ENCOMPASS HEALTH CORPORATION
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations ("MD&A") relates to Encompass Health Corporation and its
subsidiaries and should be read in conjunction with our condensed consolidated
financial statements included under Part I, Item 1, Financial Statements
(Unaudited), of this report. In addition, the following MD&A should be read in
conjunction with our audited consolidated financial statements for the year
ended December 31, 2021 , Part II, Item 7, Management's Discussion and Analysis
of Financial Condition and Results of Operations, Part I, Item 1, Business, and
Item 1A, Risk Factors, included in our Annual Report on Form 10-K for the year
ended December 31, 2021 filed on February 25, 2022 (collectively, the "2021 Form
10K").
This MD&A is designed to provide the reader with information that will assist in
understanding our condensed consolidated financial statements, the changes in
certain key items in those financial statements from period to period, and the
primary factors that accounted for those changes, as well as how certain
accounting principles affect our condensed consolidated financial statements.
See "Cautionary Statement Regarding Forward-Looking Statements" on page ii of
this report, which is incorporated herein by reference for a description of
important factors that could cause actual results to differ from expected
results. See also Item 1A, Risk Factors, of this report and to the 2021 Form
10K.
Executive Overview
Our Business
We are the nation's largest owner and operator of inpatient rehabilitation
hospitals in terms of patients treated, revenues, and number of hospitals. We
provide specialized rehabilitative treatment on predominantly an inpatient
basis. We operate hospitals in 36 states and Puerto Rico , with concentrations in
the eastern half of the United States and Texas . As of September 30, 2022 , we
operate 153 inpatient rehabilitation hospitals and manage two inpatient
rehabilitation units through management contracts.For additional information
about our business, see Item 1, Business, of the 2021 Form 10K.
The onset of the COVID-19 Pandemic (the "pandemic") in the United States
resulted in significant changes to our operating environment. For discussion of
the financial and operational impacts we have experienced as a result of the
pandemic, see Item 1, Business, Item 1A, Risk Factors, and Item 7, Management's
Discussion and Analysis of Financial Condition and Results of Operations,
"Results of Operations" and "Segment Results of Operations" of the 2021 Form
10-K. For discussion of the financial and operational impacts we are
experiencing in 2022 as a result of the pandemic, see "Key Challenges" below and
the "Results of Operations" section of this Item.
Separation of
OnJuly 1, 2022 , we completed the previously announced separation of our home health and hospice business through the distribution (the "Distribution") of all of the outstanding shares of common stock, par value$0.01 per share, of Enhabit, Inc. ("Enhabit") to the stockholders of record ofEncompass Health as of the close of business onJune 24, 2022 (the "Record Date"). The Distribution was effective at12:01 a.m., Eastern Time , onJuly 1, 2022 . The Distribution was structured as a pro rata distribution of one share of Enhabit common stock for every two shares ofEncompass Health common stock held of record as of the Record Date. No fractional shares were distributed. A cash payment was made in lieu of any fractional shares. As a result of the Distribution, Enhabit is now an independent public company and its common stock is listed under the symbol "EHAB" on theNew York Stock Exchange (the "Separation"). In accordance with applicable accounting guidance, the historical results of Enhabit have been presented as discontinued operations and, as such, have been excluded from continuing operations for all periods presented. Our presentation of discontinued operations excludes any allocation of general corporate and overhead costs as well as interest expense. Prior toJuly 1, 2022 , we operated under two reporting segments. We now operate under a single reporting segment. For additional information see Note 2, Separation ofHome Health and Hospice Business, to the condensed consolidated financial statements included in Part I, Item 1, Financial Statements (Unaudited), of this report. In connection with the Distribution, onJune 30, 2022 , we entered into several agreements with Enhabit that govern the relationship of the parties following the Distribution, including a Separation and Distribution Agreement, a Transition Services Agreement, a Tax Matters Agreement and an Employee Matters Agreement. See also Note 2, Separation ofHome Health and 18 --------------------------------------------------------------------------------
Hospice Business, to the condensed consolidated financial statements included in Part I, Item 1, Financial Statements (Unaudited), of this report.
2022 Overview
During the three and nine months endedSeptember 30, 2022 , Net operating revenues increased 7.8% and 8.0% over the same periods of 2021 due primarily to volume growth. See "Results of Operations" section of this Item for additional volume and pricing information.
