Encompass Health Corporation (NYSE: EHC) — FY2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The filing also reports fourth-quarter results; it is an annual report, not a standalone Q4 filing. Financial amounts below are in U.S. dollars.
Business context
Encompass Health provides inpatient rehabilitation, home health and hospice services. At year-end it operated 130 inpatient rehabilitation hospitals and 278 home health and hospice locations across 36 states and Puerto Rico. The company changed its name from HealthSouth Corporation and ticker from HLS to EHC effective January 1, 2018.
Financial and operating performance
| Metric | FY2018 | FY2017 | Change |
|---|---|---|---|
| Net operating revenues | $4,277.3 million | $3,913.9 million | +9.3% |
| Income from continuing operations | $374.3 million | $350.6 million | +6.8% |
| Net income attributable to Encompass Health | $292.3 million | $271.1 million | +7.8% |
| Diluted EPS | $2.93 | $2.84 | +3.2% |
| Adjusted EBITDA | $901.0 million | $823.1 million | +9.5% |
| Net cash from operating activities | $762.4 million | $658.3 million | +$104.1 million |
Revenue growth reflected inpatient rehabilitation volume and pricing gains and home health and hospice volume growth. Inpatient rehabilitation revenue rose 6.5% to $3,346.2 million; home health and hospice revenue rose 20.5% to $931.1 million, including the May 2018 Camellia acquisition. Segment Adjusted EBITDA was $871.9 million for inpatient rehabilitation (+6.2%) and $162.4 million for home health and hospice (+29.0%).
Total operating expenses increased 11.7% to $3,647.7 million, faster than revenue; expenses were 85.3% of revenue versus 83.4% in 2017. The filing attributes the increase in part to a $52.0 million government, class-action and related settlement charge, including a $48 million accrual for the DOJ investigation, and higher general and administrative costs. Stock appreciation rights expense was approximately $56 million versus $26 million in 2017. Interest expense and debt-fee amortization declined to $147.3 million from $154.4 million.
Q4 comparison: Revenue was $1,096.0 million versus $1,008.8 million in Q4 2017. Operating earnings, as defined by the company, were $93.4 million versus $144.7 million; net income attributable to Encompass Health was $28.1 million versus $75.4 million; and diluted EPS was $0.28 versus $0.76. The filing identifies the fourth-quarter $48 million DOJ accrual as a key unusual expense. 2017 quarterly and annual results were revised for a deferred-tax error, including a $14.8 million reduction in 2017 tax expense; comparisons use the revised figures.
Cash, debt and liquidity: Year-end cash and cash equivalents were $69.2 million; an additional $64.3 million of restricted cash and $62.0 million of restricted marketable securities were not generally available for corporate use. Working capital was negative $10.4 million, compared with positive $184.7 million in 2017. Long-term debt including current maturities and capital leases totaled $2,514.4 million; approximately $2.3 billion was described as long-term debt excluding capital leases. The company had $30.0 million drawn on its $700 million revolving facility and approximately $633 million available. It reported compliance with credit covenants and no significant debt maturities before 2022.
Capital expenditures were approximately $276 million in 2018. Management expected 2019 capital expenditures of $375–$445 million, including $160–$170 million described as nondiscretionary, and expected $50–$100 million for home health and hospice acquisitions. Dividends paid in 2018 were $100.8 million; the quarterly rate was raised to $0.27 per share. No common stock repurchases were made during 2018 under the public repurchase program.
Material changes and outlook
- Inpatient rehabilitation discharges rose 4.6%, same-store discharges 2.8%, and revenue per discharge 2.2%. Home health admissions increased 10.0%, including same-store growth of 5.6%; home health revenue per episode decreased 0.5%. Hospice admissions increased 53.5%, reflecting acquisition and organic growth.
- Camellia added 18 hospice, 14 home health and two private-duty locations. The company also added hospitals, beds and other home health and hospice locations.
- Management described its outlook as positive, citing aging demographics, expected Medicare enrollment growth of approximately 3% annually, and expansion opportunities. It emphasized continued growth, integration of facility- and home-based care, and positioning for coordinated and value-based care models. No specific consolidated earnings or revenue guidance was provided in the supplied filing text.
- CMS payment updates discussed for 2019 were estimated by the company at approximately +1.2% for inpatient rehabilitation and +1.5% for home health. The 2020 home health Patient-Driven Groupings Model (PDGM) changes payment periods from 60 to 30 days and removes therapy volume as a case-mix factor. The company estimated an approximate 3.8% incremental Medicare payment reduction under its stated assumptions; CMS had also proposed, but not finalized, a 6.4% base-rate reduction. Impacts remained uncertain.
- Other material risks include Medicare concentration (Medicare and Medicare Advantage together represented about 85% of revenue), reimbursement and site-neutrality reforms, claim audits and lengthy appeals, staffing shortages and wage inflation, and acquisition integration. Management expected wage and benefit costs in 2019 to rise faster than aggregate Medicare reimbursement rates.
- The DOJ investigation concerns alleged improper or fraudulent Medicare and Medicaid claims at certain rehabilitation hospitals. Encompass Health said it was cooperating and was aware of no fraud, falsity or wrongdoing; it accrued $48 million based on an estimated settlement value, but discussions were ongoing and no settlement was assured. The filing also describes other litigation, including a case remanded for a new trial.
- The company disclosed a November 2018 vendor-payment spoofing incident involving less than $1 million; the funds were frozen and returned in January 2019. It reported no known material cyber breach. The auditor issued an unqualified opinion on the financial statements and internal controls; management also concluded controls were effective.
Key facts for investors to verify
- Track the DOJ investigation and whether its resolution differs from the $48 million accrued estimate.
- Assess the actual reimbursement, volume and margin effects of PDGM and CARE Tool assessment changes, and any further CMS or legislative action.
- Reconcile earnings growth with faster operating-expense growth, the Q4 earnings decline, elevated stock appreciation rights expense and other unusual charges.
- Monitor cash conversion, working capital, restricted cash, debt and covenant headroom alongside the planned capital spending, acquisitions and shareholder distributions.
- Review the revised 2017 comparative figures and the filing’s deferred-tax correction when making year-over-year comparisons.