Encompass Health (then HealthSouth Corporation) — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. The company provided inpatient rehabilitation and home health and hospice services. On July 10, 2017, it announced a planned corporate name change to Encompass Health Corporation, effective January 1, 2018.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net operating revenue | $981.3m | $920.7m | $1,956.1m | $1,830.5m |
| Income from continuing operations | $79.2m | $81.3m | $163.9m | $158.1m |
| Net income attributable to HealthSouth | $63.0m | $62.6m | $129.8m | $120.6m |
| Diluted EPS | $0.70 | $0.65 | $1.42 | $1.26 |
| Adjusted EBITDA | $209.5m | $204.3m | $410.3m | $396.4m |
- Q2 revenue grew 6.6%; first-half revenue grew 6.9%. Management attributed growth mainly to inpatient rehabilitation pricing and volume, and home health and hospice volume.
- Q2 pre-tax continuing income declined to $107.8m from $123.7m, while first-half pre-tax income was $232.2m versus $240.2m. Higher expenses, including stock appreciation rights-related costs, weighed on results. Q2 net income attributable to the company was nearly flat; first-half net income rose 7.6%.
- Operating expenses increased 9.9% in Q2 and 9.2% in the first half, faster than revenue. Salaries and benefits rose 8.6% and 8.8%, respectively; general and administrative expenses rose 52.3% and 34.1%, including rebranding and other initiative costs.
- Segment Adjusted EBITDA increased: inpatient rehabilitation was $208.4m in Q2 and $413.8m in the first half; home health and hospice was $32.8m and $56.7m, respectively. Home health and hospice revenue increased 13.8% in Q2, alongside 19.7% admission growth, partly offset by a 1.5% decline in revenue per episode.
- Operating cash flow was $332.0m for the first half, versus $321.8m. Investing used $131.6m, including $99.9m for property and equipment; financing used $169.8m. Cash increased $30.6m to $71.1m.
- At June 30, cash was $71.1m; approximately $496m was available under the revolving credit facility. Restricted cash and restricted marketable securities were not included in cash equivalents. Current assets were $693.5m and current liabilities $493.3m.
- Debt carrying value was $2.663bn, down from $3.016bn at year-end 2016. The decrease principally reflected conversion of $319.4m of convertible notes into 8.9m common shares; the transaction generated a $10.4m early-extinguishment loss. The company reported compliance with credit agreement covenants and no significant debt maturities before 2020.
Changes, outlook, and notable items
- Inpatient rehabilitation discharges grew 3.5% in Q2, including 1.6% same-store growth; revenue per discharge increased 2.2%. Home health admission growth included 13.3% same-store growth. Management reported quality measures above relevant benchmarks.
- Management described its outlook as positive, citing aging demographics, its market position, and planned organic growth, acquisitions, and hospital development. It did not provide a consolidated full-year revenue or earnings forecast in the text provided.
- Management expected 2017 capital expenditures of $305m–$415m, including $130m–$150m described as nondiscretionary or maintenance spending. First-half property and equipment and capitalized software spending was approximately $110m.
- The board raised the quarterly dividend to $0.25 per share in July 2017, from $0.24. The company repurchased approximately $18m of stock in the first half; about $78m remained under its repurchase authorization at June 30.
- The rebranding was estimated to cost $25m–$30m over 2017–2019; $7m–$10m was expected in 2017. Management warned that cost, execution demands, and possible loss of established brand recognition could affect profitability or referrals.
- Regulatory exposure is significant: Medicare represented 75.3% of Q2 revenue. The 2018 inpatient rehabilitation final rule was estimated to increase the company’s Medicare payment rates by about 0.8%; the proposed 2018 home health rule was estimated to reduce industry payments by 0.4%. A proposed home health payment model could reduce payments by up to 4.3% in 2019 if implemented on a fully non-budget-neutral basis.
- Medicare claim denials and delayed appeals remain a risk. Management cited an approximately 70% historical success rate at administrative law judge hearings for claims it pursued, but appeals can take more than three years. The filing also describes a DOJ investigation concerning alleged improper or fraudulent claims; the company said it could not estimate a possible loss.
- A $20.0m jury verdict in the Honts matter was under appeal. At June 30, the company recorded a $20.4m liability and a $15.5m receivable for expected excess-insurance coverage. The long-running Nichols litigation dismissal was appealed; management said loss was not probable and could not be estimated.
- The IRS approved a tax accounting method change that generated approximately $56m in tax benefits through June 30, expected to reverse as disputed claims are settled and collected. The company estimated 2017 cash tax payments, net of refunds, of $95m–$115m.
Key investor verification points
- Check the durability of revenue and volume growth against rising labor and administrative costs, and reconcile GAAP results with Adjusted EBITDA.
- Track Medicare reimbursement rules, claim denials, appeal timing, and the status and potential financial impact of the DOJ inquiry.
- Confirm actual capital spending, debt reduction, revolver usage, covenant headroom, and the cash demands of dividends, repurchases, and redeemable noncontrolling interests.
- Monitor the Honts appeal and insurance recoveries, and assess the execution cost and referral effects of the Encompass rebranding.
- Assess the home health payment proposals and whether admission growth and productivity can offset lower revenue per episode and reimbursement pressure.