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Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with the accompanying consolidated financial statements and related notes. This MD&A is designed to provide the reader with information that will assist in understanding our consolidated financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles affect our consolidated financial statements. See “Cautionary Statement Regarding Forward-Looking Statements and Summary of Risk Factors” on page ii of this report, which is incorporated herein by reference, for a description of important factors that could cause actual results to differ from expected results. See also Item 1A, Risk Factors.

Executive Overview

Our Business

We are the nation’s largest owner and operator of inpatient rehabilitation hospitals in terms of patients treated, revenues, and number of hospitals. We provide specialized rehabilitative treatment on an inpatient basis. We operate hospitals in 36 states and Puerto Rico, with concentrations in the eastern half of the United States and Texas. As of December 31, 2022, we operate 153 inpatient rehabilitation hospitals. For additional information about our business, see Item 1, Business and Item 1A, Risk Factors, of this report.

The onset of the COVID-19 Pandemic (the “pandemic”) in the United States resulted in significant changes to our operating environment. For discussion of the financial and operational impacts we have experienced as a result of the pandemic, see Item 1, Business, Item 1A, Risk Factors, and the “Key Challenges” and “Results of Operations” sections of this Item.

Spin Off of Home Health and Hospice Business

On July 1, 2022, we completed the previously announced separation of our home health and hospice business through the distribution (the “Spin Off”) of all of the outstanding shares of common stock, par value $0.01 per share, of Enhabit, Inc. (“Enhabit”) to the stockholders of record of Encompass Health as of the close of business on June 24, 2022 (the “Record Date”). The Spin Off was effective at 12:01 a.m., Eastern Time, on July 1, 2022. The Spin Off was structured as a pro rata distribution of one share of Enhabit common stock for every two shares of Encompass Health common stock held of record as of the Record Date. No fractional shares were distributed. A cash payment was made in lieu of any fractional shares. As a result of the Spin Off, Enhabit is now an independent public company and its common stock is listed under the symbol “EHAB” on the New York Stock Exchange.

In accordance with applicable accounting guidance, the historical results of Enhabit have been presented as discontinued operations and, as such, have been excluded from continuing operations for all periods presented. Our presentation of discontinued operations excludes any allocation of general corporate and overhead costs as well as interest expense. Prior to July 1, 2022, we operated under two reporting segments. We now operate under a single reporting segment. For additional information see Note 2, Spin Off of Home Health and Hospice Business, to the consolidated financial statements.

In connection with the Spin Off, on June 30, 2022, we entered into several agreements with Enhabit that govern the relationship of the parties following the Spin Off, including a Separation and Distribution Agreement, a Transition Services Agreement, a Tax Matters Agreement and an Employee Matters Agreement. See also Note 2, Spin Off of Home Health and Hospice Business,to the consolidated financial statements.

2022 Overview

During 2022, Net operating revenues increased 8.3% over 2021 due primarily to volume growth and increased pricing. See the “Results of Operations” section of this Item for additional financial information.

We continued our development and expansion efforts in 2022. We:

•began operating our new 40-bed inpatient rehabilitation hospital in Shiloh, Illinois with our joint venture partner BJC HealthCare in February 2022;

•began operating our new 40-bed inpatient rehabilitation hospital in St. Augustine, Florida in March 2022;

•began operating our new 60-bed inpatient rehabilitation hospital in Libertyville, Illinois in March 2022;

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•began operating our new 50-bed inpatient rehabilitation hospital in Lakeland, Florida in May 2022;

•began operating our new 40-bed inpatient rehabilitation hospital in Cape Coral, Florida with our joint venture partner Lee Healthcare Holdings, LLC in June 2022;

•began operating our new 50-bed inpatient rehabilitation hospital in Jacksonville, Florida in June 2022;

•began operating our new 40-bed inpatient rehabilitation hospital in Grand Forks, North Dakota with our joint venture partner Altru in August 2022;

•began operating our new 40-bed inpatient rehabilitation hospital in Moline, Illinois with our joint venture partner UnityPoint Health – Trinity in August 2022;

•began operating our new 50-bed inpatient rehabilitation hospital in Naples, Florida in September 2022 (joint venture partnership with NCH Healthcare System began in December 2022);

•continued our capacity expansions by adding 87 new beds to existing hospitals; and

•announced or continued the development of the following hospitals:

Number of New Beds

Eau Claire, Wisconsin(1) 36 — —

Knoxville, Tennessee(1) 73 — —

Owasso, Oklahoma(1) 40 — —

Clermont, Florida 50 — —

Bowie, Maryland 60 — —

Prosper, Texas 40 — —

Columbus, Georgia(1) 40 — —

Fitchburg, Wisconsin 56 — —

Atlanta, Georgia(1) — 40 —

Kissimmee, Florida — 50 —

Fort Mill, South Carolina — 39 —

Louisville, Kentucky(1) — 40 —

Johnston, Rhode Island — 50 —

Houston, Texas — 61 —

Lake Worth, Florida — 50 —

Fort Myers, Florida(1) — 60 —

Palm Beach Gardens, Florida — — 50

Amarillo, Texas — — 40

Strongsville, Ohio — — 40

Norristown, Pennsylvania — — 50

Wildwood, Florida — — 50

Athens, Georgia(1) — — 40

St. Petersburg, Florida — — 50

Daytona Beach, Florida — — 50

(1) Expected joint venture

(2) Opening dates are tentative

We also continued taking steps to further increase the strength and flexibility of our balance sheet as well as augment returns from investments in operations with shareholder distributions via common stock dividends. For additional information, see the “Liquidity and Capital Resources” section of this Item.

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Business Outlook

We remain optimistic regarding the intermediate and long-term prospects of our business. Demographic trends, such as population aging, should continue to increase long-term demand for the services we provide. While we treat patients of all ages, most of our patients are 65 and older, and the number of Medicare enrollees is expected to grow approximately 3% per year for the foreseeable future, reaching approximately 73 million people over the age of 65 by 2030. More specifically, the average age of our Medicare patients is approximately 76, and the population group ranging in ages from 75 to 79 is expected to grow at approximately 5% per year through 2026. We believe the demand for the services we provide will continue to increase as the U.S. population ages. We believe these factors align with our strengths in, and focus on, inpatient rehabilitation services.

We are committed to delivering high-quality, cost-effective, integrated patient care. As the nation’s largest owner and operator of inpatient rehabilitation hospitals in terms of patients treated, revenues, and number of hospitals, we believe we differentiate ourselves from our competitors based on, among other things, the quality of our clinical outcomes, our cost-effectiveness, our financial strength, and our extensive application of technology. We also believe our competitive strengths discussed in Item 1, Business, “Competitive Strengths,” give us the ability to adapt and succeed in a healthcare industry facing regulatory uncertainty around attempts to improve outcomes and reduce costs.

The healthcare industry faces the prospect of ongoing efforts to transform the healthcare system to coordinated care delivery and payment models. The nature, timing and extent of that transformation remains uncertain, as the development and implementation of new care delivery and payment systems will require significant time and resources. Our goal is to position the Company in a prudent manner to be responsive to industry shifts. We have invested in our core business and created an infrastructure that enables us to provide high-quality care on a cost-effective basis. We have been disciplined in creating a capital structure that is flexible with no significant debt maturities prior to 2025. We continue to have a strong, well-capitalized balance sheet, including a substantial portfolio of owned real estate, and ample availability under our revolving credit facility, which along with the cash flows generated from operations should, we believe, provide sufficient support for our ability to adapt to changes in reimbursement, sustain our business model, and grow through de novo and bed additions. See also Item 1, Business, “Competitive Strengths” and “Strategy and 2023 Strategic Priorities.”

Key Challenges

Healthcare is a highly-regulated industry facing many well-publicized regulatory and reimbursement challenges. Medicare reimbursement for inpatient rehabilitation facilities (“IRFs”) has recently undergone significant changes. The future of many aspects of healthcare regulation generally and Medicare reimbursement specifically remains uncertain. Successful healthcare providers are those able to adapt to changes in the regulatory and operating environments, build strategic relationships across the healthcare continuum, and consistently provide high-quality, cost-effective care. We believe we have the necessary capabilities — change agility, strategic relationships, quality of patient outcomes, cost effectiveness, and ability to capitalize on growth opportunities — to adapt to and succeed in a dynamic, highly regulated industry, and we have a proven track record of doing so.

As we continue to execute our business plan, the following are some of the key challenges we face.

•Operating in a Highly Regulated Industry. We are required to comply with extensive and complex laws and regulations at the federal, state, and local government levels. More specifically, because Medicare comprises a significant portion of our Net operating revenues, failure to comply with the laws and regulations governing the Medicare program and related matters, including anti-kickback and anti-fraud requirements, could materially and adversely affect us. These rules and regulations have affected, or could in the future affect, our business activities by having an impact on the reimbursement we receive for services provided or the costs of compliance, mandating new documentation standards, requiring additional licensure or certification, regulating our relationships with physicians and other referral sources, regulating the use of our properties, and limiting our ability to enter new markets or add new capacity to existing hospitals. Ensuring continuous compliance with extensive laws and regulations is an operating requirement for all healthcare providers. See Item 1, Business, “Regulation” and Item 1A, Risk Factors, “Reimbursement Risks” and “Other Regulatory Risks” for detailed discussions of the most important regulations we face and our programs intended to ensure we comply with those regulations.

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Reimbursement claims made by healthcare providers, including inpatient rehabilitation hospitals, are subject to audit from time to time by governmental payors, such as Centers for Medicare & Medicaid Services (“CMS”) and state Medicaid programs, their agents, such as the Medicare Administrative Contractors (“MACs”) that act as fiscal intermediaries for all Medicare billings, other auditors contracted by CMS, and private insurance carriers, as well as the United States Department of Health and Human Services Office of Inspector General. These audits as well as the ordinary course claim reviews of our billings result in payment denials, including recoupment of previously paid claims from current accounts receivable. Healthcare providers can challenge any denials through an administrative appeals process that can be extremely lengthy, taking several years. For additional details of these claim reviews, See Item 1, Business, “Sources of Revenues,” Item 1A, Risk Factors, “Reimbursement Risks,” and Note 1, Summary of Significant Accounting Policies, “Net Operating Revenues” and “Accounts Receivable,” to the accompanying consolidated financial statements.

