Encompass Health Corp. (then HealthSouth Corporation) — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; unaudited. The company provided inpatient rehabilitation and home health and hospice services across 34 states and Puerto Rico. Results are compared with Q1 2015.
Key financial results
| Metric | Q1 2016 | Q1 2015 |
|---|---|---|
| Net operating revenue | $909.8 million | $740.6 million |
| Revenue after doubtful-account provision | $893.3 million | $729.0 million |
| Income from continuing operations | $76.8 million | $59.3 million |
| Net income attributable to HealthSouth | $58.0 million | $42.5 million |
| Diluted EPS | $0.61 | $0.44 |
| Adjusted EBITDA | $192.1 million | $156.1 million |
| Cash from operating activities | $159.7 million | $102.0 million |
- Revenue grew 22.8%; net income attributable to the company rose 36.5%. Growth primarily reflected the Reliant hospital and CareSouth home-health acquisitions, alongside volume increases.
- After-provision operating expenses were $732.8 million. Operating income, calculated as revenue after doubtful-account provision less operating expenses, was $160.5 million, or approximately 18.0% of that revenue, versus $120.5 million, or 16.5%, in Q1 2015.
- Segment Adjusted EBITDA increased to $196.9 million from $164.4 million for inpatient rehabilitation, and to $22.6 million from $16.9 million for home health and hospice.
- Capital expenditures and capitalized software totaled approximately $39.1 million. Operating cash flow less those expenditures was approximately $120.6 million; this is a simple calculation, not company-reported free cash flow.
- Cash and cash equivalents were $73.2 million at quarter-end. The company also reported $49.0 million of restricted cash and $56.7 million of restricted marketable securities. Current assets were $632.1 million and current liabilities $463.8 million.
- Debt carrying amount was $3.12 billion, including $130.0 million drawn on the revolver; long-term debt net of current maturities was $3.08 billion. Management reported approximately $435 million available under its revolving facility and compliance with credit covenants. No significant debt maturities were expected before 2020.
Material changes and operating trends
- Inpatient rehabilitation revenue rose 18.9%; discharges increased 17.0%, including 2.8% same-store growth, while net patient revenue per discharge increased 1.3%. Occupancy declined to 68.9% from 72.8%, as licensed bed capacity expanded.
- Home health and hospice revenue rose 45.6%; home-health admissions increased 56.1%, including 12.6% same-store growth. Average revenue per episode fell 2.2%, partly reflecting Medicare rate cuts and patient mix.
- Expenses increased with higher volumes, acquisitions, and new-store ramp-up. Salaries and benefits increased 26.2%, faster than revenue, and interest expense increased 40.3% to $44.6 million following acquisition-related borrowing. The prior-year quarter included $8.0 million in government, class-action, and related settlements, versus none in Q1 2016.
- In March, the company redeemed $50 million principal amount of 7.75% senior notes due 2022 for approximately $52 million, recording a $2.4 million early-extinguishment loss. It announced an additional $50 million redemption for May 2016 and expected an approximately $2 million loss.
Outlook, commentary, and risks
- Management described its outlook as positive, citing aging-related demand, market position, and growth opportunities. It expects 2016 capital expenditures of approximately $185 million to $230 million and cash income taxes, net of refunds, of approximately $20 million to $40 million.
- Management estimated the proposed FY2017 inpatient rehabilitation payment rule would increase its Medicare payment rates by approximately 1.7%, before sequestration, effective October 1, 2016. This was a proposed rule, not a final outcome.
- Management said it intends over the longer term to reduce leverage through EBITDA growth and allocating some free cash flow to debt reduction, while retaining flexibility for acquisitions, expansion, dividends, and share repurchases. The quarterly dividend was $0.23 per share; approximately $149 million remained under the repurchase authorization at March 31.
- Key exposures include heavy Medicare dependence (75.4% of consolidated revenue), reimbursement and regulatory changes, audits and delayed claim appeals, staffing costs, competition, and execution of acquisitions and new facilities. The company disclosed ongoing DOJ/HHS-OIG investigations into alleged improper or fraudulent Medicare and Medicaid claims; it could not predict their timing or outcome. It also described shareholder litigation and possible undisclosed qui tam claims. Management said an adverse outcome in the described shareholder case was not probable and the loss could not be estimated.
- A 1 percentage-point increase in interest rates was estimated to raise cash interest outflows by approximately $5.0 million over the next 12 months, assuming debt balances remained unchanged. Management reported effective disclosure controls and no material change in internal control over financial reporting; it reported no material changes to the prior annual report’s risk factors.
Investor facts to verify
- How much of reported growth and EBITDA improvement is acquisition-driven versus same-store performance, and how acquired operations integrate.
- Whether Medicare claim denials, audit delays, doubtful-account provisions, and reimbursement changes affect collections, margins, or patient mix.
- Debt, revolver availability, covenant headroom, and the cash-flow effect of the announced note redemption, capital spending, dividends, and repurchases.
- Final FY2017 reimbursement rules and the eventual impact of DOJ/HHS-OIG inquiries, litigation, and other contingencies.