Encompass Health Corporation — FY 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. The filing also reports fourth-quarter results. The company, formerly HealthSouth Corporation, changed its name and NYSE ticker from HLS to EHC effective January 1, 2018.
Business context
Encompass Health operates two segments: inpatient rehabilitation and home health and hospice, serving 36 states and Puerto Rico. At year-end it operated 127 inpatient rehabilitation hospitals, 200 home health locations and 37 hospice locations. Inpatient rehabilitation represented about 80% of FY 2017 revenue; home health and hospice represented about 20%.
Financial and operating performance
| Metric | FY 2017 | FY 2016 | Change |
|---|---|---|---|
| Net operating revenues | $3,971.4 million | $3,707.2 million | +7.1% |
| Income from continuing operations | $335.8 million | $318.1 million | +5.6% |
| Net income attributable to Encompass Health | $256.3 million | $247.6 million | +3.5% |
| Diluted EPS | $2.69 | $2.59 | +3.9% |
| Operating earnings (company-defined measure) | $578.3 million | $588.1 million | -1.7% |
| Adjusted EBITDA (non-GAAP) | $823.1 million | $793.6 million | +3.7% |
| Net cash provided by operating activities | $657.2 million | $634.4 million | +3.6% |
- Margins: Adjusted EBITDA was about 20.7% of revenue, versus 21.4% in 2016. Operating expenses were 82.3% of revenue, up from 80.8%. These ratios use reported net operating revenues.
- Cash and capital spending: Cash and cash equivalents were $54.4 million at year-end; capital expenditures were approximately $245 million. Operating cash flow less capital expenditures was approximately $412 million, before acquisitions and other investing needs.
- Debt and liquidity: Long-term debt, including current portion and capital leases, was $2,577.7 million, down from $3,016.4 million. The company reported approximately $570 million available on its $700 million revolving facility and $184.7 million of working capital. No significant debt maturities were expected before 2022; senior notes mature from 2023 onward.
- Q4 results: Revenue was $1,019.7 million, operating earnings $144.7 million, income from continuing operations $86.7 million, and net income attributable to Encompass Health $60.6 million. Diluted EPS was $0.61. Q4 2016 revenue was $949.9 million and attributable net income was $65.3 million.
Material changes versus the prior comparable period
- Inpatient rehabilitation revenue rose 5.5%; discharges increased 4.0%, including 1.8% same-store growth, and net patient revenue per discharge rose 2.0%. Segment Adjusted EBITDA increased 3.0% to $821.2 million.
- Home health and hospice revenue grew 14.2%; home health admissions rose 17.0% (11.4% same-store), while revenue per episode fell 1.1%. Segment Adjusted EBITDA increased 22.9% to $125.9 million.
- Salary and benefit expense increased 8.5%, faster than revenue, and rose to 54.3% of revenue from 53.6%. General and administrative expense increased 28.7%, including higher corporate compensation, rebranding and clinical collaboration costs.
- Operating cash flow increased, aided by revenue growth and improved receivable collections, but cash income-tax payments rose following exhaustion of the federal NOL in early 2017.
- The company converted or redeemed its $320 million 2.00% convertible notes; holders converted $319.4 million into 8.9 million common shares. It also amended its credit agreement, reducing term loans by about $110 million, lowering the interest-rate spread, extending maturity to 2022 and increasing the revolver to $700 million.
Outlook, commentary and risks
- Management described its outlook as positive, citing aging demographics, expected Medicare enrollment growth of about 3% annually, organic growth opportunities and continued acquisitions. The filing does not provide a specific FY 2018 revenue or earnings forecast.
- Management expected 2018 capital expenditures of $280 million to $350 million, including $130 million to $150 million characterized as nondiscretionary, and $50 million to $100 million for home health and hospice acquisitions. It estimated 2018 cash income taxes at $105 million to $135 million.
- Management estimated 2018 Medicare payment rates, before sequestration, would increase about 0.8% for inpatient rehabilitation and decrease about 0.5% for home health. It warned wage and benefit costs could rise faster than aggregate Medicare reimbursement.
- The 2018 Budget Act requires substantial home health payment-system changes beginning in 2020, including a 30-day payment unit replacing the current 60-day episode. The ultimate effects on reimbursement are uncertain. Medicare and Medicare Advantage together generated about 84% of revenue, creating significant exposure to policy and rate changes.
- Key risks include Medicare claim audits, denials and lengthy appeals; a DOJ investigation into alleged improper or fraudulent claims at certain hospitals; staffing shortages and wage inflation; competition and shifts in referral patterns; and changes toward bundled, value-based or site-neutral reimbursement.
- A $20.0 million jury verdict in the Honts matter was under appeal; the company recorded a $20.2 million liability and a $15.5 million insurance receivable at year-end. The DOJ investigation’s potential loss was not estimable. The filing also describes an unsealed qui tam case pursued by a relator after the government declined to intervene.
- The Tax Cuts and Jobs Act reduced the federal corporate tax rate to 21% starting in 2018. The company recorded a net $1.2 million tax charge in 2017 and was evaluating potential effects on tax deferrals related to denied claims.
- The rebranding was estimated to cost $25 million to $30 million over 2017–2019. A February 2018 purchase of management investors’ home health subsidiary shares required approximately $65 million in cash.
Most important facts for investors to verify
- Review the audited statements and segment disclosures to assess whether growth translates into durable earnings and margins, particularly as labor and corporate costs rise.
- Track Medicare denial balances, appeal collections and cash conversion; $176.8 million of patient receivables represented MAC pre-payment medical-necessity denials at year-end.
- Assess the potential financial and operational effects of the DOJ investigation, the Honts appeal, and other litigation or compliance matters; some possible losses are not estimable.
- Confirm actual 2018 capital spending, acquisitions, tax payments and reimbursement outcomes against management’s estimates, including implementation of the home health payment changes.
- Monitor debt, covenant headroom, revolver availability, dividends and share repurchases, including the cash implications of redeemable noncontrolling interests and the 2018 share purchase.