•Changes in Medicare Reimbursement and Regulatory Requirements for Operating IRFs. Substantially all of our business consists of inpatient rehabilitation services. From a payor perspective, our reimbursement and regulatory risk is concentrated in the Medicare inpatient rehabilitation rules and regulations. We derive approximately 65% of our Net operating revenues from fee-for-service Medicare.

As part of its annual rulemaking process for various healthcare provider categories, CMS adopts IRF reimbursement rate changes effective from October through the following September. On July 27, 2022, CMS released its notice of final rulemaking for fiscal year 2023 for IRFs (the “2023 IRF Rule”) under the inpatient rehabilitation facility prospective payment system (the “IRF-PPS”). Based on our analysis that utilizes, among other things, the acuity of our patients annualized over a twelve-month period ended June 30, 2022, our experience with outlier payments over this same time frame, and other factors, we believe the 2023 IRF Rule will result in a net increase to our Medicare payment rates of approximately 4.0% effective October 1, 2022.

Congress also regularly adopts legislation that directly affects Medicare reimbursement. These reimbursement changes can result in limitations on the increases in and, in some cases, significant roll-backs or reductions in the levels of payments for IRF services. For example, the Patient Protection and Affordable Care Act (the “ACA”) enacted in 2010 provides for specific reductions to healthcare providers’ annual reimbursement rate updates and other payment policy changes. The Budget Control Act of 2011 provides for an automatic 2% reduction, or “sequestration,” of Medicare program payments for all healthcare providers. Sequestration took effect April 1, 2013 and, as a result of subsequent legislation, will continue through mid-year 2032 unless Congress and the President take further action. In response to the public health emergency associated with the pandemic, Congress and the President suspended sequestration through March 31, 2022. Additional Medicare payment reductions are also possible under the Statutory Pay-As-You-Go Act of 2010 (“Statutory PAYGO”). Statutory PAYGO requires, among other things, that mandatory spending and revenue legislation not increase the federal budget deficit over a 5- or 10-year period. There can be no assurance that future federal rulemaking and legislation will not result in reimbursement freezes or reductions, or reimbursement increases that are less than the increases we experience in our costs of operation.

In addition to direct changes to Medicare reimbursement rates, other federal regulatory and legislative actions affect healthcare generally and our business specifically. For example, the ACA also included provisions intended to promote alternative payment models, such as accountable care organizations (“ACOs”) and bundled payment initiatives, including the Bundled Payments for Care Improvement Initiative Advanced (“BPCI Advanced”) and the Comprehensive Care for Joint Replacement (“CJR”) program. Likewise, CMS regulatory proposals can affect our operations. On December 14, 2020, CMS announced a five-year review choice demonstration for inpatient rehabilitation services (the “IRF RCD”). The IRF RCD would affect the process in which we submit, and receive reimbursement for, Medicare claims. A number of key details on this demonstration have yet to be released, and it is not clear how or when CMS will implement this demonstration.

For additional discussion of changes to Medicare reimbursement, including the 2023 IRF Rule and Statutory PAYGO, and other proposed and adopted legislative and regulatory actions, including alternative payment models and the IRF RCD, that may be material to our business, see Item 1, Business, and Item 1A, Risk Factors, “Reimbursement Risks” and “Other Regulatory Risks.”

Concerns held by federal policymakers about the federal deficit, national debt levels, and the solvency of the Medicare trust fund, as well as other healthcare policy priorities, could result in enactment of further federal spending reductions, further entitlement reform legislation affecting the Medicare program, and further reductions to provider payments. We cannot predict what, if any, changes in Medicare spending or modifications to the healthcare laws and regulations will result from future budget or other legislative or regulatory initiatives.

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As discussed in Item 1, Business, healthcare will almost certainly be the subject of significant regulatory and legislative changes regardless of party in control of the executive and legislative branches of state and federal governments. We will continue to evaluate these laws and regulations and position the Company for this industry shift. Based on our track record, we believe we can adapt to these regulatory and industry changes. Further, we have engaged, and will continue to engage, actively in discussions with key legislators and regulators to attempt to ensure any healthcare laws or regulations adopted or amended promote our goal of high-quality, cost-effective care.

•Maintaining Strong Volume Growth. Various factors, including competition and increasing regulatory and administrative burdens, may impact our ability to maintain and grow our hospital volumes. In any particular market, we may encounter competition from local or national entities with longer operating histories or other competitive advantages, such as acute-care hospitals who provide post-acute services similar to ours or other post-acute providers with relationships with referring acute-care hospitals or physicians. Aggressive payment review practices by Medicare contractors, aggressive enforcement of regulatory policies by government agencies, and restrictive or burdensome rules, regulations or statutes governing admissions practices may lead us to not accept patients who would be appropriate for and would benefit from the services we provide. In addition, from time to time, we must get regulatory approval to expand our services and locations in states with certificate of need laws. This approval may be withheld or take longer than expected. In the case of new-store volume growth, the addition of hospitals to our portfolio also may be difficult and take longer than expected. Clinical staffing shortages, recently exacerbated by the pandemic, can also limit our ability to admit patients in a given market.

•Recruiting and Retaining High-Quality Personnel. See Item 1A, Risk Factors, for a discussion of competition for staffing, shortages of qualified personnel, and other factors that may increase our labor costs and constrain our ability to take new patients. Recruiting and retaining qualified personnel, including management, for our inpatient hospitals remain a high priority for us. We attempt to maintain a comprehensive compensation and benefits package that allows us to remain competitive in this challenging staffing environment while remaining consistent with our goal of being a high-quality, cost-effective provider of post-acute services. Additionally, our operations have been affected and may in the future be affected by staffing shortages where employees must self-quarantine due to exposure to an infectious disease, where employees are unavailable due to a lack of childcare or care for elderly family, or where competition creates a nursing shortage in a given market. These factors have resulted in increased labor costs, including significant sign-on and shift bonuses, and increased use of contract labor as discussed in the “Results of Operations” section of this Item.

We remain confident in the prospects of our business based on the increasing demands for the services we provide to an aging population. This confidence is further supported by our strong financial foundation and the substantial investments we have made in our business. We have a proven track record of working through difficult situations, and we believe in our ability to overcome current and future challenges.

Results of Operations

Payor Mix

We derived consolidated Net operating revenues from the following payor sources:

For the Year Ended December 31,

Other third-party payors 0.9 % 1.1 % 1.2 %

Workers' compensation 0.6 % 0.6 % 0.6 %

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Our payor mix is weighted heavily towards Medicare. We receive Medicare reimbursements under the IRF-PPS. For additional information regarding Medicare reimbursement, see the “Sources of Revenues” section of Item 1, Business.

As part of the Balanced Budget Act of 1997, Congress created a program of private, managed healthcare coverage for Medicare beneficiaries. This program has been referred to as Medicare Part C, or “Medicare Advantage.” The program offers beneficiaries a range of Medicare coverage options by providing a choice between the traditional fee-for-service program (under Medicare Parts A and B) or enrollment in a health maintenance organization, preferred provider organization, point-of-service plan, provider sponsor organization, or an insurance plan operated in conjunction with a medical savings account.

Our Net operating revenues consist primarily of revenues derived from patient care services. Net operating revenues also include other revenues generated from management and administrative fees and other non-patient care services. These other revenues are included in “other income” in the above table.

Our Results

Our consolidated results of operations were as follows:

For the Year Ended December 31, Percentage Change

(In Millions)

Operating expenses:

Government, class action, and related settlements — — 2.8 — % (100.0) %

Loss on early extinguishment of debt 1.4 1.0 2.3 40.0 % (56.5) %

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Operating Expenses as a % of Net Operating Revenues

For the Year Ended December 31,

Operating expenses:

Occupancy costs 1.3 % 1.5 % 1.7 %

General and administrative expenses 3.5 % 4.2 % 4.3 %

Depreciation and amortization 5.6 % 5.5 % 5.7 %

Government, class action, and related settlements — % — % 0.1 %

Additional information regarding our operating results is as follows:

For the Year Ended December 31, Percentage Change

(In Millions, Except Percentage Change)

Net operating revenues:

(Actual Amounts)

* Full-time equivalents included in the above table represent our employees who participate in or support the operations of our hospitals and include an estimate of full-time equivalents related to contract labor.

We actively manage the productive portion of our Salaries and benefits utilizing certain metrics, including employees per occupied bed, or “EPOB.” This metric is determined by dividing the number of full-time equivalents, including an estimate of full-time equivalents from the utilization of contract labor, by the number of occupied beds during each period. The number of occupied beds is determined by multiplying the number of licensed beds by our occupancy percentage.

In the discussion that follows, we use “same-store” comparisons to explain the changes in certain performance metrics and line items within our financial statements. We calculate same-store comparisons based on hospitals open throughout both the full current period and prior periods presented. These comparisons include the financial results of market consolidation transactions in existing markets, as it is difficult to determine, with precision, the incremental impact of these transactions on our results of operations.

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2022 Compared to 2021

Net Operating Revenues

Our consolidated Net operating revenues increased during 2022 compared to 2021 primarily due to increased volumes and favorable pricing. Discharge growth included a 3.1% increase in same-store discharges. Discharge growth from new stores during 2022 compared to 2021 resulted from our joint ventures in San Angelo, Texas (March 2021), Henry County, Georgia (October 2021), Shiloh, Illinois (February 2022), Cape Coral, Florida (June 2022), Moline, Illinois (August 2022), Grand Forks, North Dakota (August 2022), and Naples, Florida (September 2022), as well as wholly owned hospitals in North Tampa, Florida (April 2021), Cumming, Georgia (June 2021), Waco, Texas (August 2021), Shreveport, Louisiana (August 2021), Greenville, South Carolina (August 2021), Pensacola, Florida (September 2021), St. Augustine, Florida (March 2022), Libertyville, Illinois (March 2022), Lakeland, Florida (May 2022), and Jacksonville, Florida (June 2022). Growth in net patient revenue per discharge during 2022 compared to 2021 primarily attributable to an increase in reimbursement rates partially offset by the resumption of sequestration on April 1, 2022.