We continued our development and expansion efforts in 2022. We:
•began operating our new 40-bed inpatient rehabilitation hospital in
•began operating our new 40-bed inpatient rehabilitation hospital in
•began operating our new 60-bed inpatient rehabilitation hospital in
•began operating our new 50-bed inpatient rehabilitation hospital in
•began operating our new 40-bed inpatient rehabilitation hospital in
•began operating our new 50-bed inpatient rehabilitation hospital in
•began operating our new 40-bed inpatient rehabilitation hospital in
•began operating our new 40-bed inpatient rehabilitation hospital inMoline, Illinois with our joint venture partnerUnityPoint Health - Trinity inAugust 2022 ;
•began operating our new 50-bed inpatient rehabilitation hospital in
•continued our capacity expansions by adding 87 new beds to existing hospitals; and
19
--------------------------------------------------------------------------------•announced or continued the development of the following hospitals:
Number of New Beds
Expected Opening 2023 2024(2) 2025(2)
Eau Claire, Wisconsin(1) 36 - -
Owasso, Oklahoma(1) 40 - -
Clermont, Florida 50 - -
Knoxville, Tennessee(1) 73 - -
Bowie, Maryland 60 - -
Prosper, Texas 40 - -
Columbus, Georgia(1) 40 - -
Fitchburg, Wisconsin 56 - -
Kissimmee, Florida - 50 -
Fort Mill, South Carolina - 39 -
Atlanta, Georgia(1) - 40 -
Louisville, Kentucky(1) - 40 -
Houston, Texas - 60 -
Lake Worth, Florida - 50 -
Fort Myers, Florida(1) - - 60
Palm Beach Gardens, Florida - - 50
Amarillo, Texas - - 40
Strongsville, Ohio - - 40
Norristown, Pennsylvania - - 50
Wildwood, Florida - - 50
Athens, Georgia(1) - - 40
St. Petersburg, Florida - - 50
(1) Expected joint venture
(2) Opening dates are tentative
We also continued our shareholder distributions. InOctober 2021 ,February 2022 , andMay 2022 , our board of directors declared cash dividends of$0.28 per share that were paid inJanuary 2022 ,April 2022 , andJuly 2022 , respectively. InJuly 2022 , our board of directors declared a cash dividend of$0.15 per share that was paid onOctober 17, 2022 . OnOctober 19, 2022 , our board of directors declared a cash dividend of$0.15 per share, payable onJanuary 17, 2023 to stockholders of record onJanuary 3, 2023 . For additional information see the "Liquidity and Capital Resources" section of this Item.
Business Outlook
Notwithstanding the current impacts from the pandemic, we remain optimistic regarding the intermediate and long-term prospects for our business. Demographic trends, such as population aging, should continue to increase long-term demand for the services we provide. While we treat patients of all ages, most of our patients are 65 and older, and the number of Medicare enrollees is expected to grow approximately 3% per year for the foreseeable future, reaching approximately 73 million people over the age of 65 by 2030. Even more specifically, the average age of our patients is approximately 76, and the population group ranging in ages from 75 to 79 is expected to grow at approximately 5% per year through 2026. We believe the demand for the services we provide will continue to increase as theU.S. population ages. We believe these factors align with our strengths in, and focus on, post-acute services. In addition, we believe we can address the demand for facility-based post-acute care services in markets where we currently do not have a presence by constructing or acquiring new hospitals. We are committed to delivering high-quality, cost-effective, integrated patient care. As the nation's largest owner and operator of inpatient rehabilitation hospitals in terms of patients treated, revenues, and number of hospitals, we believe we differentiate ourselves from our competitors based on the quality of our clinical outcomes, our cost-effectiveness, our financial strength, and our extensive application of technology. 20 -------------------------------------------------------------------------------- Although the healthcare industry is currently engaged in addressing the healthcare crisis caused by the pandemic, the industry also faces the prospect of ongoing efforts to transform the healthcare system to coordinated care delivery and payment models. The nature, timing and extent of that transformation remains uncertain, as the development and implementation of new care delivery and payment systems will require significant time and resources. Our short-term goal is to serve our communities and provide the best care possible during the pandemic. Our long-term goal is to position the Company in a prudent manner to be responsive to industry shifts. We have invested in our core business and created an infrastructure that enables us to provide high-quality care on a cost-effective basis. We have been disciplined in creating a capital structure that is flexible with no significant debt maturities prior to 2025. We continue to have a strong, well-capitalized balance sheet, including a substantial portfolio of owned real estate and significant availability under our revolving credit facility. For these and other reasons, we believe we will be able to adapt to changes in reimbursement, sustain our business model, and grow through acquisition and consolidation opportunities as they arise. See also Item 1, Business, "Competitive Strengths" and "Strategy and 2022 Strategic Priorities" of the 2021 Form 10K.
Key Challenges
Healthcare is a highly regulated industry facing many well-publicized regulatory
and reimbursement challenges. Medicare reimbursement for inpatient
rehabilitation facilities ("IRFs") has recently undergone significant changes.
