Encompass Health Corporation — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; filed May 2, 2018. Encompass Health, formerly HealthSouth, provides inpatient rehabilitation, home health, and hospice services in 36 states and Puerto Rico. The company changed its name and ticker to EHC effective January 1, 2018.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net operating revenue | $1,046.0 million | $957.1 million | +9.3% |
| Income from continuing operations | $105.7 million | $84.7 million | +24.8% |
| Net income attributable to Encompass Health | $83.8 million | $66.8 million | +25.4% |
| Diluted EPS | $0.84 | $0.70 | +$0.14 |
| Adjusted EBITDA, credit-agreement definition | $223.3 million | $200.8 million | +11.2% |
| Cash dividends per common share | $0.25 | $0.24 | +$0.01 |
- Operating expenses were $876.9 million, or 83.8% of revenue, versus $794.5 million, or 83.0%. General and administrative expense rose 67.4% to $61.1 million, largely due to compensation, stock appreciation rights, and rebranding costs.
- Segment revenue and Adjusted EBITDA: inpatient rehabilitation revenue was $840.3 million (+8.0%) and segment Adjusted EBITDA was $223.8 million (+9.0%); home health and hospice revenue was $205.7 million (+14.7%) and segment Adjusted EBITDA was $33.5 million (+40.2%).
- Operating cash flow was $216.3 million, up from $180.8 million. Investing cash use was $60.6 million; financing cash use was $116.7 million. Cash, cash equivalents, and restricted cash totaled $155.8 million at quarter-end, including $86.4 million of unrestricted cash.
- Quarter-end total debt was approximately $2.58 billion, including $32.7 million current and $2,544.4 million long-term debt. The company reported approximately $568 million available under its revolving credit facility and compliance with its credit covenants. No significant debt maturities were reported before 2022.
- Capital spending on property and equipment was $59.9 million in the cash flow statement; management reported approximately $64 million including capitalized software. Current assets were $708.5 million and current liabilities $572.0 million.
Material changes and operating drivers
- Revenue growth reflected inpatient rehabilitation discharge growth of 6.7% and a 1.7% increase in net patient revenue per discharge. Home health admissions rose 9.9%, while revenue per episode fell 1.5%.
- Home health revenue per episode included an approximately $4 million reserve related to a Zone Program Integrity Contractor audit; excluding the reserve, management said revenue per episode would have risen 0.7%.
- Interest expense fell 13.8%, primarily following redemption of convertible notes in 2017. Income tax expense declined to $30.0 million from $39.7 million, reflecting the Tax Cuts and Jobs Act.
- Comparative 2017 revenue was restated for adoption of ASC 606: reported revenue was reduced by $17.7 million, with doubtful-account provisions reclassified principally as implicit price concessions. The adoption did not change 2017 net income attributable to the company.
- In February 2018, the company paid approximately $65 million to acquire one-third of management investors’ home health and hospice equity interests. The remaining interests were valued at approximately $170 million at March 31.
- After quarter-end, on May 1, the company completed the approximately $135 million Camellia Healthcare acquisition, funded with cash and revolving-credit borrowings. Management expected a $20 million to $25 million present-value tax benefit.
Outlook, risks, and contingencies
- Management described its outlook as positive, citing aging demographics, growth opportunities, operating initiatives, and cash generation. It did not provide a full-year revenue or earnings forecast in this filing.
- For 2018, management expected capital expenditures of $280 million to $350 million, including $130 million to $150 million considered nondiscretionary, and home health and hospice acquisitions of $160 million to $185 million, inclusive of Camellia. Estimated cash tax payments, net of refunds, were $105 million to $135 million.
- CMS’s proposed FY2019 inpatient rehabilitation rule indicated a 1.35% net market-basket update; management estimated it could increase the company’s Medicare payment rates by approximately 1.2% beginning October 1, 2018. The estimate is subject to the final rule. Legislation also mandates a transition in 2020 from 60-day to 30-day home health payment units; the company said the effect was uncertain.
- Medicare represented 76.6% of consolidated revenue. Key risks include reimbursement changes, audits and claim denials, lengthy appeals, staffing availability and costs, competition, regulatory compliance, and uncertainty in alternative payment models.
- The company was cooperating with a DOJ investigation into alleged improper or fraudulent Medicare and Medicaid claims at certain hospitals, including matters related to the Medicare 60% rule. It could not estimate a possible loss.
- A $20 million jury verdict in the Honts case remained under appeal; the company recorded a $20.1 million liability and a $15.5 million receivable for expected excess-insurance coverage. In the Nichols litigation, the Alabama Supreme Court reversed dismissal and remanded the case; the company sought rehearing and said loss could not be estimated.
- The company estimated 2018 rebranding investment at $16 million to $19 million, with $3.6 million incurred in Q1. A 1% interest-rate increase was estimated to add approximately $3.4 million to cash interest over the next 12 months, assuming balances remained unchanged.
Most important facts for investors to verify
- Whether volume and pricing gains persist, particularly in inpatient rehabilitation and home health, and whether the approximately $4 million audit reserve proves adequate.
- The final CMS inpatient rehabilitation rule and the eventual effect of the 2020 home health payment-system changes.
- Cash flow and leverage after the Camellia acquisition, planned acquisition spending, capital expenditures, dividends, and any further repurchases of management-held interests.
- Developments, potential financial exposure, and appeal outcomes in the DOJ inquiry, Honts case, Nichols case, and Medicare claim audits.
- Actual rebranding costs, tax payments and benefits, and the impact of labor costs and staffing availability on margins.