Encompass Health (then HealthSouth Corporation) — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016; unaudited consolidated results. The filing identifies the registrant as HealthSouth Corporation, the company now known as Encompass Health.
Business context
The company provided inpatient rehabilitation, home health, and hospice services across 34 states and Puerto Rico. Inpatient rehabilitation generated about 82% of revenue and home health and hospice about 18%. Medicare represented 74.7% of Q2 revenue, underscoring exposure to government reimbursement.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $920.7m | $764.4m | $1,830.5m | $1,505.0m |
| Net income attributable to HealthSouth | $62.6m | $42.9m | $120.6m | $85.4m |
| Diluted EPS | $0.65 | $0.45 | $1.26 | $0.89 |
| Adjusted EBITDA | $204.3m | $169.5m | $396.4m | $325.6m |
| Operating cash flow | Not separately stated for quarter | Not separately stated for quarter | $311.9m | $204.9m |
- Q2 revenue rose 20.4% and six-month revenue 21.6%; growth primarily reflected the Reliant and CareSouth acquisitions, alongside volume growth.
- Q2 net income attributable to the company increased 45.9%; six-month net income increased 41.2%. Adjusted EBITDA increased 20.5% for Q2 and 21.7% for six months. Adjusted EBITDA margin was approximately 22.2% in Q2 and 21.7% for the six-month period, broadly similar to prior-year levels.
- Q2 inpatient rehabilitation revenue rose 16.6%; discharges increased 13.6%, including 1.9% same-store growth, while revenue per discharge increased 2.6%. Home health and hospice revenue rose 41.1%; admissions increased 52.7%, including 11.1% same-store growth, while revenue per episode fell 1.6%.
- Six-month capital expenditures, including capitalized software, were approximately $86.6m. Operating cash flow exceeded investing and financing outflows; cash increased to $70.3m from $61.6m at year-end.
Debt and liquidity
- June 30 total debt was $3,086.5m, including $150.0m drawn on the revolving facility; cash was $70.3m. Cash less total debt was approximately $3.02bn net debt.
- Current assets were $659.5m and current liabilities $459.1m. The company reported approximately $415m available under its revolving credit facility and compliance with its credit-agreement covenants.
- Debt redemptions of $50m principal each were completed in March and May, at a combined cash cost of about $104m; the company recorded $4.8m of debt-extinguishment losses in the first half. After quarter-end, it committed to redeem the remaining $76m of 2022 Notes for about $78m in September, expecting an additional roughly $3m loss.
- Net cash provided by operating activities was $311.9m, versus $204.9m in the prior-year half. Investing used $105.5m and financing used $197.7m, including debt redemptions, dividends, and share repurchases.
Changes, outlook, and risks
- Management attributed growth mainly to acquisitions of Reliant and CareSouth completed in 2015. Salaries and benefits rose 21.0% in Q2, occupancy costs 43.2%, and depreciation and amortization 31.2%; higher scale and acquired operations contributed to cost growth. Interest expense rose 40.5% in Q2, primarily due to increased average borrowings used to fund acquisitions.
- Management described the outlook as positive, citing aging demographics, demand for post-acute care, and the company’s scale and operating platform. It anticipated longer-term leverage reduction through EBITDA growth and allocation of some free cash flow to debt reduction.
- For fiscal 2016, capital spending was expected to be $185m–$225m. A proposed 2017 inpatient rehabilitation payment rule was estimated by management to increase its Medicare rates about 1.7%, before sequestration. The proposed home health rule was expected to reduce Encompass Medicare rates by 3%–4% in 2017 and could reduce Q4 2016 revenue by about $1.5m.
- On July 21, the board raised the quarterly dividend from $0.23 to $0.24 per share. Future dividends and repurchases remain subject to board discretion and financial constraints.
- Key risks include Medicare reimbursement changes and claim denials or delayed appeals, labor availability and costs, regulatory compliance, and integration of acquisitions. A DOJ investigation concerning alleged improper Medicare and Medicaid claims remained ongoing; the company said it could not predict its outcome.
- A jury returned a $20m verdict against a hospital subsidiary in the Honts case. The company recorded a $21m liability and a $15m insurance receivable, with a $5.7m additional net expense; post-judgment motions were pending and appeal was possible. In the Nichols litigation, the court dismissed the case, but plaintiffs appealed.
Most important facts for investors to verify
- How much reported growth and EBITDA improvement came from acquisitions versus same-store performance, and whether integration delivers expected benefits.
- Trends in Medicare claim denials, doubtful-account provisions, receivables, and cash collection delays.
- Final CMS payment rules and their actual impact on inpatient rehabilitation and home health reimbursement.
- Debt, covenant headroom, and liquidity after the planned 2022 Notes redemption, alongside the $185m–$225m capital-spending plan and shareholder returns.
- Developments in the DOJ investigation and Honts and Nichols proceedings, including insurance recovery and any additional exposure.