Encompass Health (then HealthSouth Corporation) — FY 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. The filing reports annual results and unaudited quarterly data; it is not a standalone Q4 filing. The company provided inpatient rehabilitation and home health and hospice services across 35 states and Puerto Rico.
Financial and operating performance
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Net operating revenue | $3,707.2 million | $3,162.9 million |
| Operating earnings | $588.1 million | $485.7 million |
| Income from continuing operations | $318.1 million | $253.7 million |
| Net income attributable to HealthSouth | $247.6 million | $183.1 million |
| Diluted EPS | $2.59 | $1.91 |
| Cash from operating activities | $605.5 million | $484.8 million |
| Adjusted EBITDA | $793.6 million | $682.5 million |
| Capital expenditures | Approximately $203 million | Approximately $184 million |
- Revenue increased 17.2%; operating earnings increased 21.1%, and net income attributable to the company increased 35.2%. Growth principally reflected the full-year contribution of the 2015 Reliant and CareSouth acquisitions, alongside organic volume growth.
- Operating earnings margin was approximately 15.9%, versus 15.4% in 2015. Adjusted EBITDA margin was approximately 21.4%, versus 21.6%; Adjusted EBITDA is a non-GAAP measure.
- Inpatient rehabilitation generated $3,021.1 million in revenue and $797.2 million in segment Adjusted EBITDA. Discharges grew 10.8%, including 1.7% same-store growth; revenue per discharge rose 2.9%.
- Home health and hospice generated $686.1 million in revenue and $102.4 million in segment Adjusted EBITDA. Home health admissions rose 43.6%, including 13.7% same-store growth, while average revenue per episode declined 1.3%.
- Q4 2016: Revenue was $949.9 million, operating earnings $145.5 million, net income attributable to HealthSouth $65.3 million, and diluted EPS $0.68. The filing does not provide Q4 cash flow.
- Medicare and Medicare Advantage accounted for approximately 83.1% of consolidated revenue, making results highly exposed to reimbursement policy.
Liquidity, debt, and shareholder returns
- At year-end, cash and cash equivalents were $40.5 million; restricted cash and restricted marketable securities were $60.9 million and $57.7 million, respectively. The company reported approximately $415 million available on its revolving credit facility.
- Total debt, including current maturities and $279.3 million in capital lease obligations, was $3,016.4 million, down from $3,171.5 million. The company also reported $138.3 million of redeemable noncontrolling interests. Current assets of $654.5 million compared with current liabilities of $475.6 million.
- The credit agreement matures in 2020; management said there were no significant debt maturities before then. The debt schedule shows $836.2 million of principal due in 2020. The company reported compliance with its leverage and interest-coverage covenants at year-end.
- Operating cash flow increased by $120.7 million year over year. Investing used $245.0 million and financing used $381.6 million; year-end cash decreased $21.1 million.
- The company redeemed the remaining $176 million principal balance of its 7.75% notes due 2022 during 2016 and recorded $7.4 million in total debt-extinguishment losses. Interest expense rose to $172.1 million from $142.9 million.
- 2016 common dividends were $0.94 per share; the quarterly rate was raised to $0.24. The company repurchased 1.7 million shares for approximately $64.1 million.
Outlook, risks, and notable items
- Management described the outlook as positive, citing aging demographics, anticipated Medicare enrollee growth, its market position, and opportunities to expand through acquisitions, new hospitals, and agency development. It did not provide specific revenue or EPS guidance.
- Management forecast 2017 capital expenditures of $305–$415 million, including $130–$150 million characterized as nondiscretionary, and estimated 2017 cash income taxes of $120–$175 million, net of refunds. It anticipated reducing leverage over time through EBITDA growth and allocating some free cash flow to debt reduction.
- CMS’s 2017 inpatient rehabilitation rule was expected by management to increase its Medicare payment rates approximately 1.9% before sequestration. The 2017 home health rule was expected to reduce Medicare payment rates approximately 3.6%; the filing says this rule reduced Q4 2016 revenue by about $1.5 million for episodes spanning 2016 and 2017.
- Key uncertainties include potential Medicare rate reductions, site-neutral post-acute payment reforms, quality-based payment programs, claims audits and lengthy appeals, staffing costs and shortages, and integration and execution risks from acquisitions. Management also cited uncertainty about healthcare policy following the 2016 U.S. elections.
- The company disclosed an ongoing DOJ investigation into alleged improper or fraudulent Medicare and Medicaid claims at certain hospitals; it could not estimate a potential loss. Separately, a hospital subsidiary appealed a $20 million jury verdict; the company recorded a $21 million liability and a $15 million insurance receivable, for an additional net charge of $5.7 million in 2016.
- Management reported no goodwill impairment in 2016. The independent auditor gave an unqualified opinion on the financial statements and internal control over financial reporting; management also concluded controls were effective.
Important facts for investors to verify
- How much reported growth and margin performance reflects acquisitions versus comparable, same-store operations, particularly given the late-2015 Reliant and CareSouth deals.
- Trends in Medicare denials, receivables, and appeals: denied claims under prepayment review were $172.0 million at year-end, and administrative resolution can take years.
- The financial impact of 2017 home health reimbursement reductions, sequestration, and any subsequent site-neutral or value-based payment changes.
- Debt refinancing and covenant capacity ahead of the 2020 maturity concentration, alongside planned capital spending, dividends, and repurchases.
- Developments in the DOJ investigation and the appeal of the $20 million verdict, including insurance coverage and any resulting cash-flow effects.