The future of many aspects of healthcare regulation remains uncertain.
Successful healthcare providers are those able to adapt to changes in the
regulatory and operating environments, build strategic relationships across the
healthcare continuum, and consistently provide high-quality, cost-effective
care. We believe we have the necessary capabilities-change agility, strategic
relationships, quality of patient outcomes, cost effectiveness, and ability to
capitalize on growth opportunities-to adapt to and succeed in a dynamic, highly
regulated industry, and we have a proven track record of doing so. For a
detailed discussion of the challenges we face, see Item 7, Management's
Discussion and Analysis of Financial Condition and Results of Operations,
"Executive Overview-Key Challenges" of the 2021 Form 10K.
As we continue to execute our business plan, the following are some of the challenges we face.
•Operating in a Highly Regulated Industry. We are required to comply with extensive and complex laws and regulations at the federal, state, and local government levels. More specifically, because Medicare comprises a significant portion of our Net operating revenues, failure to comply with the laws and regulations governing the Medicare program and related matters, including anti-kickback and anti-fraud requirements, could materially and adversely affect us. These rules and regulations have affected, or could in the future affect, our business activities by having an impact on the reimbursement we receive for services provided or the costs of compliance, mandating new documentation standards, requiring additional licensure or certification, regulating our relationships with physicians and other referral sources, regulating the use of our properties, and limiting our ability to enter new markets or add new capacity to existing hospitals. Ensuring continuous compliance with extensive laws and regulations is an operating requirement for all healthcare providers. See Item 1, Business, "Regulation," Item 1A, Risk Factors, and Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, "Executive Overview-Key Challenges," of the 2021 Form 10K for detailed discussions of the most important regulations we face and our programs intended to ensure we comply with those regulations. •Changes to Our Operating Environment Resulting from the pandemic. Since the beginning of the pandemic, healthcare providers have experienced staffing and supply shortages and associated cost increases. In response to the public health emergency associated with the pandemic,Congress and theCenters for Medicare & Medicaid Services ("CMS") adopted several statutory and regulatory measures intended to provide relief to healthcare providers in order to ensure patients would continue to have adequate access to care. OnMarch 27, 2020 , formerPresident Trump signed into law the Coronavirus Aid, Relief, and Economic Security Act of 2020 (the "CARES Act"), which suspended sequestration, an automatic 2% reduction of Medicare program payments for all healthcare providers, for the period ofMay 1 through December 31, 2020 . The sequestration suspension was extended a number of times. Sequestration resumed as ofApril 1, 2022 , but was only a 1% payment reduction throughJune 30, 2022 . OnJuly 1, 2022 , the full 2% Medicare payment reduction resumed. During the nine months endedSeptember 30, 2022 , the sequestration suspension provided additional revenues of approximately$24 million . The CARES Act and CMS regulatory actions include a number of other provisions affecting our reimbursement and operations in both segments. These provisions are discussed in Item 1, Business, "Sources of Revenue," Item 1A, Risk Factors, and Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, "Results of Operations" of the 2021 Form 10-K. 21 -------------------------------------------------------------------------------- •Changes to Our Operating Environment Resulting from Federal Regulatory and Legislative Actions. OnJuly 27, 2022 , CMS released its notice of final rulemaking for fiscal year 2023 for IRFs (the "2023 Final IRF Rule") under the inpatient rehabilitation facility prospective payment system (the "IRF-PPS"). The 2023 Final IRF Rule will implement a net 3.9% market basket increase (market basket update of 4.2% reduced by a productivity adjustment of 0.3%) effective for discharges betweenOctober 1, 2022 andSeptember 30, 2023 . The 2023 Final IRF Rule also includes changes that impact our hospital-by-hospital base rate for Medicare reimbursement. Such changes include, but are not limited to, revisions to the wage index, updates to outlier payments and updates to the case-mix group relative weights and average lengths of stay values. Based on our analysis that utilizes, among other things, the acuity of our patients annualized over a twelve-month period endedJune 30, 2022 , our experience with outlier payments over this same time frame, and other factors, we believe the 2023 Final IRF Rule will result in a net increase to our Medicare payment rates of approximately 4.0% effectiveOctober 1, 2022 . The proposed rulemaking for fiscal year 2023 for the IRF-PPS included a request for comment on a potential change that could be included in future rulemaking. Based on a recentUnited States Department of Health andHuman Services Office of Inspector