Salaries and Benefits

Salaries and benefits are the most significant cost to us and represent an investment in our most important asset: our employees. Salaries and benefits include all amounts paid to full- and part-time employees who directly participate in or support the operations of our hospitals, including all related costs of benefits provided to employees. It also includes amounts paid for contract labor.

Salaries and benefits increased in terms of dollars and as a percent of revenue in 2022 compared to 2021 primarily due to increases in contract labor and clinician compensation, including sign-on and shift bonuses, to meet higher patient volumes, and the ramping up of new stores. Total contract labor plus sign-on and shift bonuses increased approximately $70 million from $134.2 million in 2021 to $204.3 million in 2022

Other Operating Expenses

Other operating expenses include costs associated with managing and maintaining our hospitals. These expenses include such items as contract services, non-income related taxes, professional fees, utilities, insurance, and repairs and maintenance.

Other operating expenses increased in terms of dollars and as a percent of Net operating revenues during 2022 compared to 2021 primarily due to increased provider taxes of approximately $8 million and higher costs associated with recruiting, utilities, and travel of approximately $26 million.

Supplies

Supplies expense includes all costs associated with supplies used while providing patient care. Specifically, these costs include personal protective equipment (“PPE”), pharmaceuticals, food, syringes, bandages, and other similar items.

Supplies increased during 2022 compared to 2021 primarily due to higher costs for food and medical supplies.

General and Administrative Expenses

General and administrative expenses primarily include administrative expenses such as information technology services, human resources, corporate accounting, legal services, and internal audit and controls that are managed from our home office in Birmingham, Alabama. These expenses also include stock-based compensation expenses and transaction costs.

General and administrative expenses decreased in terms of dollars and as a percent of Net operating revenues during 2022 compared to 2021primarily due to the mark-to-market adjustments on our non-qualified 401k plan, approximately $2 million related to our transition services agreement with Enhabit, and lower incentive compensation costs. For additional information on the transition services agreement with Enhabit, see Note 2, Spin Off of Home Health and Hospice Business, to the accompanying consolidated financial statements.

Depreciation and Amortization

Depreciation and amortization increased during 2022 compared to 2021 due to our capital investments throughout 2021 and 2022. See “Executive Overview” section of this Item for information related to our development activity. We expect Depreciation and amortization to increase going forward as a result of our recent and ongoing capital investments.

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Interest Expense and Amortization of Debt Discounts and Fees

The increase in Interest expense and amortization of debt discounts and fees in 2022 compared to 2021 primarily resulted from the $20.5 million consent solicitation fee paid to bond holders in June 2022 related to the Spin Off of Enhabit partially offset by the March 2022 redemption of the remaining $100 million in outstanding principal amount of the 5.125% Senior Notes due 2023. Cash paid for interest approximated $178 million and $168 million in 2022 and 2021, respectively. For additional information, see Note 10, Long-term Debt, to the accompanying consolidated financial statements.

Provision for Income Tax Expense

Our Provision for income tax expense decreased in 2022 compared to 2021 primarily due to lower Income from continuing operations before income tax expense offset by increases to the valuation allowance and equity compensation shortfalls. See also Note 16, Income Taxes, to the accompanying consolidated financial statements.

The Coronavirus Aid, Relief, and Economic Security Act of 2020 (the “CARES Act”) included provisions relating to net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations, technical corrections to tax depreciation methods for qualified improvement property, and deferral of employer payroll taxes. The CARES Act did not materially impact our effective tax rate for the year ended December 31, 2022 and 2021, although it has impacted the timing of cash payments for taxes.

Our cash payments for income taxes approximated $50 and $130 million, net of refunds, in 2022 and 2021, respectively. These payments were based on estimates of taxable income. We estimate we will pay approximately $85 million to $100 million of cash income taxes, net of refunds, in 2023. These payments are expected to primarily result from federal and state income tax expenses based on estimates of taxable income for 2023. In 2022 and 2021, current income tax expense was $72.2 million and $84.5 million, respectively.

In certain jurisdictions, we do not expect to generate sufficient income to use all of the available state net operating losses and other credits prior to their expiration. This determination is based on our evaluation of all available evidence in these jurisdictions including results of operations during the preceding three years, our forecast of future earnings, and prudent tax planning strategies. It is possible we may be required to increase or decrease our valuation allowance at some future time if our forecast of future earnings varies from actual results on a consolidated basis or in the applicable tax jurisdiction, if the timing of future tax deductions differs from our expectations, or pursuant to changes in state tax laws and rates.

See Note 16, Income Taxes, to the accompanying consolidated financial statements and the “Critical Accounting Estimates” section of this Item.

Net Income Attributable to Noncontrolling Interests

The decrease in Net income attributable to noncontrolling interests during 2022 compared to 2021 resulted from the ramp up of new joint venture de novo locations. For additional information see the “Executive Overview” section of this Item.

2021 Compared to 2020

Net Operating Revenues

Our consolidated Net operating revenues increased in 2021 compared to 2020 primarily due to increased volumes and favorable pricing.Discharge growth included a 6.2% increase in same-store discharges. Discharge growth from new stores during 2021 resulted from our joint ventures in Coralville, Iowa (June 2020), San Angelo, Texas (March 2021), and Henry County, Georgia (October 2021), as well as wholly owned hospitals in Murrieta, California (February 2020), Sioux Falls, South Dakota (June 2020), Toledo, Ohio (November 2020), North Tampa, Florida (April 2021), Cumming, Georgia (June 2021), Waco, Texas (August 2021), Shreveport, Louisiana (August 2021), Greenville, South Carolina (August 2021), and Pensacola, Florida (September 2021). Growth in net patient revenue per discharge during 2021 compared to 2020 primarily resulted from an increase in reimbursement rates, a higher acuity patient mix and the suspension of sequestration starting in May 2020.

The increase in outpatient and other revenue during 2021 compared to 2020 primarily resulted from an increase of $29.7 million in provider tax revenues (offset by $17.8 million of provider tax expense increases included in Other operating expenses).

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Salaries and Benefits

Salaries and benefits in terms of dollars increased in 2021 compared to 2020 primarily due to salary and benefit cost increases for our employees, increased contract labor to meet higher patient volumes, and the ramping up of new stores. Salaries and benefits as a percent of Net operating revenues decreased in 2021 compared to 2020 primarily due to the additional paid-time-off awarded to employees in the second quarter of 2020 (discussed below) and improved labor productivity (contributing to lower EPOB) partially offset by higher clinician compensation costs due to staffing challenges resulting from the pandemic.

In April 2020, we initiated a program for eligible frontline employees to earn additional paid time off in recognition of their outstanding efforts responding to the pandemic. We accrued approximately $29 million in salary and benefits expense in the second quarter of 2020 in connection with this award.

Other Operating Expenses

Other operating expenses decreased as a percent of Net operating revenues during 2021 compared to 2020 primarily due to the increase in Net operating revenues as discussed above.

Supplies

Supplies decreased as a percent of Net operating revenues during 2021 compared to 2020 primarily due to the increase in Net operating revenues as discussed above.

General and Administrative Expenses

General and administrative expenses increased in terms of dollars during 2021 compared to 2020primarily due to higher costs associated with incentive compensation. General and administrative expenses decreased as a percent of Net operating revenues during 2021 compared to 2020primarily due to the increase in Net operating revenues as discussed above.

Depreciation and Amortization

Depreciation and amortization increased during 2021 compared to 2020 due to our capital expenditures and development activities throughout 2020 and 2021.

Interest Expense and Amortization of Debt Discounts and Fees

The decrease in Interest expense and amortization of debt discounts and fees in 2021 compared to 2020 primarily resulted from the redemption of approximately $700 million in November 2020 for the remaining 5.75% Senior Notes due 2024 as well as the April and June 2021 redemptions of $100 million in outstanding principal amount of the 5.125% Senior Notes due 2023 (the “2023 Notes”). Cash paid for interest approximated $168 million in 2021 and 2020, respectively. For additional information, see Note 10, Long-term Debt, to the accompanying consolidated financial statements.

Income from Continuing Operations Before Income Tax Expense

Our pre-tax income from continuing operations in 2021 increased compared to 2020 primarily due to the increase in earnings.

Provision for Income Tax Expense

Our Provision for income tax expense increased in 2021 compared to 2020 primarily due to higher Income from continuing operations before income tax expense. See also Note 16, Income Taxes, to the accompanying consolidated financial statements. The CARES Act, as discussed above, did not materially impact our effective tax rate for the year ended December 31, 2020 and 2021, although it has impacted the timing of future cash payments for taxes.

Our cash payments for income taxes approximated $130 and $33 million, net of refunds, in 2021 and 2020, respectively. These payments were based on estimates of taxable income. In 2021 and 2020, current income tax expense was $84.5 million and $40.2 million, respectively. See Note 16, Income Taxes, to the accompanying consolidated financial statements and the “Critical Accounting Estimates” section of this Item.

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Net Income Attributable to Noncontrolling Interests

The increase in Net income attributable to noncontrolling interests during 2021 compared to 2020 resulted from increased profitability of our existing joint ventures due to the impact of the pandemic on 2020.

Impact of Inflation

The impact of inflation on the Company will be primarily in the area of labor costs. The healthcare industry is labor intensive. Wages and other expenses increase during periods of inflation and when labor shortages occur in the marketplace. There can be no guarantee we will not experience increases in the cost of labor, as the need for clinical healthcare professionals is expected to grow. In addition, increases in healthcare costs are typically higher than inflation and impact our costs under our employee benefit plans. Managing these costs remains a significant challenge and priority for us.

Suppliers pass along rising costs to us in the form of higher prices. In addition, we have experienced higher prices for our medical supplies (including PPE) and food as a result of the pandemic. Our supply chain efforts and our continual focus on monitoring and actively managing medical supplies and pharmaceutical costs has enabled us to accommodate increased pricing related to supplies and other operating expenses over the past few years. However, we cannot predict our ability to cover future cost increases including increase in the cost of PPE.

It should be noted that we have little or no ability to pass on these increased costs associated with providing services to Medicare and Medicaid patients due to federal and state laws that establish fixed reimbursement rates.

See Item 1A, Risk Factors, for additional information.

Relationships and Transactions with Related Parties

Related party transactions were not material to our operations in 2022, 2021, or 2020, and therefore, are not presented as a separate discussion within this Item.

