Encompass Health (then HealthSouth) — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017; unaudited. The company operated inpatient rehabilitation and home health and hospice businesses across 36 states and Puerto Rico. It announced a corporate rebrand to Encompass Health, effective January 1, 2018, with the NYSE ticker expected to change from HLS to EHC.
Financial and operating results
| Metric | Q3 2017 | Q3 2016 | First nine months 2017 | First nine months 2016 |
|---|---|---|---|---|
| Net operating revenues | $995.6 million | $926.8 million | $2,951.7 million | $2,757.3 million |
| Net income attributable to HealthSouth | $65.9 million | $61.7 million | $195.7 million | $182.3 million |
| Diluted EPS | $0.67 | $0.64 | $2.08 | $1.90 |
| Adjusted EBITDA | $204.6 million | $198.4 million | $614.9 million | $594.8 million |
| Cash from operations | Not provided for the quarter | Not provided for the quarter | $505.8 million | $499.4 million |
- Q3 revenue grew 7.4% year over year and nine-month revenue grew 7.1%. Q3 pre-tax income increased 6.7% to $128.3 million; nine-month pre-tax income was unchanged at $360.5 million.
- Operating expenses were 82.4% of revenue in Q3, compared with 80.9% a year earlier; for the nine-month periods, 82.3% versus 80.6%. Higher salaries, general and administrative costs, and hurricane-related costs weighed on expense ratios.
- Inpatient rehabilitation revenue increased 5.7% in Q3 and 5.5% year to date. Q3 discharges rose 3.8%, with same-store discharges up 1.4%; net patient revenue per discharge increased 2.2%.
- Home health and hospice revenue rose 14.7% in Q3 and 14.0% year to date. Home health admissions increased 15.5% in Q3, including 8.8% same-store growth, while average revenue per episode declined 0.3%. Segment Adjusted EBITDA rose 34.9% in Q3 to $34.8 million.
- Medicare represented 75.7% of consolidated Q3 revenue, up from 74.8% a year earlier.
Balance sheet, cash flow, and capital
- At September 30, cash and cash equivalents were $67.6 million, current assets $687.4 million, and current liabilities $511.2 million. The current ratio was approximately 1.34.
- Total debt carrying value was $2,622.4 million, down from $3,016.4 million at year-end 2016. Long-term debt, net of current portion, was $2,591.3 million. Shareholders’ equity was $1,373.2 million.
- Cash from operations of $505.8 million was largely offset by $209.2 million of investing outflows and $269.5 million of financing outflows. Cash increased $27.1 million from year-end. Property and equipment purchases were $155.7 million; acquisitions used $36.6 million.
- The company reported approximately $527 million available under its revolving credit facility and was in compliance with credit covenants. The facility capacity was increased to $700 million, its maturity extended to September 2022, and the term loan reduced to approximately $300 million. The maximum leverage covenant was 4.50x and minimum interest coverage covenant 3.0x.
- Restricted cash and restricted marketable securities were excluded from reported cash: $70.8 million and $59.9 million, respectively. These assets primarily related to captive insurance and joint-venture obligations.
- The company converted $319.4 million of convertible notes into 8.9 million common shares, reducing debt but increasing shares outstanding. It repurchased approximately $38 million of stock during the first nine months and raised its quarterly dividend to $0.25 per share.
Outlook, commentary, and material risks
- Management described its outlook as positive, citing aging demographics, demand for post-acute care, its market position, and continued organic and acquisition-led growth. The filing does not provide formal revenue or EPS guidance.
- Management expected 2017 capital expenditures of $255 million to $315 million, including $130 million to $150 million of maintenance expenditures, and $50 million to $100 million for home health and hospice acquisitions. Rebranding costs were estimated at $25 million to $30 million over 2017–2019, including $7 million to $10 million in 2017.
- The company estimated the FY2018 inpatient rehabilitation rule would increase its Medicare payment rates by approximately 0.8%. It did not expect its home health pricing impact in 2018 to differ substantially from the proposed industry decrease of 0.4%. CMS proposed a new home health payment model for 2019 that it estimated could reduce industry payments by up to 4.3% if implemented on a fully non-budget-neutral basis.
- Key exposures include Medicare reimbursement and claims audits, regulatory changes and alternative payment models, staffing availability and labor costs, competition, and execution of acquisitions and new facilities. Hurricanes Harvey, Irma, and Maria reduced volumes and added costs; management cited approximately $2.5 million of Q3 hurricane-related inpatient rehabilitation expenses and lower same-store volumes.
- Legal matters include a DOJ investigation into alleged improper Medicare and Medicaid claims; the company said the outcome and possible loss could not be estimated. In the Honts case, a $20 million jury verdict was under appeal; the company recorded a $20.2 million liability and a $15.5 million insurance-related receivable. The Nichols case dismissal was on appeal; management did not consider an adverse judgment or settlement probable.
- Other notable items included a $10.4 million second-quarter debt extinguishment loss related to convertible-note retirement, a $0.3 million third-quarter loss from the credit agreement amendment, and a $74.1 million increase in the fair value of redeemable noncontrolling interests during the first nine months.
Important facts for investors to verify
- Whether volume growth and the home health and hospice segment’s margin gains continue, particularly as average home health revenue per episode declines.
- The final effects of Medicare reimbursement rules, the proposed home health payment model, and delayed claims appeals on revenue, collections, and bad-debt provisions.
- Debt, covenant headroom, and potential cash needs related to redeemable noncontrolling interests, whose reported value was $221.3 million.
- Progress and actual costs of the rebrand, capital projects, acquisitions, and stated capital expenditure plans.
- Developments in the DOJ investigation and the Honts appeal, including any change to recorded liabilities or insurance recoveries.