Encompass Health Corporation — FY2020 Form 10-K
Reporting period: Year ended December 31, 2020. The filing also reports fourth-quarter results; this is an annual report, not a standalone quarterly filing.
Business context
Encompass Health provides post-acute care through inpatient rehabilitation hospitals and home health and hospice agencies. At year-end it operated 137 hospitals, 241 home health locations and 82 hospice locations across 39 states and Puerto Rico. Inpatient rehabilitation accounted for about 77% of FY2020 revenue, and home health and hospice about 23%.
Financial performance and liquidity
| Metric | FY2020 | FY2019 |
|---|---|---|
| Net operating revenue | $4.644 billion | $4.605 billion |
| Operating expenses | $3.999 billion | $3.913 billion |
| Income from continuing operations | $368.8 million | $446.4 million |
| Net income attributable to Encompass Health shareholders | $284.2 million | $358.7 million |
| Diluted earnings per share | $2.85 | $3.61 |
| Net cash from operating activities | $704.7 million | $635.3 million |
| Adjusted EBITDA | $860.3 million | $964.9 million |
| Cash and cash equivalents at year-end | $224.0 million | $94.8 million |
| Long-term debt, including current portion | $3.289 billion | $3.063 billion |
Revenue increased 0.9%, while shareholder-attributable net income fell 20.8%. Operating expenses rose 2.2%; salaries and benefits increased 4.2% and supplies rose 19.4%, reflecting pandemic-related costs and lower productivity. Operating cash flow improved, but the company attributed part of the increase to payroll accrual timing and deferred payroll taxes. Capital expenditures were approximately $408 million, making operating cash flow less capital expenditures approximately $297 million.
The filing’s reported operating earnings were $563.9 million versus $612.1 million; this is a company-defined measure, not GAAP operating income. GAAP operating income calculated as revenue less operating expenses was $645.0 million, or about 13.9% of revenue. Consolidated net income margin was about 7.9%; shareholder-attributable net income margin was about 6.1%.
Segment results: inpatient rehabilitation revenue rose 1.5% to $3.566 billion and Segment Adjusted EBITDA fell 8.5% to $823.0 million. Home health and hospice revenue declined 1.3% to $1.078 billion and Segment Adjusted EBITDA fell 16.6% to $163.3 million. Home health revenue decreased 4.4%, while hospice revenue increased 15.3%.
At December 31, unrestricted cash was $224.0 million and approximately $963 million was available under the revolving credit facility; no revolver balance was outstanding. The company reported covenant compliance. Debt maturities were described as having no significant amounts due before 2023, though the credit facility matures in 2024. The annual dividend was $1.12 per share; the board declared a subsequent quarterly dividend of $0.28 per share.
Fourth quarter: Revenue was $1.214 billion versus $1.184 billion in Q4 2019; net income attributable to shareholders was $86.0 million versus $67.6 million, and diluted EPS was $0.86 versus $0.68.
Material changes versus prior year
- COVID-19 reduced patient volumes in both segments from mid-March, amid postponed elective procedures, referral constraints, patient concerns and access restrictions. Volumes improved from their April lows, but remained exposed to renewed disruption.
- Inpatient rehabilitation discharges fell 2.6%; same-store discharges declined 4.4%. Net patient revenue per discharge rose 4.9%, supported by pricing, higher acuity and the temporary suspension of Medicare sequestration.
- Home health episodic admissions were nearly flat overall, but same-store episodic admissions declined 6.1%. Revenue per episode decreased 2.3%, with the new Patient-Driven Groupings Model (PDGM) contributing to lower pricing.
- Home health and hospice Segment Adjusted EBITDA was pressured by pandemic effects, PDGM, higher costs and administrative expenses. In inpatient rehabilitation, higher supplies costs and pandemic-related paid time off also weighed on results.
- Operating cash flow increased, while investing cash outflow fell substantially, in part because 2019 included the Alacare acquisition. Financing cash flow included refinancing activity and repayment of the 2024 notes.
Outlook, commentary, risks and unusual items
- Management cited aging demographics as a long-term demand driver but cautioned that the pandemic’s duration and effects remained uncertain. It expected increased wage and benefit costs in 2021 to outpace aggregate Medicare reimbursement growth.
- For 2021, the company planned to add six to ten inpatient rehabilitation hospitals, spend approximately $580–$665 million on capital expenditures, and pursue $50–$100 million of home health and hospice acquisitions. Some development projects could be delayed by the pandemic.
- Management estimated 2021 Medicare rate increases of approximately 2.3% for inpatient rehabilitation and 1.9% for home health; the CMS hospice update was 2.4%. Four home health and hospice agencies were expected to receive reimbursement reductions for quality-reporting issues.
- In December 2020, the company began a formal review of strategic alternatives for home health and hospice, including a possible IPO, spin-off, merger or sale. There was no established timetable and no assurance a transaction would occur.
- The CARES Act and subsequent legislation suspended Medicare sequestration through March 2021. The company estimated the 2020 suspension increased revenue by $49.3 million ($35.3 million in inpatient rehabilitation and $14.0 million in home health and hospice). It refused and returned provider relief funds and said it intended to refuse future distributions.
- The company accrued approximately $43 million in Q2 2020 for additional paid time off for eligible frontline employees. It issued senior notes during 2020 and redeemed the remaining $700 million of 5.75% notes due 2024, recording a $2.3 million early-extinguishment loss.
- Medicare and Medicare Advantage together represented 84.7% of consolidated revenue. Key risks include reimbursement reductions, regulatory and quality requirements, staffing shortages, supply cost inflation, audit denials and lengthy appeals, cyber incidents, litigation, and debt covenants.
- At year-end, $117.8 million of inpatient rehabilitation patient receivables represented claims under review or audit. The filing also describes a prior UPIC audit in which less than $2 million of denials led to an approximately $30 million extrapolated recoupment, which the company appealed.
- The company disclosed two suits on behalf of former patients alleging COVID-19 exposure at one hospital. It stated it did not believe pending legal proceedings were material, while noting that outcomes and potential liabilities can be uncertain.
Most important facts for investors to verify
- Whether patient volumes and referral activity recover sustainably, and how future COVID-19 waves affect staffing, occupancy and costs.
- How PDGM and other reimbursement rules affect home health pricing, margins and cash conversion; confirm the company’s estimated 2021 rate impacts against realized results.
- The status, collectability and timing of the $117.8 million of audited or disputed inpatient rehabilitation receivables and related appeals.
- Whether the home health and hospice strategic review results in a transaction, and the effects on valuation, debt, operations and capital allocation.
- Whether labor, PPE and other operating cost growth continues to exceed reimbursement increases, and whether planned capital spending and acquisitions remain affordable.
- Debt covenant headroom, refinancing terms and capacity for dividends or repurchases; reported Adjusted EBITDA is a non-GAAP, company-defined measure.