Encompass Health Corp quarterly report, Q3 FY2020

Encompass Health Corporation — Q3 2020 Form 10-Q

Reporting period: Three and nine months ended September 30, 2020; filed November 2, 2020. Encompass Health provides inpatient rehabilitation, home health, and hospice services across 39 states and Puerto Rico.

Financial results and liquidity

Metric	Q3 2020	Q3 2019	Nine months 2020	Nine months 2019
Net operating revenue	$1,173.9 million	$1,161.6 million	$3,430.0 million	$3,420.6 million
Net income attributable to Encompass Health	$77.7 million	$97.6 million	$198.2 million	$291.1 million
Diluted EPS	$0.78	$0.98	$1.99	$2.93
Adjusted EBITDA	$230.2 million	$231.6 million	$620.4 million	$726.7 million

Q3 operating expenses were $1,001.4 million, or 85.3% of revenue, versus $989.7 million, or 85.2%, a year earlier. Q3 income from continuing operations was $100.1 million, down 16.2%.
For the nine months, operating cash flow was $425.0 million versus $419.7 million. Capital expenditures for property and equipment were $256.2 million; investing cash outflow was $264.8 million.
Cash and cash equivalents were $450.0 million at September 30, 2020, compared with $94.8 million at year-end 2019. Restricted cash was $57.2 million, with an additional $20.9 million of restricted cash in other long-term assets. Approximately $964 million was available under the revolving credit facility.
Long-term debt, including current portion, was approximately $3.58 billion, up from $3.06 billion at year-end 2019. The company reported compliance with its credit agreement covenants at quarter-end: maximum leverage ratio 5.50x and minimum interest coverage ratio 2.0x.

Material changes versus prior comparable periods

Q3 revenue increased 1.1%; nine-month revenue increased 0.3%. Growth reflected inpatient rehabilitation pricing, partly offset by lower volume in both segments and lower home health pricing.
Q3 net income attributable to the company fell 20.4%, while nine-month net income fell 31.9%. Q3 adjusted EBITDA was nearly flat; nine-month adjusted EBITDA declined 14.6%.
Inpatient rehabilitation revenue rose 3.1% in Q3, but segment Adjusted EBITDA decreased 0.7% to $209.2 million. Same-store discharges fell 2.8%; higher revenue per discharge, reflecting acuity and the temporary Medicare sequestration suspension, partly offset lower volume.
Home health and hospice revenue declined 5.1% in Q3. Segment Adjusted EBITDA rose 2.0% to $51.8 million in Q3, but declined 26.3% for the nine months. Home health revenue was pressured by lower admissions, fewer visits per episode, and Patient-Driven Groupings Model effects; hospice revenue benefited from admissions growth.
COVID-19-related volume declines began in mid-March; management said volumes in both segments had substantially recovered by the end of Q3, though some markets remained affected.

Outlook, management commentary, and risks

Management expressed confidence in intermediate- and long-term demand, citing aging demographics, while emphasizing uncertainty about the pandemic’s duration and effects. The filing provides no specific full-year earnings or revenue guidance.
Management estimated 2020 capital expenditures of $410 million to $450 million, including $155 million to $165 million considered nondiscretionary. Estimated 2020 income tax cash payments were $45 million to $65 million, net of refunds.
The CARES Act temporarily suspended the 2% Medicare sequestration reduction from May 1 through December 31, 2020. Through September 30, the reported revenue benefit was $21.9 million for inpatient rehabilitation and $8.6 million for home health and hospice. The company declined and returned HHS relief funds.
The 2021 final inpatient rehabilitation rule was expected to increase Medicare payment rates by approximately 2.3%, according to management’s analysis. The company had not yet estimated the impact of the 2021 home health rule.
COVID-19 risks include renewed volume disruption, referral constraints, supply shortages and higher PPE costs, staffing pressure, and potential operational restrictions or litigation. Management said pandemic-related expense trends continued into October and could reduce segment Adjusted EBITDA.
In Q2, the company accrued approximately $43 million for additional paid time off for eligible frontline employees. Higher medical supply costs and labor expenses pressured results; lower G&A partly reflected lower stock appreciation rights costs.
In April, the company amended its credit agreement to provide covenant relief. It issued $600 million of additional senior notes in May and used part of the proceeds to repay revolver borrowings. In October, it issued $400 million of 4.625% notes due 2031 and announced redemption of $700 million of 2024 notes, expected to settle November 1; management expected an approximately $2 million early-extinguishment loss in Q4.
Quarterly dividends were $0.28 per share; a further $0.28 dividend was declared for payment in January 2021. Share repurchases under the authorization paused after mid-March.
Medicare claim reviews and appeals remain a risk. Management noted that changes to the appeals process could increase unfavorable decisions, but said it was too early to estimate any effect on revenue. The company also disclosed ongoing litigation and the possibility of undisclosed qui tam claims; it did not consider pending legal proceedings material at the filing date.

Most important facts for investors to verify

Whether patient volumes and referrals continue to recover, particularly in markets affected by COVID-19 resurgences.
Whether PPE, staffing, and other pandemic-related costs continue to weigh on segment margins and Adjusted EBITDA.
Actual cash generation, capital spending, debt levels, and covenant headroom following the 2020 note issuance and planned 2024-note redemption.
How Medicare sequestration relief, the 2021 reimbursement rules, home health PDGM, and claim-review outcomes affect future revenue and pricing.
Whether the declared dividend and development plans remain supportable if operating cash flows weaken.