Liquidity and Capital Resources

Our primary sources of liquidity are cash on hand, cash flows from operations, and borrowings under our revolving credit facility.

The objectives of our capital structure strategy are to ensure we maintain adequate liquidity and flexibility. Pursuing and achieving those objectives allow us to support the execution of our operating and strategic plans and weather temporary disruptions in the capital markets and general business environment. Maintaining adequate liquidity is a function of our unrestricted Cash and cash equivalents and our available borrowing capacity. Maintaining flexibility in our capital structure is a function of, among other things, the amount of debt maturities in any given year, the options for debt prepayments without onerous penalties, and limiting restrictive terms and maintenance covenants in our debt agreements.

Consistent with these objectives, in March 2022, we redeemed the remaining $100 million in outstanding principal amount of the 2023 Notes using capacity under our revolving credit facility. Pursuant to the terms of the 2023 Notes, this optional redemption was made at a price of par. As a result of this redemption, we recorded a $0.3 million Loss on early extinguishment of debt in the first quarter of 2022.

In June 2022, we amended our credit agreement primarily in preparation for the Spin Off of the home health and hospice business. The modifications are described in Note 10, Long-term Debt, to the accompanying consolidated financial statements. On June 30, 2022, Enhabit distributed $566.6 million to Encompass Health who used it to fully repay both the $250 million outstanding balance of the Encompass Health revolving credit facility and approximately $236 million of the Encompass Health term loan. As a result of this repayment, we recorded a $1.1 million Loss on early extinguishment of debt in the second quarter of 2022. In October 2022, we further amended the credit agreement primarily to extend the maturity date to October 2027. For further details on the June 2022 and October 2022 amendments to our credit agreement, see Note 10, Long-term Debt, to the accompanying consolidated financial statements.

We have been disciplined in creating a capital structure that is flexible with no significant debt maturities prior to 2025. We continue to have a strong, well-capitalized balance sheet, including a substantial portfolio of owned real estate, and we have significant availability under our revolving credit facility. We continue to generate strong cash flows from operations, and we have significant flexibility with how we choose to invest our cash and return capital to shareholders.

See Note 10, Long-term Debt, to the accompanying consolidated financial statements.

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Current Liquidity

As of December 31, 2022, we had $21.8 million in Cash and cash equivalents. This amount excludes $31.6 million in Restricted cash and $110.0 million of restricted marketable securities ($30.9 million included in Other current assets and $79.1 million included in Other long-term assets in our consolidated balance sheet). Our restricted assets pertain primarily to obligations associated with our captive insurance company, as well as obligations we have under agreements with joint venture partners. See Note 5, Cash and Marketable Securities, to the accompanying consolidated financial statements.

In addition to Cash and cash equivalents, as of December 31, 2022, we had approximately $912 million available to us under our revolving credit facility. Our credit agreement governs the substantial majority of our senior secured borrowing capacity and contains a leverage ratio and an interest coverage ratio as financial covenants. Our leverage ratio is defined in our credit agreement as the ratio of consolidated total debt (less cash on hand) to Adjusted EBITDA for the trailing four quarters. In calculating the leverage ratio under our credit agreement, we are permitted to use pro forma Adjusted EBITDA, the calculation of which includes historical income statement items and pro forma adjustments, subject to certain limitations, resulting from (1) dispositions and repayments or incurrence of debt and (2) investments, acquisitions, mergers, amalgamations, consolidations and other operational changes to the extent such items or effects are not yet reflected in our trailing four-quarter financial statements. Our interest coverage ratio is defined in our credit agreement as the ratio of Adjusted EBITDA to consolidated interest expense, excluding the amortization of financing fees, for the trailing four quarters. As of December 31, 2022, the maximum leverage ratio requirement per our credit agreement was 4.75x and the minimum interest coverage ratio requirement was 3.0x, and we were in compliance with these covenants. Based on Adjusted EBITDA for 2022 and the interest rate in effect under our credit agreement during the three-month period ended December 31, 2022, if we had drawn on the first day and maintained the maximum amount of outstanding draws under our revolving credit facility for the entire year, we would still be in compliance with the maximum leverage ratio and minimum interest coverage ratio requirements.

On December 9, 2021, we announced the commencement of a consent solicitation of holders of our 5.75% Senior Notes due 2025, 4.50% Senior Notes due 2028 (the “2028 Notes”), 4.75% Senior Notes due 2030 (the “2030 Notes”), and 4.625% Senior Notes due 2031 (the “2031 Notes” and collectively the “Notes”) for the adoption of certain amendments to an indenture (the “Base Indenture”) dated as of December 1, 2009, as supplemented by each Notes’ respective supplemental indenture (together with the Base Indenture, the “Indenture”), which provided us with greater flexibility in effecting the Spin Off discussed in the “Executive Overview” section of this Item. Each Indenture contains restrictive covenants that, among other things, limit our ability and the ability of certain of our subsidiaries to make certain asset dispositions, investments, and distributions to holders of our capital stock. The amendments to the Indentures permit us, subject to the leverage ratio condition set forth below, to distribute to our equity holders in one or more transactions (a “Distribution”) some or all of the common stock of a subsidiary that holds substantially all of the assets of our home health and hospice business. We may make any such distribution so long as the Leverage Ratio (as defined in each Indenture) is no more than 3.5 to 1.0 on a pro forma basis after giving effect thereto. The amendments also reduce the capacity under our restricted payments builder basket under each existing Indenture for the 2028 Notes, 2030 Notes, and 2031 Notes by $200 million and amends the definition of “Consolidated Net Income” to allow us to exclude from Consolidated Net Income (a component of the Leverage Ratio) any fees, expenses or charges related to any Distribution and the solicitation of consents from the holders of the Notes. In December 2021 and January 2022, we received the requisite consents for the adoption of these amendments. Under the terms of the amendments, we agreed to pay the holders of the Notes a total of $40.5 million, excluding fees. We paid $20.0 million and $20.5 million in January and June 2022, respectively.

We do not face near-term refinancing risk, as the amounts outstanding under our credit agreement do not mature until 2027, and our bonds all mature in 2025 and beyond. See the “Contractual Obligations” section below for information related to our contractual obligations as of December 31, 2022.

We anticipate we will continue to generate strong cash flows from operations that, together with availability under our revolving credit facility, will allow us to invest in growth opportunities and continue to improve our existing business. We also will continue to consider additional shareholder value-enhancing strategies such as repurchases of our common stock and distribution of common stock dividends, including the potential growth of the quarterly cash dividend on our common stock, recognizing that these actions may increase our leverage ratio. See also the “Authorizations for Returning Capital to Stakeholders” section of this Item.

See Item 1A, Risk Factors, for a discussion of risks and uncertainties facing us.

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Sources and Uses of Cash

The following table shows the cash flows provided by or used in operating, investing, and financing activities of continuing operations (in millions):

For the Year Ended December 31,

Net cash provided by operating activities $ 653.5 $ 564.7 $ 668.9

Net cash used in investing activities (623.5) (547.1) (404.5)

Net cash used in financing activities (660.8) (229.9) (134.3)

2022 Compared to 2021

Operating activities. The increase in Net cash provided by operating activities of continuing operations during 2022 compared to 2021 primarily resulted from lower cash tax payments and improved collection of accounts receivable, including the recovery of $12.5 million of previously denied Medicare claims (as discussed in Note 1, Summary of Significant Accounting Policies, “Net Operating Revenues,” to the accompanying consolidated financial statements).

Investing activities. The increase in Net cash used in investing activities of continuing operations during 2022 compared to 2021 primarily resulted from increased purchases of property and equipment and restricted investments.

Financing activities. The increase in Net cash used in financing activities of continuing operations during 2022 compared to 2021 primarily resulted from increased net debt payments. For additional information, see Note 10, Long-term Debt, to the accompanying consolidated financial statements.

2021 Compared to 2020

Operating activities. The decrease in Net cash provided by operating activities of continuing operations during 2021 compared to 2020 primarily resulted from the decrease in payroll accruals partially offset by the increase in Net income (see the “Results of Operations” section of this Item). The decrease in payroll accruals was attributable to the award of additional paid time off to employees during the second quarter of 2020 in response to the pandemic and the deferral of payroll taxes resulting from government relief efforts during the pandemic. Half of the payroll taxes were paid in December 2021, with the remaining half paid in December 2022.

Investing activities. The increase in Net cash used in investing activities of continuing operations during 2021 compared to 2020 primarily resulted from the increased purchases of property and equipment.

Financing activities. The increase in Net cash used in financing activities of continuing operations during 2021 compared to 2020 primarily resulted from increased net debt payments partially offset by the purchase of equity interests held by management investors of our former home health and hospice business during the first quarter of 2020. For additional information, see Note 10, Long-term Debt, and Note 12, Redeemable Noncontrolling Interests, to the accompanying consolidated financial statements.

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Contractual Obligations

Our consolidated contractual obligations as of December 31, 2022 are as follows (in millions):

Total Current Long-term

Long-term debt obligations:

Revolving credit facility 55.0 — 55.0

(a)Included in long-term debt are amounts owed on our bonds payable and other notes payable. These borrowings are further explained in Note 10, Long-term Debt, to the accompanying consolidated financial statements.

(b)Interest on our fixed rate debt is presented using the stated interest rate. Interest expense on our variable rate debt is estimated using the rate in effect as of December 31, 2022. Interest pertaining to our credit agreement and bonds is included to their respective ultimate maturity dates. Interest related to finance lease obligations is excluded from this line (see Note 8, Leases, and Note 10, Long-term Debt, to the accompanying consolidated financial statements). Amounts exclude amortization of debt discounts, amortization of loan fees, or fees for lines of credit that would be included in interest expense in our consolidated statements of comprehensive income.

(c)Amounts include interest portion of future minimum finance lease payments.

(d)We lease approximately 10% of our hospitals as well as other property and equipment under operating leases in the normal course of business. Amounts include interest portion of future minimum operating lease payments. For more information, see Note 8, Leases, to the accompanying consolidated financial statements.

(e)Purchase obligations include agreements to purchase goods or services that are enforceable and legally binding on Encompass Health and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum, or variable price provisions; and the approximate timing of the transaction. Purchase obligations exclude agreements that are cancelable without penalty. Our purchase obligations primarily relate to software licensing and support and medical equipment. Purchase obligations are not recognized in our consolidated balance sheet.

