Encompass Health Corporation — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. Encompass Health provides inpatient rehabilitation and home health and hospice services across 37 states and Puerto Rico.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net operating revenues | $1,161.6 million | $1,067.6 million | $3,420.6 million | $3,181.3 million |
| Income from continuing operations | $119.5 million | $109.4 million | $356.2 million | $328.1 million |
| Net income attributable to Encompass Health | $97.6 million | $88.6 million | $291.1 million | $264.2 million |
| Diluted EPS | $0.98 | $0.89 | $2.93 | $2.65 |
| Segment Adjusted EBITDA | $261.4 million | $256.1 million | $820.7 million | $778.5 million |
| Adjusted EBITDA, company-reported measure | $231.6 million | $224.3 million | $726.7 million | $679.2 million |
- Q3 revenue rose 8.8% and nine-month revenue rose 7.5% year over year. Medicare represented 75.3% of revenue in both periods.
- Q3 operating expenses were 85.2% of revenue, up from 83.8%; nine-month operating expenses were 84.5%, up from 83.7%. Salaries and benefits rose faster than revenue, reflecting wage and benefit costs and higher staffing.
- Q3 net income attributable to the company increased 10.2%. Results included a $19.2 million gain from consolidating Yuma Rehabilitation Hospital; the gain is excluded from the company’s reported Adjusted EBITDA.
- Nine-month operating cash flow was $419.7 million, versus $584.0 million. Capital expenditures were $259.9 million for property and equipment, plus $9.2 million for software. Investing cash outflow was $511.7 million; financing cash inflow was $472.3 million.
- At September 30, cash and cash equivalents were $422.0 million; restricted cash was $66.8 million, with another $25.0 million of restricted cash in other long-term assets. Revolver availability was approximately $662 million.
- Total debt, including finance lease obligations, was $3.399 billion, compared with $2.514 billion at December 31, 2018. The balance included $437.2 million classified as current, including approximately $400 million of 2024 notes scheduled for redemption on November 1, 2019. The company reported compliance with its credit agreement covenants.
Segment trends and material changes
- Inpatient rehabilitation: Q3 revenue increased 5.7%; discharges rose 5.5%, including 3.1% same-store growth, while revenue per discharge increased 1.0%. Segment Adjusted EBITDA declined 1.1% to $210.6 million, principally due to labor costs and the prior-year comparison including $4.5 million of hurricane-related business interruption insurance recoveries. Nine-month segment revenue rose 4.6% and Segment Adjusted EBITDA rose 2.2%.
- Home health and hospice: Q3 revenue rose 19.5% to $289.3 million and Segment Adjusted EBITDA rose 17.6% to $50.8 million. Growth reflected volume, acquisitions and the July acquisition of Alacare; Q3 home health admissions grew 22.7%, while revenue per episode declined 0.5%. Nine-month revenue increased 18.1% and Segment Adjusted EBITDA increased 23.6%.
- Alacare was acquired for $217.5 million cash and contributed 23 home health and 23 hospice locations in Alabama. The company estimated an approximately $30 million present-value income tax benefit related to the transaction.
- In September, Encompass issued $500 million of 4.50% notes due 2028 and $500 million of 4.75% notes due 2030, receiving approximately $983 million net proceeds. Proceeds funded management equity and stock-appreciation-right purchases, revolver repayment, and the planned redemption of $400 million of 2024 notes. The company expected an approximately $5 million debt-extinguishment loss in Q4.
Outlook, risks and unusual items
- Management described its outlook as positive, citing demographic demand and growth opportunities. It expected 2019 capital expenditures of $375 million to $445 million, including $160 million to $170 million of maintenance spending, and up to $50 million of additional home health and hospice acquisitions, excluding Alacare.
- For fiscal 2020, management estimated inpatient rehabilitation Medicare payment rates would be flat to up 0.50%. For home health, it estimated an approximately 1.0% incremental payment reduction after the proposed 1.3% market-basket update under the proposed Patient-Driven Groupings Model; this estimate excluded potential base-rate reductions from CMS behavioral assumptions. The home health rule was proposed, and the estimates were subject to change.
- Key risks include Medicare reimbursement and regulatory changes, implementation of the CARE Tool and home health payment reforms, audits and delayed claims appeals, staffing shortages and labor-cost pressure, competition, and acquisition integration. The Home Health Review Choice Demonstration had begun in Illinois and expanded to Ohio; further expansion was expected in 2020.
- The company settled a DOJ investigation and related qui tam claims for $48 million; $46.4 million was paid in Q2 2019. It reported a remaining shareholder lawsuit scheduled for trial in August 2020, but management said an adverse outcome was not probable and loss could not be estimated. The filing disclosed no material changes to previously reported risk factors.
- The company adopted lease accounting on January 1, 2019, adding approximately $349 million in assets and $347 million in liabilities at adoption. It also repurchased 0.8 million shares for approximately $45.9 million during the first nine months and declared a quarterly dividend of $0.28 per share.
Investor verification priorities
- Assess the durability of revenue and admission growth, especially same-store trends and the contribution of Alacare and other acquisitions.
- Track labor and benefit costs against revenue growth and the effect on inpatient rehabilitation margins.
- Review actual Medicare payment outcomes under the CARE Tool and PDGM, including any changes from the filing’s estimates.
- Reconcile operating cash flow’s year-over-year decline, including settlement, stock-appreciation-right payments, and working-capital movements.
- Confirm completion and funding of the November 2019 note redemption, subsequent debt levels, and remaining liquidity and covenant headroom.
- Monitor the remaining legal proceedings, acquisition valuation adjustments, and the company’s capacity to fund capital spending, dividends, and repurchases.