Encompass Health's Q3 2025 Earnings Call: Contradictions Emerge on Occupancy Targets, Managed Care Pricing, and Payer Mix Strategies

Date of Call: October 30, 2025

Financials Results

• Revenue: Q3 revenue increased 9.4% (YTD revenue growth 10.6%); company raised full-year net operating revenue guidance to $5.905B–$5.955B
• EPS: Adjusted EPS guidance $5.22–$5.37 for 2025 (guidance raised)

Guidance:

• Net operating revenue for 2025 expected to be $5.905B to $5.955B
• Adjusted EBITDA for 2025 expected to be $1.235B to $1.255B
• Adjusted EPS for 2025 expected to be $5.22 to $5.37
• Adjusted free cash flow raised to $730M to $810M for 2025
• Bed additions: ~127 beds to existing hospitals in 2025; ~150–200 beds expected in each of 2026 and 2027
• Continued de novo openings and pipeline (14 announced projects, >40 active pipeline) with capacity expansion ramp through 2026–2027

Business Commentary:

• Revenue and Adjusted EBITDA Growth:
• Encompass Health reported revenue growth of 9.4% and adjusted EBITDA increase of 11.4% in Q3.

• Growth was driven by a 5% increase in total discharges and a 3.3% rise in net revenue per discharge.

• Capacity Expansion and Bed Additions:

• The company increased its estimated bed additions for existing hospitals from approximately 110 to 127 for 2025, with plans for 150 to 200 beds annually from 2026 to 2027.

• This is in response to the growing demand for services and to maintain high occupancy rates, especially in hospitals with a high percentage of semi-private rooms.

• Occupancy and Market Demand:

• Encompass Health's hospital occupancy rates have been rising, with private rooms accounting for 57% of the portfolio, up from 41% in 2020.

• This increase is driven by the underserved market for inpatient rehabilitation services, especially among the Medicare beneficiary population aged 65 and older.

• Labor and Cost Management:

• Premium labor costs declined to $5.6 million in Q3, down from $27 million in Q3 2024.
• The decrease is attributed to effective labor management strategies and anniversary effects in benefits expenses, which are expected to stabilize in the coming periods.

Sentiment Analysis:

Overall Tone: Positive

• "Revenue in Q3 increased 9.4% and adjusted EBITDA grew 11.4%"; management said they "have again increased our 2025 guidance" and raised adjusted free cash flow to $730M–$810M, while reiterating strong clinical outcomes and expanding capacity.

Q&A:

• Question from Joanna Gajuk (Bank of America): How should we think about accelerated bed additions impacting volume growth going forward and the 6%–8% long‑term discharge growth target?
  Response: Management: Increasing multiyear bed expansions validates demand; going forward the company will emphasize bed additions (higher ROI) alongside de novos and expects these expansions to support the 6%–8% discharge CAGR.

• Question from Pito Chickering (Deutsche Bank): What level of growth CapEx should we model to sustain 6%–8% discharge growth?
  Response: Management: Growth CapEx midpoint for the year is about $580M; average incremental cost per bed for additions is roughly $800k, so incremental spend scales with announced bed expansion cadence (midpoint ~175 beds).

• Question from Pito Chickering (Deutsche Bank): What occupancy threshold triggers bed expansion and how quickly can you add capacity?
  Response: Management: Hospitals typically hit our expansion radar after sustained ~80% occupancy; private-room hospitals can operate into mid‑90s; adding beds to existing hospitals generally takes <24 months (often ~18 months), subject to plant/configuration and CON rules.

• Question from Ann Hynes (Mizuho Securities): Did anything surprise you in the quarter and any update on Washington-related regulatory risk?
  Response: Management: No material surprises aside from timing of retro provider tax payments and a CA property assessment; otherwise results were in line and no near‑term Washington issues of concern.

• Question from Matthew Gillmor (KeyBanc): How did payer mix evolve in Q3 versus H1 and any modeling notes for 2026 headwinds/tailwinds?
  Response: Management: Q3 discharge growth: Medicare +4.4%, Medicare Advantage +4.8%, managed care +9.2% (VA ~+26%), Medicaid +3.5%; for 2026 net provider taxes remain a wildcard but improved premium labor trends and comparable ramp/start‑up costs are expected.

