Encompass Health Corporation — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2018. Encompass Health provides inpatient rehabilitation, home health, and hospice services. Effective January 1, 2018, it changed its name from HealthSouth Corporation; its ticker changed from HLS to EHC.
Financial performance
Amounts are in millions, except per-share data. Comparisons are with the corresponding 2017 period.
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net operating revenue | $1,067.7 | $966.4 | $2,113.7 | $1,923.5 |
| Income from continuing operations | $113.0 | $79.2 | $218.7 | $163.9 |
| Net income attributable to Encompass Health | $91.8 | $63.0 | $175.6 | $129.8 |
| Diluted EPS | $0.92 | $0.70 | $1.76 | $1.42 |
| Adjusted EBITDA | $231.6 | $209.5 | $454.9 | $410.3 |
| Net cash provided by operating activities | Not provided for quarter | Not provided for quarter | $385.5 | $332.0 |
- Q2 revenue grew 10.5%; six-month revenue grew 9.9%. Q2 net income attributable to the company rose 45.7%, and six-month net income rose 35.3%.
- Q2 segment Adjusted EBITDA was $223.5 million for inpatient rehabilitation, up 7.2%, and $41.6 million for home health and hospice, up 26.8%. Six-month segment amounts were $447.3 million, up 8.1%, and $75.1 million, up 32.5%, respectively.
- Q2 operating expenses were 83.5% of revenue versus 83.9% a year earlier; six-month operating expenses were 83.6% versus 83.5%. Salaries and benefits declined as a share of revenue, while other operating expenses increased as a share.
- At June 30, cash and cash equivalents were $59.0 million and restricted cash was $65.8 million. Current assets were $671.6 million and current liabilities $573.9 million. Restricted cash and restricted securities are not equivalent to freely available cash.
- Reported debt was $2,636.5 million: $36.0 million current and $2,600.5 million long-term. The company reported about $512 million of availability under its revolving credit facility and compliance with its leverage and interest-coverage covenants. No significant debt maturities were identified before 2022.
- Six-month investing cash outflow was $261.0 million, including $135.8 million for acquisitions and $108.8 million for property and equipment. Financing cash outflow was $116.5 million. Cash, cash equivalents, and restricted cash increased by $8.0 million.
Material changes and operating drivers
- Inpatient rehabilitation revenue increased 7.3% in Q2. Discharges grew 5.2%, including same-store growth of 3.6%; net patient revenue per discharge rose 2.5%.
- Home health and hospice revenue increased 23.5% in Q2. Home health admissions rose 10.4%, including same-store growth of 5.1%; revenue per episode declined 0.2%. Hospice revenue growth reflected admission growth and acquisitions.
- Growth reflected volume and pricing, new locations, and the May 1 acquisition of Camellia Healthcare. Camellia contributed $13.7 million of revenue from acquisition through June 30; its preliminary purchase accounting included $97.0 million of goodwill. The company expects a $20 million to $25 million present-value tax benefit from the transaction.
- Interest expense declined from 2017, primarily because the 2.0% convertible notes were redeemed in June 2017. The prior-year comparison included a $10.4 million loss on early extinguishment of debt; there was no such charge in 2018.
- Six-month cash from operations rose to $385.5 million from $332.0 million, which management attributed mainly to revenue growth and improved receivable collections following fewer claims denials. Investing outflows increased substantially, principally because of Camellia.
- Comparative 2017 revenue was retrospectively adjusted for ASC 606: bad-debt provisions were reclassified as implicit price concessions reducing revenue. The change did not affect reported net income attributable to the company for the comparative periods.
Outlook, risks, and unusual items
- Management described its outlook as positive, citing aging-related demand and growth opportunities, but the filing does not provide a clear consolidated revenue or earnings forecast for 2018.
- Management expected 2018 capital expenditures of $280 million to $350 million, including $130 million to $150 million described as nondiscretionary, and home health and hospice acquisition spending of $160 million to $185 million, inclusive of Camellia. Estimated 2018 cash tax payments, net of refunds, were $105 million to $135 million.
- The board declared a quarterly dividend of $0.27 per share on July 24, 2018, payable October 15, 2018. The board also reset the share repurchase authorization to $250 million; authorization does not require purchases.
- CMS’s final FY2019 inpatient rehabilitation rule was expected by the company to increase its Medicare payment rates approximately 1.2% from October 1, 2018. The proposed CY2019 home health rule was expected by the company to increase rates approximately 1.6%. These are management estimates, not guaranteed outcomes.
- For the proposed home health Patient-Driven Groupings Model, scheduled for 2020, the company estimated an approximately 5.4% Medicare payment reduction under a budget-neutral implementation, based on 2017 data and assumptions. Management said the ultimate impact was uncertain.
- Key risks include Medicare and Medicaid reimbursement changes, claims audits and delayed appeals, staffing shortages and labor costs, regulatory compliance, competition, acquisition integration, and dependence on Medicare (75.5% of Q2 revenue). CMS may suspend payments during certain investigations.
- Contingencies include a DOJ investigation concerning alleged improper or fraudulent claims at certain hospitals; the company said it could not estimate a possible loss. A separate Alabama case had a $20.0 million jury verdict under appeal; the company recorded a $20.1 million liability and a $15.5 million insurance-related receivable at June 30. The Nichols litigation was remanded for further proceedings; management said an adverse outcome was not probable and loss could not be estimated.
- Rebranding costs were estimated at $16 million to $19 million for 2018; $6.4 million had been incurred in the first half. The fair value of management stock appreciation rights was approximately $65 million at June 30, including $36 million in current accrued liabilities.
Important facts for investors to verify
- Track the effect of the 2020 home health payment-model changes and subsequent CMS rules on reimbursement and margins.
- Monitor Medicare claim denials, audit appeals, collection estimates, and developments in the DOJ investigation and Alabama litigation.
- Assess Camellia integration, final purchase-accounting values, acquisition returns, and planned acquisition and capital spending.
- Reconcile freely available liquidity with restricted cash and securities, revolving-facility usage, debt balances, and covenant headroom.
- Evaluate whether volume growth, labor productivity, and expense trends support continued improvement in profitability; note that 2017 revenue comparatives were restated under ASC 606.