Our capital expenditures include costs associated with our hospital refresh program, de novo projects, capacity expansions, technology initiatives, and building and equipment upgrades and purchases. During the year ended December 31, 2022, we made capital expenditures of approximately $584 million for property and equipment, capitalized software, and other intangible assets. During 2023, we expect to spend approximately $565 million to $605 million for capital expenditures using cash on hand and borrowings under our revolving credit facility. Approximately $230 million to $240 million of this budgeted amount is considered nondiscretionary expenditures, which we may refer to in other filings as “maintenance” expenditures. Actual amounts spent will be dependent upon the timing of development projects.

Authorizations for Returning Capital to Stakeholders

In October 2021, February 2022, and May 2022, our board of directors declared cash dividends of $0.28 per share that were paid in January 2022, April 2022, and July 2022, respectively. In July 2022, our board of directors revised our quarterly dividend in response to the Spin Off of Enhabit and declared a cash dividend of $0.15 per share that was paid in October 2022. Also in October 2022, our board of directors declared cash dividends of $0.15 per share that was paid in January 2023. We expect quarterly dividends to be paid in January, April, July, and October. However, the actual declaration of any future cash dividends, and the setting of record and payment dates as well as the per share amounts, will be at the discretion of our board of directors after consideration of various factors, including our capital position and alternative uses of funds. Cash dividends are expected to be funded using cash flows from operations, cash on hand, and availability under our revolving credit facility.

On October 28, 2013, we announced our board of directors authorized the repurchase of up to $200 million of our common stock, which amount was subsequently increased to $250 million. On July 24, 2018, our board approved resetting the aggregate common stock repurchase authorization to $250 million. As of December 31, 2022, approximately $198 million remained under this authorization. The repurchase authorization does not require the repurchase of a specific number of shares,

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has an indefinite term, and is subject to termination at any time by our board of directors. Subject to certain terms and conditions, including a maximum price per share and compliance with federal and state securities and other laws, the repurchases may be made from time to time in open market transactions, privately negotiated transactions, or other transactions, including trades under a plan established in accordance with Rule 10b5-1 under the Securities Exchange Act of 1934, as amended.

Supplemental Guarantor Financial Information

Our indebtedness under our credit agreement and the Notes are guaranteed by certain consolidated subsidiaries. These guarantees are full and unconditional and joint and several, subject to certain customary conditions for release. The Notes are guaranteed on a senior, unsecured basis by all of our existing and future subsidiaries that guarantee borrowings under our credit agreement and other capital markets debt. The other subsidiaries of Encompass Health do not guarantee the Notes (such subsidiaries are referred to as the “non-guarantor subsidiaries”).

The terms of our credit agreement allow us to declare and pay cash dividends on our common stock so long as: (1) we are not in default under our credit agreement, and (2) either (a) our senior secured leverage ratio (as defined in our credit agreement) remains less than or equal to 2x and our leverage ratio (as defined in our credit agreement) remains less than or equal to 4.50x or (b) our leverage ratio remains in compliance with the leverage ratio covenant and there is capacity under the Available Amount as defined in the credit agreement. The terms of our Notes indenture allow us to declare and pay cash dividends on our common stock so long as (1) we are not in default, (2) the consolidated coverage ratio (as defined in the indenture) exceeds 2x or we are otherwise allowed under the indenture to incur debt, and (3) we have capacity under the indenture’s restricted payments covenant to declare and pay dividends. See Note 10, Long-term Debt, to the accompanying consolidated financial statements.

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Summarized financial information is presented below for Encompass Health, the parent company, and the subsidiary guarantors on a combined basis after elimination of intercompany transactions and balances among Encompass Health and the subsidiary guarantors and does not include investments in and equity in the earnings of non-guarantor subsidiaries.

For the Year Ended December 31, 2022

(In Millions)

Net operating revenues $ 2,819.4

Intercompany revenues generated from non-guarantor subsidiaries 78.7

Total net operating revenues $ 2,898.1

Operating expenses $ 2,496.0

Total operating expenses $ 2,527.9

Income from continuing operations $ 135.7

Net income $ 98.0

Net income attributable to Encompass Health $ 96.8

(In Millions)

Total current assets $ 469.2

Property and equipment, net $ 2,004.5

Intercompany receivable due from non-guarantor subsidiaries 255.0

Other noncurrent assets 509.1

Total noncurrent assets $ 3,671.2

Total current liabilities $ 438.4

Long-term debt, net of current portion $ 2,670.6

Other noncurrent liabilities 349.7

Total noncurrent liabilities $ 3,020.3

Adjusted EBITDA

Management believes Adjusted EBITDA as defined in our credit agreement is a measure of our ability to service our debt and our ability to make capital expenditures. We reconcile Adjusted EBITDA to Net cash provided by operating activities and to Net income.

We use Adjusted EBITDA on a consolidated basis as a liquidity measure. We believe this financial measure on a consolidated basis is important in analyzing our liquidity because it is the key component of certain material covenants contained within our credit agreement, which is discussed in more detail in Note 10, Long-term Debt, to the accompanying consolidated financial statements. These covenants are material terms of the credit agreement. Noncompliance with these financial covenants under our credit agreement—our interest coverage ratio and our leverage ratio—could result in our lenders requiring us to immediately repay all amounts borrowed. If we anticipated a potential covenant violation, we would seek relief from our lenders, which would have some cost to us, and such relief might be on terms less favorable to us than those in our existing credit agreement. In addition, if we cannot satisfy these financial covenants, we would be prohibited under our credit agreement from engaging in certain activities, such as incurring additional indebtedness, paying common stock dividends, making certain payments, and acquiring and disposing of assets. Consequently, Adjusted EBITDA is critical to our assessment of our liquidity.

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In general terms, the credit agreement definition of Adjusted EBITDA, therein referred to as “Adjusted Consolidated EBITDA,” allows us to add back to consolidated Net income interest expense, income taxes, and depreciation and amortization and then add back to consolidated Net income (1) all unusual or nonrecurring items reducing consolidated Net income (of which only up to $10 million in a year may be cash expenditures), (2) any losses from discontinued operations, (3) non-ordinary course fees, costs and expenses incurred with respect to any litigation or settlement, (4) share-based compensation expense, (5) costs and expenses associated with changes in the fair value of marketable securities, (6) costs and expenses associated with the issuance or prepayment debt and acquisitions, and (7) any restructuring charges and certain pro forma cost savings and synergies related to transactions and initiatives, which in the aggregate are not in excess of 25% of Adjusted Consolidated EBITDA. We also subtract from consolidated Net income all unusual or nonrecurring items to the extent they increase consolidated Net income.

Under the credit agreement, the Adjusted EBITDA calculation does not require us to deduct net income attributable to noncontrolling interests or gains on fair value adjustments of hedging and equity instruments, disposal of assets, and development activities. It also does not allow us to add back losses on fair value adjustments of hedging instruments or unusual or nonrecurring cash expenditures in excess of $10 million. These items and amounts, in addition to the items falling within the credit agreement’s “unusual or nonrecurring” classification, may occur in future periods, but can vary significantly from period to period and may not directly relate to, or be indicative of, our ongoing liquidity or operating performance. Accordingly, the Adjusted EBITDA calculation presented here includes adjustments for them.

Adjusted EBITDA is not a measure of financial performance under generally accepted accounting principles in the United States of America, and the items excluded from Adjusted EBITDA are significant components in understanding and assessing financial performance. Therefore, Adjusted EBITDA should not be considered a substitute for Net income or cash flows from operating, investing, or financing activities. Because Adjusted EBITDA is not a measurement determined in accordance with GAAP and is thus susceptible to varying calculations, Adjusted EBITDA, as presented, may not be comparable to other similarly titled measures of other companies. Revenues and expenses are measured in accordance with the policies and procedures described in Note 1, Summary of Significant Accounting Policies, to the accompanying consolidated financial statements.

Our Adjusted EBITDA for the years ended December 31, 2022, 2021, and 2020 was as follows (in millions):

Reconciliation of Net Cash Provided by Operating Activities to Adjusted EBITDA

For the Year Ended December 31,

Net cash provided by operating activities $ 705.8 $ 715.8 $ 704.7

Interest expense and amortization of debt discounts and fees 175.7 164.3 183.7

(Loss) gain on sale of investments, excluding impairments (15.5) 3.8 3.6

Equity in net income of nonconsolidated affiliates 2.9 3.4 2.9

Amortization of debt-related items (9.7) (7.8) (7.2)

Distributions from nonconsolidated affiliates (4.0) (2.6) (3.4)

Current portion of income tax expense 72.2 84.5 40.2

Change in fair market value of equity securities 7.4 (0.6) (0.4)

Other — — 0.1

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Reconciliation of Net Income to Adjusted EBITDA

For the Year Ended December 31,

Interest expense and amortization of debt discounts and fees 175.7 164.3 183.7

Loss on early extinguishment of debt 1.4 1.0 2.3

Government, class action, and related settlements — — 2.8

Loss on disposal or impairment of assets 4.8 1.2 10.5

Stock-based compensation expense 29.2 29.1 25.6

Change in fair market value of equity securities 7.4 (0.6) (0.4)

For additional information see the “Results of Operations” section of this Item.

Critical Accounting Estimates

Our consolidated financial statements are prepared in accordance with GAAP. In connection with the preparation of our financial statements, we are required to make assumptions and estimates about future events and apply judgments that affect the reported amounts of assets, liabilities, revenue, expenses, and the related disclosures. We base our assumptions, estimates, and judgments on historical experience, current trends, and other factors we believe to be relevant at the time we prepared our consolidated financial statements. On a regular basis, we review the accounting policies, assumptions, estimates, and judgments to ensure our consolidated financial statements are presented fairly and in accordance with GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material.

Our significant accounting policies are discussed in Note 1, Summary of Significant Accounting Policies, to the accompanying consolidated financial statements. We believe the following accounting estimates are the most critical to aid in fully understanding and evaluating our reported financial results, as they require our most difficult, subjective, or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain. We have reviewed these critical accounting estimates and related disclosures with the audit committee of our board of directors.