• Question from Whit Mayo (Leerink Partners): Can you quantify timing/calendar effects and other factors that impacted same‑store discharge cadence this quarter?
  Response: Management: Quarter showed a U-shaped volume cadence (July solid, August weak, September recovery); timing of holidays and capacity transitions creates quarter‑to‑quarter variability and is difficult to precisely quantify.

• Question from Whit Mayo (Leerink Partners): Update on the Palmetto/Review Choice Demonstration experience this year?
  Response: Management: Performance improved — all seven Alabama hospitals have affirmation rates north of 90% since cycle 4 began; program running better but requires ongoing administrative attention.

• Question from Andrew Mok (Barclays): Were the satellite closures unique events or common in the business?
  Response: Management: These were one‑off, lease‑driven consolidations representing a very small portion of the portfolio; no expectation of broader similar activity.

• Question from Andrew Mok (Barclays): How would shifts between Medicare Advantage and fee‑for‑service affect the business?
  Response: Management: The company performs well across payers; a shift toward fee‑for‑service could be neutral to slightly positive (higher payment and conversion rates); company can also operate within growing MA volumes.

• Question from A.J. Rice (UBS): Can you describe pipeline depth, competition and speed with JV partners?
  Response: Management: 14 announced projects and >40 active pipeline projects; company can generally move faster than many JV partners due to internal capabilities; market remains underserved and barriers to entry are high, so competition is manageable.

• Question from A.J. Rice (UBS): Status of prefab/modular construction expansion and geographic limits?
  Response: Management: Evaluating module redesign to enable rail transport or adding a second manufacturing site; panelized/hybrid prefab approaches are being assessed but initiatives remain in evaluation.

• Question from Brian Tanquilut (Jefferies): Thoughts on salaries/EPOB trends and labor inflation once capacity ramps?
  Response: Management: Q3 hiring pushed EPOB higher in near term but will normalize; premium labor spend has declined versus prior year; expect core SWB inflation ~3–3.25% and benefits (group medical) inflation in high single digits.

• Question from Brian Tanquilut (Jefferies): What is the status of the Oracle Fusion ERP rollout and expected P&L efficiencies?
  Response: Management: Conversion (Oct 3) largely successful with some bugs; incurred ~$3M post‑implementation costs; expect workflow/efficiency gains over time but will not quantify a specific P&L ROI now.

• Question from Jared Haase (William Blair): Any preauthorization/network impacts from MA plans shifting to HMO products?
  Response: Management: No material change observed on preauthorization; teams continue to manage appeals and advocate for patient access; no anticipated MA preauth disruption into 2026.

• Question from Jared Haase (William Blair): Should we expect occupancy cadence effects in 2026 as 2025 investments mature?
  Response: Management: Q4 de novos ramp late in year will likely put downward pressure on YoY occupancy in Q1 2026, but overall occupancy remains on an upward trajectory.

• Question from Raj Kumar (Unknown): What is the embedded YoY headwind in Q4 from the satellite consolidations and any referral impact from negative headlines?
  Response: Management: Satellite consolidations reduced Q3 growth by ~35 bps; Q4 headwind estimated ~25–30 bps; no observed change in referral patterns from prior negative headlines.

• Question from Raj Kumar (Unknown): How should we think about preopening/start‑up costs realized in Q3 and expected in Q4/early 2026?
  Response: Management: Preopening/start‑up costs accrue on a rolling basis; YTD run‑rate is ~11% of the year's estimate and Q4 will be back‑half weighted with midpoint pacing toward the full‑year range (company uses rolling estimates).

Contradiction Point 1

Occupancy Targets and Capacity Expansion Strategy

It involves differing statements about the occupancy targets and capacity expansion strategy, which are crucial for understanding the company's growth and operational plans.

