Encompass Health Corporation — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; compared with the three months ended March 31, 2018 unless otherwise noted. Encompass Health provides inpatient rehabilitation, home health and hospice services across 37 states and Puerto Rico.
Financial performance and liquidity
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Net operating revenues | $1,124.0 million | $1,046.0 million | +7.5% |
| Operating expenses | $936.5 million | $876.9 million | +6.8% |
| Operating income, calculated as revenue less operating expenses | $187.5 million | $169.1 million | +10.9% |
| Income from continuing operations | $125.7 million | $105.7 million | +18.9% |
| Net income attributable to Encompass Health | $102.3 million | $83.8 million | +22.1% |
| Diluted earnings per share | $1.03 | $0.84 | +22.6% |
| Adjusted EBITDA, as defined by the company | $242.9 million | $223.3 million | +8.8% |
| Cash flow from operations | $159.9 million | $216.3 million | Down $56.4 million |
Operating margin was approximately 16.7%, versus 16.2% in Q1 2018, calculated from reported revenue and operating expenses. Salaries and benefits rose 8.9% to $620.8 million and increased to 55.2% of revenue from 54.5%; depreciation and amortization rose 14.4% to $52.5 million. General and administrative expense fell 12.6% to $53.4 million, mainly due to lower stock appreciation rights and rebranding costs.
Cash and cash equivalents were $56.1 million at March 31, 2019; cash, cash equivalents and restricted cash totaled $120.2 million. The company reported approximately $636 million of availability under its revolving credit facility and compliance with its debt covenants. Long-term debt was $2,559.1 million, including current maturities; this reported debt includes finance lease obligations. Current assets were $682.7 million and current liabilities were $768.2 million. The company reported no significant debt maturities before 2022. Operating cash flow declined year over year; management attributed the comparison primarily to prior-year recoupments of previously denied claims and changes associated with higher volumes.
Segment results and material changes
- Inpatient rehabilitation: Revenue increased 3.5% to $870.1 million; Segment Adjusted EBITDA rose 2.8% to $230.0 million. Discharges increased 1.1%, including a 0.2% decline in same-store discharges; revenue per discharge increased 2.6% to $18,584.
- Home health and hospice: Revenue increased 23.4% to $253.9 million; Segment Adjusted EBITDA rose 38.2% to $46.3 million. Home health admissions increased 12.1%, with same-store admissions up 6.4%; hospice admissions increased 49.3%. Growth reflected volume, reimbursement and revenue-per-episode gains, as well as acquisitions, including Camellia Healthcare, acquired in 2018.
- Consolidated revenue growth reflected pricing and volume gains in both segments. Medicare represented 76.0% of revenue, down from 76.6%; Medicare Advantage share increased to 9.8% from 8.8%.
- Investing cash outflow increased to $91.5 million, including $72.3 million of property and equipment purchases and $13.7 million for acquisitions. Capital expenditures were higher than in the prior-year quarter. Financing outflow was $81.7 million, versus $116.7 million, partly because Q1 2018 included a $65.1 million purchase of affiliate equity interests.
Outlook, risks and unusual items
- Management described its outlook as positive, citing aging demographics, organic growth opportunities and potential expansion through development and acquisitions. It did not provide a consolidated revenue or earnings forecast in the supplied filing text.
- The company estimated fiscal 2020 Medicare payment rates for inpatient rehabilitation would be flat to down 0.25%, based on its analysis of the proposed rule and other factors. CMS’s proposed rule included a net 2.5% market-basket increase, alongside changes to assessment measures and other payment calculations.
- CMS announced a Home Health Review Choice Demonstration beginning in Illinois in June 2019, with expansion to other states planned. The company said agencies in the affected states represent approximately 45% of its home health Medicare claims; nonparticipation may result in a 25% payment reduction on claims under the program’s terms.
- In March, the company agreed to acquire substantially all Alacare Home Health & Hospice assets for approximately $217.5 million, subject to customary closing conditions and regulatory approvals, with closing expected in June 2019. It planned to use cash and revolver borrowings and estimated a present-value income tax benefit of approximately $30 million.
- Management forecast 2019 capital expenditures of $375 million to $445 million, including $160 million to $170 million described as nondiscretionary, and approximately $50 million for home health and hospice acquisitions, excluding Alacare. Estimated 2019 income tax cash payments, net of refunds, were $110 million to $130 million.
- The company accrued a $48 million loss contingency for a long-running DOJ investigation into alleged Medicare and Medicaid claims practices. Settlement discussions were ongoing, with no certainty about their nature, timing or likelihood. The filing said the company did not consider an adverse judgment or settlement probable in the Nichols litigation and could not estimate a loss. A separate Honts matter was settled in February 2019 for an amount below the remaining reserve and not material to the company.
- Labor costs, staffing availability, reimbursement and regulatory changes, claim audits and appeals, competitive pressures, and execution of acquisitions and new developments remain material risks. Adoption of the new lease standard added approximately $349 million of assets and $347 million of liabilities at January 1, 2019.
Important facts for investors to verify
- Progress and final terms of the DOJ investigation resolution, and whether the $48 million accrual is adequate.
- Final CMS rules and actual reimbursement effects, particularly the inpatient rehabilitation payment outlook and home health review requirements.
- Alacare closing, financing, integration and realization of the estimated tax benefit.
- Whether operating cash flow recovers and accounts receivable growth and claim-review activity remain manageable.
- Execution against capital spending and acquisition plans while maintaining debt covenant compliance and shareholder distributions.