Revenue Recognition

We recognize net operating revenue in the reporting period in which we perform the service based on our best estimate of the transaction price for the type of service provided to the patient. Our estimate of the transaction price includes estimates of price concessions for such items as contractual allowances (principally for patients covered by Medicare, Medicare Advantage, Medicaid, and other third-party payors), potential adjustments that may arise from payment and other reviews, and uncollectible amounts. See Note 1, Summary of Significant Accounting Policies, “Net Operating Revenues,” to the accompanying consolidated financial statements of this report for a complete discussion of our revenue recognition policies.

Our patient accounting systems calculate contractual allowances on a patient-by-patient basis based on the rates in effect for each primary third-party payor. Certain other factors that are considered and could influence the estimated transaction price are assumed to remain consistent with the experience for patients discharged in similar time periods for the same payor classes, and additional adjustments are provided to account for these factors.

Management continually reviews the revenue transaction price estimation process to consider and incorporate updates to laws and regulations and the frequent changes in managed care contractual terms that result from contract renegotiations and renewals. In addition, laws and regulations governing the Medicare and Medicaid programs are complex and subject to interpretation. If actual results are not consistent with our assumptions and judgments, we may be exposed to gains or losses that could be material.

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Due to complexities involved in determining amounts ultimately due under reimbursement arrangements with third-party payors, which are often subject to interpretation and review, we may receive reimbursement for healthcare services authorized and provided that is different from our estimates, and such differences could be material. However, we continually review the amounts actually collected in subsequent periods in order to determine the amounts by which our estimates differed. Historically, such differences have not been material from either a quantitative or qualitative perspective.

The collection of outstanding receivables from third-party payors and patients is our primary source of cash and is critical to our operating performance. Our primary collection risks relate to patient responsibility amounts and claims reviews conducted by MACs or other contractors.

The table below shows a summary of our net accounts receivable balances as of December 31, 2022 and 2021. Information on the concentration of total patient accounts receivable by payor class can be found in Note 1, Summary of Significant Accounting Policies, “Accounts Receivable,” to the accompanying consolidated financial statements.

As of December 31,

(In Millions)

Current:

Other accounts receivable 12.0 13.7

Noncurrent patient accounts receivable 73.3 77.4

Changes in general economic conditions (such as increased unemployment rates or periods of recession), business office operations, payor mix, or trends in federal or state governmental and private employer healthcare coverage could affect our collection of accounts receivable. Our collection risks include patient accounts for which the primary insurance carrier has paid the amounts covered by the applicable agreement, but patient responsibility amounts (deductibles and co-payments) remain outstanding, pre-payment claim reviews by our respective MACs, and reimbursement claims audits by governmental or other payors and their agents. As of December 31, 2022 and 2021, $73.6 million and $77.8 million, respectively, of our patient accounts receivable represented denials that were under review or audit. If actual results are not consistent with our assumptions and judgments, we may be exposed to gains or losses that could be material. See Note 1, Summary of Significant Accounting Policies, “Net Operating Revenues” and “Accounts Receivable,” to the accompanying consolidated financial statements of this report.

Self-Insured Risks

We are self-insured for certain losses related to professional liability, general liability, and workers’ compensation risks. Although we obtain third-party insurance coverage to limit our exposure to these claims, a substantial portion of our professional liability, general liability, and workers’ compensation risks are insured through a wholly owned insurance subsidiary. See Note 11, Self-Insured Risks, to the accompanying consolidated financial statements for a more complete discussion of our self-insured risks.

Our self-insured liabilities contain uncertainties because management must make assumptions and apply judgment to estimate the ultimate cost of reported claims and claims incurred but not reported as of the balance sheet date. Our reserves and provisions for professional liability, general liability, and workers’ compensation risks are based largely upon semi-annual actuarial calculations prepared by third-party actuaries.

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Periodically, we review our assumptions and the valuations provided by third-party actuaries to determine the adequacy of our self-insurance reserves. The following are certain of the key assumptions and other factors that significantly influence our estimate of self-insurance reserves: historical claims experience; trending of loss development factors; trends in the frequency and severity of claims; coverage limits of third-party insurance; demographic information; statistical confidence levels; medical cost inflation; payroll dollars; and hospital patient census.

The time period to resolve claims can vary depending upon the jurisdiction, the nature, and the form of resolution of the claims. The estimation of the timing of payments beyond a year can vary significantly. In addition, if current and future claims differ from historical trends, our estimated reserves for self-insured claims may be significantly affected. Our self-insurance reserves are not discounted.

Given the number of factors used to establish our self-insurance reserves, we believe there is limited benefit to isolating any individual assumption or parameter from the detailed computational process and calculating the impact of changing that single item. Instead, we believe the sensitivity in our reserve estimates is best illustrated by changes in the statistical confidence level used in the computations. Using a higher statistical confidence level increases the estimated self-insurance reserves. The following table shows the sensitivity of our recorded self-insurance reserves to the statistical confidence level (in millions):

Net self-insurance reserves as of December 31, 2022:

As reported, with 50% statistical confidence level 142.8

With 70% statistical confidence level 153.9

We believe our efforts to improve patient safety and overall quality of care, as well as our efforts to reduce workplace injuries, have helped contain our ultimate claim costs. See Note 11, Self-Insured Risks, to the accompanying consolidated financial statements for additional information.

We believe our self-insurance reserves are adequate to cover projected costs. Due to the considerable variability that is inherent in such estimates, there can be no assurance the ultimate liability will not exceed management’s estimates. If actual results are not consistent with our assumptions and judgments, we may be exposed to gains or losses that could be material.

Goodwill

Absent any impairment indicators, we evaluate goodwill for impairment as of October 1st of each year. We test goodwill for impairment at the reporting unit level and are required to make certain subjective and complex judgments on a number of matters, including assumptions and estimates used to determine the fair value of our inpatient rehabilitation reporting unit. We assess qualitative factors in our reporting unit to determine whether it is necessary to perform the quantitative goodwill impairment test. The quantitative impairment test is required only if we conclude it is more likely than not our reporting unit’s fair value is less than its carrying amount.

If, based on our qualitative assessment, we were to believe we must perform the quantitative goodwill impairment test, we would determine the fair value of the applicable reporting unit using generally accepted valuation techniques including the income approach and the market approach. We would validate our estimates under the income approach by reconciling the estimated fair value of the reporting unit determined under the income approach to our market capitalization and estimated fair value determined under the market approach. Values from the income approach and market approach would then be evaluated and weighted to arrive at the estimated aggregate fair value of the reporting unit.

The income approach includes the use of our reporting unit’s projected operating results and cash flows that are discounted using a weighted-average cost of capital that reflects market participant assumptions. The projected operating results use management’s best estimates of economic and market conditions over the forecasted period including assumptions for pricing and volume, operating expenses, and capital expenditures. Other significant estimates and assumptions include cost-saving synergies and tax benefits that would accrue to a market participant under a fair value methodology. The market approach estimates fair value through the use of observable inputs, including the Company’s stock price.

See Note 1, Summary of Significant Accounting Policies, “Goodwill and Other Intangibles,” and Note 9, Goodwill and Other Intangible Assets, to the accompanying consolidated financial statements for additional information.

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The following events and circumstances are certain of the qualitative factors we consider in evaluating whether it is more likely than not the fair value of a reporting unit is less than its carrying amount:

•macroeconomic conditions, such as deterioration in general economic conditions, limitations on accessing capital, or other developments in equity and credit markets;

•industry and market considerations and changes in healthcare regulations, including reimbursement and compliance requirements under the Medicare and Medicaid programs;

•cost factors, such as an increase in labor, supply, or other costs;

•overall financial performance, such as negative or declining cash flows or a decline in actual or forecasted revenue or earnings;

•other relevant company-specific events, such as material changes in management or key personnel or outstanding litigation;

•material events, such as a change in the composition or carrying amount of each reporting unit’s net assets, including acquisitions and dispositions;

•consideration of the relationship of our market capitalization to our book value, as well as a sustained decrease in our share price; and

•length of time since most recent quantitative analysis.

In the fourth quarter of 2022, we performed our annual evaluation of goodwill and determined no adjustment to impair goodwill was necessary. If actual results are not consistent with our assumptions and estimates, we may be exposed to goodwill impairment charges. However, at this time, we continue to believe our inpatient rehabilitation unit is not at risk for any impairment charges.

Income Taxes

We provide for income taxes using the asset and liability method. We also evaluate our tax positions and establish assets and liabilities in accordance with the applicable accounting guidance on uncertainty in income taxes. See Note 1, Summary of Significant Accounting Policies, “Income Taxes,” and Note 16, Income Taxes, to the accompanying consolidated financial statements for a more complete discussion of income taxes and our policies related to income taxes.

The application of income tax law is inherently complex. Laws and regulations in this area are voluminous and are often ambiguous. We are required to make many subjective assumptions and judgments regarding our income tax exposures. Interpretations of and guidance surrounding income tax laws and regulations change over time. As such, changes in our subjective assumptions and judgments can materially affect amounts recognized in our consolidated financial statements.

The ultimate recovery of certain of our deferred tax assets is dependent on the amount and timing of taxable income we will ultimately generate in the future, as well as other factors. A high degree of judgment is required to determine the extent a valuation allowance should be provided against deferred tax assets. On a quarterly basis, we assess the likelihood of realization of our deferred tax assets considering all available evidence, both positive and negative. Our operating performance in recent years, the scheduled reversal of temporary differences, our forecast of taxable income in future periods in each applicable tax jurisdiction, our ability to sustain a core level of earnings, and the availability of prudent tax planning strategies are important considerations in our assessment. Our forecast of future earnings includes assumptions about patient volumes, payor reimbursement, labor costs, hospital operating expenses, and interest expense. Based on the weight of available evidence, we determine if it is more likely than not our deferred tax assets will be realized in the future.

Our liability for unrecognized tax benefits contains uncertainties because management is required to make assumptions and to apply judgment to estimate the exposures associated with our various filing positions which are periodically audited by tax authorities. In addition, our effective income tax rate is affected by changes in tax law, the tax jurisdictions in which we operate, and the results of income tax audits.

