleeding edge. Then you saw a lot of systems kind of wait and see what happens and didn't want to get after it too far. I think it's the nice thing about our ability to work with our joint venture partners in these markets where team will come out. We have a very collaborative approach. Pat and his team have been out talking to all the major systems in our markets impacted to see what their plans are and also to bring forth our value proposition because there's a big quality factor in teams that where the acute care hospitals will be penalized for readmissions. So that's a big part of the value that we bring in to that. So I think that, in large part, as I noted, there is typically an overreaction in terms of what people think will be the impact on our facilities. And with time, as noted, we just continue to grow through them because there are enough patients that would fall outside these plans that can benefit from the care that we provide. So I'll ask Pat just talk a little bit about what he and his team have done, I think specifically in the Boston marketplace, where we have some team introduction.

Q: There was a pretty meaningful beat on labor costs in the quarter with improvements in both wage growth and EPOB. Can you help us understand the drivers of that in the context of moderating volume growth?

A: Andrew, just real quick. I think it's kind of twofold. I'll ask Pat to talk specific about premium pay. But I think we're seeing some softening in the labor markets as a whole, which has been a positive thing for us for the last year or so. And then I think, secondly, while we've always been very disciplined around the use of premium pay and managing our staffing ratios, Pat has really dug in with his team to look at some of the outliers we had with our portfolio, and it's been meaningful. So Pat, do you want to give some detail?

Q: So I apologize in advance for this one, but I want to go in the weeds and talk about the Alabama RCB experience. From a process perspective, can you explain with the 93% affirmation rate, what happens with a 77% of claims that weren't affirmed? When you appeal at 7%, so what percent of those are you winning? And when you appeal to the administrative law judge level, what percentage of those are you winning? So at the end of the day, after you peel and go to the ALJ, what percent of these claims do you guys need to reserve for?

A: Well, you were in line. You were down in the weeds. Let me first kind of pull us up a little bit, and then I'll see if I can get down to that level. So first of all, there's a perception out there that both team and RCD represent new risk to IRFs. And Mark referred to some of this. In our opinion, they do not. They are ordinary course of business. We have lived continuously with episodic payment models since 2014. And CMS has always had the right audit 100% of IRF Medicare claims on both a prepayment and post-payment basis. And they have done so under a series of programs such as TPE, ADR, RACK, SMRK, et cetera. RCD is just a new acronym for the same old thing. The Medicare coverage requirements under RCD have not changed. The documentation requirements under RCD have not changed. And the third parties performing the RCD audits have not changed. The potential upside to RCD is that if we choose to remain on a 100% review, and Mark alluded to this in his comments, it potentially obviates the other audit programs. Moving specifically to Alabama. 93% is the current affirmation rate for the 7 hospitals in Alabama, where we're dealing with a difficult MAC who continues to non-affirm claims for reasons that are in contravention of Medicare coverage requirements and guidelines. As a result, we appeal the overwhelming majority of non-affirm claims through the multiple levels available to us. And although it's still early to call the ultimate resolution rate because those claims are still pending and because the sample size is relatively small, we're having a good success reversing the denials. We continue to educate Palmetto, and we continue to involve CMS, and we believe that it is more likely than not that, that 93% affirmation rate moves up. When we look at the Pennsylvania experience, it covers more hospitals, and we believe that, that rate, 98% to 99% is more representative of where a broadly adjudicated RCD program will land. And so all of that suggests to us that the go-forward bad debt expense rate that we experience is going to be consistent with our recent historical experience, thus the 2% to 2.5% number that is included in our 2026 guidance.