What CapEx-to-revenue ratio should we model to sustain 6% to 8% discharge growth? - Pito Chickering(Deutsche Bank)

2025Q3: Occupancy expansion starts at 80% sustained occupancy. Capability depends on the physical plant and CON state regulations. Expansion can often be quicker than CON processes. Alternatives include adding freestanding satellites or small format hospitals. - [Douglas Coltharp](CFO)

How have occupancy rates changed year-over-year in the first half of the year? - Andrew Mok(Barclays)

2025Q2: When we're looking at an all private room facility, when the occupancy starts to stabilize north of 80%, we start putting it on a list and start thinking about a future period bed expansion. The capacity in those facilities can run into the mid- to high 90s because you're not facing issues of gender or germ compatibility. - [Douglas E. Coltharp](CFO)

Contradiction Point 2

Managed Care Pricing Assumptions

It involves differing statements about the expectations for managed care pricing assumptions, which are critical for financial forecasting and revenue projections.

How did the payer mix change in Q3 compared to the first half? - Matthew Gillmor(KeyBanc)

2025Q3: Growth rates for Medicare and Medicare Advantage are comparable. Managed care, including VA Community Care, showed strong growth. - [Douglas Coltharp](CFO)

Was the managed care pricing assumption increased? - Matthew Dale Gillmor(KeyBanc)

2025Q2: The increase in managed care pricing assumption is driven by the VA Community Care Network contract, which has been administered by Optum and Tri-West. This contract has seen growth in the mid-teens over the last 3 years and now comprises almost 18% of our overall managed care business. - [Douglas E. Coltharp](CFO)

Contradiction Point 3

Payer Mix and Medicare Advantage

It involves differing perspectives on the payer mix, particularly regarding Medicare Advantage and fee-for-service, which can impact revenue and financial planning.

How did Q3's payer mix change vs H1? - Matthew Gillmor(KeyBanc)

2025Q3: Growth rates for Medicare and Medicare Advantage are comparable. - [Douglas Coltharp](CFO)

Is the recent significant increase in Medicare fee-for-service discharges due to strategic actions you've implemented? - Pito Chickering(Deutsche Bank)

2025Q1: The increase in Medicare fee-for-service discharges is not the result of deliberate strategic actions favoring referrals or patient admissions from fee-for-service versus Medicare Advantage. - [Douglas Coltharp](CFO)

Contradiction Point 4

Occupancy and Bed Expansion Strategy

It involves the company's strategy for managing occupancy levels and bed expansion, which directly affects capacity utilization and growth potential.

How will accelerated bed addition plans impact future volume growth? And how do they align with the 6% to 8% growth target? - Joanna Gajuk(Bank of America)

2025Q3: We are more heavily weighted towards bed additions now versus de novos. - [Douglas Coltharp](CFO)

How did you exceed volume expectations, and was guidance conservative? - Ann Hynes(Mizuho Securities)

2025Q1: We did better on volume and Revenue per Discharge due to payer mix and leverages in premium labor. We expect we may not sustain all these trends, but anesthesia to maintain our underlying assumptions. - [Douglas Coltharp](CFO)

Contradiction Point 5

Bed Expansion Strategy and Capacity Additions

It involves differing perspectives on the strategy and timing of bed expansions, which impacts growth expectations and capacity planning.

How will accelerated bed additions affect volume growth and align with the 6% to 8% growth target? - Joanna Gajuk(Bank of America)

2025Q3: The increase in bed expansions is a validation of the business model due to de novo performance and unmet market demand. Encompass is more heavily weighted towards bed additions now versus de novos. This strategy is expected to continue for the next 3 years, with increased occupancy and continued favorable trends in turnover rates. - [Douglas Coltharp](CFO)

Is the 2025 bed addition pace vs. last year a timing issue or a long-term capacity shift? - Matthew Gillmor(KeyBanc Capital Markets)

2024Q4: The increase in hospital openings and bed additions in 2025 is due to timing rather than a fundamental change in capacity. There are more hospitals planned this year, and the addition of beds will be higher than in the previous year. - [Mark Tarr](CEO)