During the year ended December 31, 2022, we decreased our valuation allowance by $7.3 million. As of December 31, 2022, we had a remaining valuation allowance of $35.8 million which primarily related to state net operating losses. At the state jurisdiction level, we determined it was necessary to maintain a valuation allowance due to uncertainties related to our ability to utilize a portion of the net operating losses before they expire. The amount of the valuation allowance has been determined for

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each tax jurisdiction based on the weight of all available evidence, as described above, including management’s estimates of taxable income for each jurisdiction in which we operate over the periods in which the related deferred tax assets will be recoverable.

While management believes the assumptions included in its forecast of future earnings are reasonable and it is more likely than not the net deferred tax asset balance as of December 31, 2022 will be realized, no such assurances can be provided. If management’s expectations for future operating results on a consolidated basis or at the state jurisdiction level vary from actual results due to changes in healthcare regulations, general economic conditions, or other factors, we may need to increase our valuation allowance, or reverse amounts recorded currently in the valuation allowance, for all or a portion of our deferred tax assets. Similarly, future adjustments to our valuation allowance may be necessary if the timing of future tax deductions is different than currently expected. Our income tax expense in future periods will be reduced or increased to the extent of offsetting decreases or increases, respectively, in our valuation allowance in the period when the change in circumstances occurs. These changes could have a significant impact on our future earnings.

Assessment of Loss Contingencies

We have legal and other contingencies that could result in significant losses upon the ultimate resolution of such contingencies. See Note 1, Summary of Significant Accounting Policies, “Litigation Reserves,” and Note 18, Contingencies and Other Commitments, to the accompanying consolidated financial statements for additional information.

We have provided for losses in situations where we have concluded it is probable a loss has been or will be incurred and the amount of loss is reasonably estimable. A significant amount of judgment is involved in determining whether a loss is probable and reasonably estimable due to the uncertainty involved in determining the likelihood of future events and estimating the financial statement impact of such events. If further developments or resolution of a contingent matter are not consistent with our assumptions and judgments, we may need to recognize a significant charge in a future period related to an existing contingent matter.

Recent Accounting Pronouncements

For information regarding recent accounting pronouncements, see Note 1, Summary of Significant Accounting Policies, to the accompanying consolidated financial statements.

Item 7A.Quantitative and Qualitative Disclosures about Market Risk

Our primary exposure to market risk is to changes in interest rates on our variable rate long-term debt. We use a sensitivity analysis model to evaluate the impact of interest rate changes on our variable rate debt. As of December 31, 2022, our primary variable rate debt outstanding related to $55.0 million in advances under our revolving credit facility. Assuming outstanding balances were to remain the same, a 1% increase in interest rates would result in an incremental negative cash flow of approximately $0.6 million over the next 12 months, while a 1% decrease in interest rates, assuming a floor of zero in the variable rate index, would result in an incremental positive cash flow of approximately $0.6 million over the next 12 months. HCS, Ltd., our wholly owned insurance captive maintains positions in investment securities for other than trading purposes, which, as of December 31, 2022, had a fair market value of approximately $110 million. Changes in the value of these securities is recorded in the accompanying consolidated statements of comprehensive income. During the year ended December 31, 2022, we recorded an unrealized loss of $7.4 million pertaining to these securities. For additional information, see Note 5, Cash and Marketable Securities, and Note 13, Fair Value Measurements, to the accompanying consolidated financial statements.

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The fair value of our fixed rate debt is determined using inputs, including quoted prices in nonactive markets, that are observable either directly or indirectly, or Level 2 inputs within the fair value hierarchy, and is summarized as follows (in millions):

Financial Instrument: Book Value Market Value Book Value Market Value

Carrying Value $ — $ — $ 99.6 $ —

Unamortized debt discount and fees — — 0.4 —

Unamortized debt discount and fees 2.3 — 3.0 —

Unamortized debt discount and fees 18.2 — 13.2 —

Unamortized debt discount and fees 21.0 — 15.3 —

Unamortized debt discount and fees 9.4 — 6.3 —

Foreign operations, and the related market risks associated with foreign currencies, are currently, and have been, insignificant to our financial position, results of operations, and cash flows. See also Note 10, Long-term Debt, and Note 13, Fair Value Measurements, to the accompanying consolidated financial statements.

Item 8.Financial Statements and Supplementary Data

Our consolidated financial statements and related notes are filed together with this report. See the index to financial statements on page F-1 for a list of financial statements filed with this report.

Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

Item 9A.Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this report, an evaluation was carried out by our management, including our chief executive officer and chief financial officer, of the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Our disclosure controls and procedures are designed to ensure that information required to be disclosed in reports we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, to allow timely decisions regarding required disclosures. Based on our evaluation, our chief executive officer and chief financial officer concluded that, as of December 31, 2022, our disclosure controls and procedures were effective.

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Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. Internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on its financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.

Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we conducted an assessment of the effectiveness of our internal control over financial reporting as of December 31, 2022. In making this assessment, management used the criteria set forth in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, the COSO framework. Based on our evaluation, our chief executive officer and chief financial officer concluded that, as of December 31, 2022, our internal control over financial reporting was effective.

The effectiveness of the Company’s internal control over financial reporting as of December 31, 2022 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.

Changes in Internal Control Over Financial Reporting

There were no changes in the Company’s internal controls over financial reporting that occurred during the quarter ended December 31, 2022 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Item 9B.Other Information

None.

Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections

None applicable.

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PART III

We expect to file a definitive proxy statement relating to our 2023 Annual Meeting of Stockholders (the “2023 Proxy Statement”) with the United States Securities and Exchange Commission, pursuant to Regulation 14A, not later than 120 days after the end of our most recent fiscal year. Accordingly, certain information required by Part III has been omitted under General Instruction G(3) to Form 10-K. Only the information from the 2023 Proxy Statement that specifically addresses disclosure requirements of Items 10-14 below is incorporated by reference.

Item 10.Directors and Executive Officers of the Registrant

The information required by Item 10 is hereby incorporated by reference from our 2023 Proxy Statement under the captions “Items of Business Requiring Your Vote—Proposal 1—Election of Directors,” “Corporate Governance and Board Structure—Corporate Governance—Code of Ethics,” “—Board Structure and Committees—Audit Committee,” “—Board Composition and Director Nomination Process—Director Nominees Proposed by Stockholders,” and “Executive Officers.”

Item 11.Executive Compensation

The information required by Item 11 is hereby incorporated by reference from our 2023 Proxy Statement under the captions “Corporate Governance and Board Structure—Compensation of Directors,” “Compensation and Human Capital Committee Matters,” and “Executive Compensation.”

Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information required by Item 12 is hereby incorporated by reference from our 2023 Proxy Statement under the captions “Executive Compensation—Equity Compensation Plans” and “Security Ownership of Certain Beneficial Owners and Management.”

Item 13.Certain Relationships and Related Transactions and Director Independence

The information required by Item 13 is hereby incorporated by reference from our 2023 Proxy Statement under the captions “Corporate Governance and Board Structure—Director Independence” and “Certain Relationships and Related Transactions.”

Item 14.Principal Accountant Fees and Services

The information required by Item 14 is hereby incorporated by reference from our 2023 Proxy Statement under the caption “Items of Business Requiring Your Vote—Proposal 2—Ratification of Appointment of Independent Registered Public Accounting Firm.”

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PART IV

Item 15.Exhibits and Financial Statement Schedules

Financial Statements

See the accompanying index on page F-1 for a list of financial statements filed as part of this report.

Financial Statement Schedules

None.

Exhibits

See Exhibit Index immediately following page F-53 of this report.

Item 16.Form 10-K Summary

Not applicable.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

ENCOMPASS HEALTH CORPORATION

By: /s/ MARK J. TARR

Mark J. Tarr

President and Chief Executive Officer

[Signatures continue on the following page]

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POWER OF ATTORNEY

Each person whose signature appears below hereby constitutes and appoints Patrick Darby his true and lawful attorney-in-fact and agent with full power of substitution and re-substitution, for him in his name, place and stead, in any and all capacities, to sign any and all amendments to this Report and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, and hereby grants to such attorney-in-fact and agent, full power and authority to do and perform each and every act and thing requisite and necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorney-in-fact and agent or his substitute or substitutes may lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

Signature Capacity Date

Mark J. Tarr

Douglas E. Coltharp

/s/ ANDREW L. PRICE Chief Accounting Officer February 27, 2023

Andrew L. Price

/s/ DONALD L. CORRELL Chairman of the Board of Directors February 27, 2023

Donald L. Correll

/s/ GREG D. CARMICHAEL Director February 27, 2023

Greg D. Carmichael

/s/ JOHN W. CHIDSEY Director February 27, 2023

John W. Chidsey

/s/ JOAN E. HERMAN Director February 27, 2023

Joan E. Herman

/s/ LESLYE G. KATZ Director February 27, 2023

Leslye G. Katz

/s/ PATRICIA A. MARYLAND Director February 27, 2023

Patricia A. Maryland

/s/ KEVIN J. O’CONNOR Director February 27, 2023

Kevin J. O’Connor

/s/ CHRISTOPHER R. REIDY Director February 27, 2023

Christopher R. Reidy

/s/ NANCY M. SCHLICHTING Director February 27, 2023

Nancy M. Schlichting

/s/ TERRANCE WILLIAMS Director February 27, 2023

Terrance Williams

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Item 15.Financial Statements

Report of Independent Registered Public Accounting Firm (PCAOB ID 238) F-2

Consolidated Balance Sheets as of December 31, 2022 and 2021 F-6

Notes to Consolidated Financial Statements F-10

F-1

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of Encompass Health Corporation

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated balance sheets of Encompass Health Corporation and its subsidiaries (the “Company”) as of December 31, 2022 and 2021, and the related consolidated statements of comprehensive income, of shareholders' equity and of cash flows for each of the three years in the period ended December 31, 2022, including the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2022 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.

Basis for Opinions

The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

Definition and Limitations of Internal Control over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

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Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Critical Audit Matters

The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that (i) relate to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.

