Encompass Health Corporation — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods. Encompass Health provides inpatient rehabilitation, home health and hospice services. The company changed its name from HealthSouth effective January 1, 2018.
Financial performance and liquidity
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net operating revenue | $1,067.6m | $981.6m | $3,181.3m | $2,905.1m |
| Income from continuing operations | $109.4m | $85.2m | $328.1m | $249.1m |
| Net income attributable to Encompass Health | $88.6m | $65.9m | $264.2m | $195.7m |
| Diluted EPS | $0.89 | $0.67 | $2.65 | $2.08 |
| Adjusted EBITDA | $224.3m | $204.6m | $679.2m | $614.9m |
- Q3 revenue grew 8.8%; net income attributable to the company rose 34.4%. Nine-month revenue and attributable net income increased 9.5% and 35.0%, respectively.
- Q3 operating expenses were 83.8% of revenue versus 83.5% a year earlier; operating margin, calculated as revenue less operating expenses, was approximately 16.2% versus 16.5%. The nine-month operating margin was approximately 16.3% versus 16.5%.
- Operating cash flow for the first nine months was $584.0m, up from $506.9m. Capital expenditures and capitalized software totaled about $184.7m; investing cash outflow was $326.3m, including $135.8m of net acquisition spending. Cash, cash equivalents and restricted cash increased $4.2m to $121.0m.
- At September 30, cash and cash equivalents were $56.9m, current assets $638.0m and current liabilities $609.6m. Restricted cash and restricted securities are not generally available for ordinary corporate liquidity. The company reported approximately $595m available under its revolving facility.
- Total debt, including current maturities, was approximately $2.541bn, compared with $2.578bn at year-end 2017. Debt maturities were described as having no significant amount before 2022. The company reported compliance with its credit agreement covenants; maximum leverage and minimum interest coverage thresholds were 4.50x and 3.0x.
- Q3 segment Adjusted EBITDA was $212.9m for inpatient rehabilitation and $43.2m for home health and hospice. Nine-month amounts were $660.2m and $118.3m, respectively.
Material changes and operating drivers
- Inpatient rehabilitation revenue grew 5.4% in Q3 and 6.9% year to date, supported by discharge growth and higher revenue per discharge. Q3 discharges rose 3.0%, including 2.0% same-store growth; revenue per discharge increased 2.2%.
- Home health and hospice revenue grew 22.2% in Q3 and 20.2% year to date. Growth included the Camellia acquisition, higher home health admissions and strong hospice growth. Home health revenue per episode declined 0.4% in Q3 and 0.7% year to date.
- The May 2018 Camellia acquisition expanded home health and hospice operations in the Southeast. The company reported $129.7m net cash paid for Camellia. It also acquired smaller hospice businesses and developed or expanded inpatient rehabilitation capacity.
- General and administrative expense rose 25.7% in Q3 and 29.0% year to date, principally due to compensation, stock appreciation rights and rebranding. Rebranding expense was $8.3m for the first nine months; the company estimated approximately $11m–$13m for 2018.
- Year-to-date operating cash flow benefited from revenue growth and improved receivable collection amid fewer claim denials. Investing outflows rose largely because of acquisitions. Financing included a $65.1m purchase of home health and hospice management equity interests.
Outlook, risks and unusual items
- Management described the outlook as positive, citing aging-related demand, organic growth, new facilities and acquisitions. The filing does not provide a full-year revenue or earnings forecast. It expected 2018 capital expenditures of $285m–$350m and home health and hospice acquisition spending of $145m–$155m, including Camellia.
- Management estimated the FY2019 inpatient rehabilitation final rule would increase its Medicare payment rates by about 1.2%. It estimated the proposed 2019 home health rule would raise its rates about 1.6%. The proposed 2020 Patient-Driven Groupings Model could reduce Medicare payments by approximately 5.4% if implemented budget-neutral, based on 2017 data and stated assumptions; the impact remains uncertain.
- Key exposures include Medicare reimbursement and claim audits, lengthy appeals, potential extrapolation of audit findings, staffing availability and costs, regulatory changes, competition, and execution of acquisitions and new developments. Medicare represented 75.4% of Q3 revenue.
- The company disclosed an ongoing DOJ investigation relating to alleged improper or fraudulent Medicare and Medicaid claims at certain hospitals; it could not estimate a potential loss. A long-running shareholder lawsuit was remanded for further proceedings, with the company stating an adverse outcome was not probable and loss could not be estimated. In another case, an Alabama Supreme Court reversal resulted in a new trial; a liability remained on the balance sheet, but the filing does not provide a clear September 30 amount.
- The Honts reversal and other legal developments, rebranding costs, and the Tax Act’s possible effect on tax treatment of denied claims are notable items. The company estimated 2018 cash income taxes, net of refunds, at $110m–$120m. It also increased its quarterly dividend from $0.25 to $0.27 per share.
Important facts for investors to verify
- Whether revenue and EBITDA growth persists after separating same-store growth from acquisitions and checking the related margins and integration costs.
- Medicare payment-rule developments, especially the 2020 home health payment model, and the effect of claim denials, audits and appeals on revenue and cash collections.
- Available borrowing capacity, covenant headroom, debt service and the funding needs of planned capital spending, acquisitions and shareholder distributions.
- Final acquisition valuations and performance, including Camellia, and the eventual cash requirements associated with redeemable noncontrolling interests and stock appreciation rights.
- Updates on the DOJ investigation and litigation matters, including the outcome and financial exposure in the retrial case.