Valuation of Patient Accounts Receivable - Contractual Allowances and Uncollectible Amounts

As described in Notes 1 and 6 to the consolidated financial statements, revenues are recognized (or measured) using the input method as therapy, nursing, and auxiliary services are provided based on management’s estimate of the respective transaction price. Management’s estimate of the transaction price includes estimates of price concessions for such items as contractual allowances, potential adjustments that may arise from payment and other reviews, and uncollectible amounts. Revenues recognized are subject to a number of elements which impact both the overall amount of revenue realized as well as the timing of the collection of the related patient accounts receivable. Factors considered by management in determining the estimated transaction price include the patient’s total length of stay for in-house patients, each patient’s discharge destination, the proportion of patients with secondary insurance coverage and the level of reimbursement under that secondary coverage, and the amount of charges that will be disallowed by payors. Management assumes these factors will remain consistent with the experience for patients discharged in similar time periods for the same payor classes. The Company’s consolidated accounts receivable balance is $610.1 million as of December 31, 2022. Management estimates the allowance for uncollectible amounts based on the aging of accounts receivable, historical collection experience for each type of payor, and other relevant factors. As disclosed by management, changes in general economic conditions are also considered.

The principal considerations for our determination that performing procedures relating to the valuation of patient accounts receivable – contractual allowances and uncollectible amounts is a critical audit matter are the significant judgment by management to estimate patient accounts receivable and the amount that will ultimately be collected under the terms of the third-party payor contracts, which in turn led to significant auditor judgment and effort to evaluate the audit evidence obtained related to the valuation of patient accounts receivable.

Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the valuation of patient accounts receivable related to contractual allowances and uncollectible amounts, which included controls over management’s process, assumptions, and data used to estimate contractual allowances and uncollectible amounts and determine patient accounts receivable. These procedures also included, among others, i) evaluating management’s process for developing the estimate for contractual allowances and uncollectible amounts, ii) testing the completeness and accuracy of underlying data used in the model, iii) evaluating the historical accuracy of management’s process for developing the estimate of the amount which will ultimately be collected by comparing actual cash collections to the previously recorded patient accounts receivable, and iv) developing an independent expectation of the amount expected to be collected by management. Developing an independent expectation involved calculating the percentage of cash collections as compared to the recorded patient accounts receivable balance for prior years and comparing that percentage to management’s collection expectation used to determine the current year estimate for contractual allowances and uncollectible amounts.

Valuation of Patient Accounts Receivable - Denied Claims

As described in Note 1 to the consolidated financial statements, the Company’s Medicare claims have been subject to review by Medicare Administrative Contractors (“MACs”) under various programs such as “widespread probes” and the Targeted Probe and Educate initiative. The MACs reviews have resulted in denial of payment for claims billed under certain diagnosis codes. As of December 31, 2022, $73.6 million of the Company’s patient accounts receivable represented denials that were under review or audit. While the Company generally appeals most of the denials of claims by the MACs, the Medicare appeals adjudication process, which is administered by the Office of Medicare Hearings and Appeals (“OMHA”), has been subject to significant delay resulting in a backlog of claims awaiting hearing, the resolution of which may take several years. As disclosed in Note 1, the Company’s historical experience and success in the adjudication of these appeals is a component of management’s estimate of the transaction price.

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The principal considerations for our determination that performing procedures relating to the valuation of patient accounts receivable – denied claims is a critical audit matter are the significant judgment by management to estimate the ultimate expected amount of collectible accounts receivable related to denied claims. This in turn led to a high degree of auditor judgment and effort to evaluate the audit evidence obtained related to the valuation of such denied claims.

Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the valuation of patient accounts receivable related to denied claims, which included controls around the identification of denied claims at period-end, as well as controls to assess the reasonableness of the success rate estimates. These procedures also included, among others, i) evaluating management’s process for developing the estimate for collectible amounts related to denied claims, as well as the relevance and use of the historical billing and collection data as an input to the valuation analysis, ii) evaluating the reasonableness of management’s analysis and success rate estimate for denied claims by comparing it to the Company’s adjudicated denied claim results, iii) performing testing over a sample of denied revenue transactions by inspecting evidence that the claim was denied, and iv) performing testing over a sample of cash collections from the historical collection data used in management’s estimation of collectability.

/s/ PricewaterhouseCoopers LLP

Birmingham, Alabama

February 27, 2023

We have served as the Company’s auditor since 2003.

F-4

For the Year Ended December 31,

(In Millions, Except Per Share Data)

Operating expenses:

Government, class action, and related settlements — — 2.8

Loss on early extinguishment of debt 1.4 1.0 2.3

Interest expense and amortization of debt discounts and fees 175.7 164.3 183.7

Other expense (income) 5.2 (7.5) (8.4)

Equity in net income of nonconsolidated affiliates (2.9) (3.4) (2.9)

Income from continuing operations before income tax expense 450.8 505.0 352.9

Income from discontinued operations, net of tax 15.2 114.1 90.6

Weighted average common shares outstanding:

Earnings per common share:

Basic earnings per share attributable to Encompass Health common shareholders:

Diluted earnings per share attributable to Encompass Health common shareholders:

Amounts attributable to Encompass Health:

Income from discontinued operations, net of tax 13.9 112.3 89.3

Net income attributable to Encompass Health $ 271.0 $ 412.2 $ 284.2

The accompanying notes to consolidated financial statements are an integral part of these statements.

F-5

As of December 31,

(In Millions, Except Share Data)

Assets

Current assets:

Cash and cash equivalents $ 21.8 $ 49.4

Prepaid expenses and other current assets 127.0 114.9

Current assets of discontinued operations — 178.8

Operating lease right-of-use assets 212.5 193.7

Noncurrent assets of discontinued operations 0.1 1,543.2

Liabilities and Shareholders’ Equity

Current liabilities:

Current portion of long-term debt $ 25.2 $ 37.8

Current operating lease liabilities 25.6 23.5

Accrued interest payable 42.8 44.4

Current liabilities of discontinued operations 0.1 132.4

Long-term debt, net of current portion 2,741.8 3,240.5

Long-term operating lease liabilities 199.7 179.6

Deferred income tax liabilities 83.0 23.3

Other long-term liabilities 45.3 48.9

Noncurrent liabilities of discontinued operations 0.4 100.8

Commitments and contingencies

Redeemable noncontrolling interests 35.6 42.2

Shareholders’ equity:

Encompass Health shareholders’ equity:

Total Encompass Health shareholders’ equity 1,310.3 1,911.3

Total liabilities(1) and shareholders’ equity $ 5,636.5 $ 6,864.9

(1)Our consolidated assets as of December 31, 2022 and December 31, 2021 include total assets of variable interest entities of $207.8 million and $226.2 million, respectively, which cannot be used by us to settle the obligations of other entities. Our consolidated liabilities as of December 31, 2022 and December 31, 2021 include total liabilities of the variable interest entities of $47.9 million and $38.2 million, respectively. See Note 4, Variable Interest Entities.

The accompanying notes to consolidated financial statements are an integral part of these statements.

F-6

Encompass Health Common Shareholders

(In Millions)

Receipt of treasury stock (0.2) — — — (15.7) — (15.7)

Dividends declared ($1.12 per share) — — (111.6) — — — (111.6)

Stock-based compensation — — 29.5 — — — 29.5

Stock options exercised 0.1 — 1.1 — — — 1.1

Distributions declared — — — — — (72.1) (72.1)

Repurchases of common stock in open market (0.1) — — — (6.1) — (6.1)

Capital contributions from consolidated affiliates — — — — — 42.8 42.8

Fair value adjustments to redeemable noncontrolling interests — — 1.4 — — — 1.4

Receipt of treasury stock (0.2) — — — (16.4) — (16.4)

Dividends declared ($1.12 per share) — — (83.8) (28.1) — — (111.9)

Stock-based compensation — — 32.8 — — — 32.8

Distributions declared — — — — — (87.8) (87.8)

Capital contributions from consolidated affiliates — — — — — 72.5 72.5

Receipt of treasury stock (0.1) — — — (7.7) — (7.7)

Dividends declared ($0.86 per share) — — (11.1) (75.2) — — (86.3)

Stock-based compensation — — 31.7 — — — 31.7

Distributions declared — — — — — (99.5) (99.5)

Capital contributions from consolidated affiliates — — — — — 100.1 100.1

The accompanying notes to consolidated financial statements are an integral part of these statements.

F-7

For the Year Ended December 31,

(In Millions)

Cash flows from operating activities:

Income from discontinued operations, net of tax (15.2) (114.1) (90.6)

Provision for government, class action, and related settlements — — 2.8

Amortization of debt-related items 9.7 7.8 7.2

Loss on early extinguishment of debt 1.4 1.0 2.3

Equity in net income of nonconsolidated affiliates (2.9) (3.4) (2.9)

Distributions from nonconsolidated affiliates 4.0 2.6 3.4

Changes in assets and liabilities, net of acquisitions —

Prepaid expenses and other assets 8.0 (41.8) (1.2)

Accrued interest payable (1.7) (2.6) 14.7

Cash flows from investing activities:

Acquisition of businesses, net of cash acquired — (1.1) —

Additions to capitalized software costs (9.2) (14.6) (8.3)

Purchases of intangible assets (10.1) (6.5) (3.5)

Proceeds from sale of restricted investments — — 12.6

Purchases of restricted investments (35.2) (9.0) (8.7)

Net cash used in investing activities (627.0) (666.3) (407.5)

(Continued)

F-8

For the Year Ended December 31,

(In Millions)

Cash flows from financing activities:

Proceeds from bond issuance — — 992.5

Principal payments on debt, including pre-payments (345.8) (214.5) (717.2)

Principal borrowings on notes 11.8 — —

Payments on revolving credit facility (385.0) (100.0) (375.0)

Principal payments under finance lease obligations (19.2) (44.6) (14.4)

Debt amendment and issuance costs (24.1) — (20.3)

Repurchases of common stock, including fees and expenses — — (6.1)

Purchase of equity interests in consolidated affiliates — — (162.3)

Taxes paid on behalf of employees for shares withheld (7.3) (14.6) (14.7)

Net cash used in financing activities (145.7) (240.1) (145.9)

Reconciliation of Cash, Cash Equivalents, and Restricted Cash

Cash and cash equivalents at beginning of period $ 49.4 $ 185.6 $ 60.0

Restricted cash at beginning of period 62.5 63.9 57.4

Cash and cash equivalents at end of period $ 21.8 $ 49.4 $ 185.6

Restricted cash at end of period 31.6 62.5 63.9

Restricted cash included in other long-term assets at end of period — 0.4 21.5

Supplemental cash flow information:

Cash (paid) received during the year for —

The accompanying notes to consolidated financial statements are an integral part of these statements.