General ("HHS-OIG") report, CMS is considering whether to modify the IRF "transfer" payment policy to reduce reimbursement for early discharges to home health, similar to how early discharges to acute care hospitals, skilled nursing facilities, long-term acute care hospitals, or another IRF, are currently treated under the IRF-PPS. HHS-OIG estimated that its recommended change to the policy could reduce total IRF industry reimbursements by approximately 6% based on 2017 and 2018 data. In the 2023 Final IRF Rule, CMS acknowledged industry comments on the policy and noted those comments would be taken under advisement for future rulemaking. OnDecember 14, 2020 , CMS announced the proposal of a five-year review choice demonstration ("RCD") for inpatient rehabilitation services. CMS plans to implement the demonstration inAlabama , and then expand toPennsylvania ,Texas , andCalifornia . The timing of this demonstration is not known. We operate 46 hospitals (representing approximately 33% of our IRF Medicare claims) in those four states. After the initial four states, CMS intends to expand the demonstration to include additional IRFs based on the Medicare Administrative Contractor to which those IRFs submit claims. Under the demonstration, participating IRFs would have an initial choice between pre-claim or post-payment review of 100% of claims submitted to demonstrate compliance with applicable Medicare coverage and clinical documentation requirements. Under the pre-claim review choice, services could begin prior to the submission of the review request and continue while the decision is being made. The pre-claim review request with required documentation must be submitted and reviewed before the final claim is submitted for payment. Under the post-payment review choice, IRFs would provide services, submit all claims for payment following their normal processes, and then submit required documentation for medical review. If after six months of being in the demonstration, 90% or more of its claims are found to be valid, the IRF may then opt out of the RCD review, except for spot reviews of samples consisting of 5% of total claims. The IRF RCD would not create new documentation requirements. A number of key details on this proposal have yet to be released, and it is not clear how or when this demonstration will be implemented. •Maintaining Strong Volume Growth. As described in our 2021 Form 10K, we believe a number of conditions related to the pandemic negatively impacted volumes in 2021. While we continue to see our volumes recover, as discussed in the "Results of Operations" section of this Item, a current or future resurgence of COVID-19 infections could cause disruptions to our volume growth. •Recruiting and Retaining High-Quality Personnel. See Item 1A, Risk Factors, of the 2021 Form 10K for a discussion of competition for staffing, shortages of qualified personnel, and other factors that may increase our labor costs and constrain our ability to take new patients. Additionally, our operations have been affected and may in the future be affected by staffing shortages where employees must self-quarantine due to exposure to COVID-19, where employees are unavailable due to a lack of childcare or care for elderly family, or due to competition within the local market. These factors have resulted in increased labor costs, including significant sign-on and shift bonuses, and increased use of contract labor as discussed in the "Results of Operations" section of this Item. We remain confident in the prospects of our business based on the increasing demands for the services we provide to an aging population. This confidence is further supported by our strong financial foundation and the substantial investments we have made in our businesses. We have a proven track record of working through difficult situations, and we believe in our ability to overcome current and future challenges. 22 --------------------------------------------------------------------------------
Results of Operations
Payor Mix
We derived consolidated Net operating revenues from the following payor sources:
Three Months Ended September 30, Nine Months Ended September 30,
2022 2021 2022 2021
Medicare 65.3 % 64.2 % 65.0 % 64.4 %
Medicare Advantage 15.0 % 15.1 % 15.0 % 15.6 %
Managed care 11.6 % 12.2 % 11.9 % 11.8 %
Medicaid 4.4 % 4.1 % 4.3 % 4.1 %
Other third-party payors 0.9 % 1.0 % 0.9 % 1.1 %
Workers' compensation 0.6 % 0.6 % 0.6 % 0.6 %
Patients 0.3 % 0.5 % 0.4 % 0.5 %
Other income 1.9 % 2.3 % 1.9 % 1.9 %
Total 100.0 % 100.0 % 100.0 % 100.0 %
For additional information regarding our payors, see the "Sources of Revenues" section of Item 1, Business, of the 2021 Form 10K.
23
--------------------------------------------------------------------------------Our Results
Our consolidated results of operations were as follows:
Three Months Ended September 30, Percentage Change Nine Months Ended September 30, Percentage Change
2022 2021 2022 vs. 2021 2022 2021 2022 vs. 2021
(In Millions, Except Percentage Change)
Net operating revenues $ 1,089.5 $ 1,010.8 7.8 % $ 3,211.3 $ 2,972.4 8.0 %
Operating expenses:
Salaries and benefits 605.6 537.0 12.8 % 1,778.9 1,554.8 14.4 %
Other operating expenses 172.0 151.4 13.6 % 500.3 442.2 13.1 %
Occupancy costs 12.4 14.5 (14.5) % 41.6 44.5 (6.5) %
Supplies 51.1 46.7 9.4 % 148.2 136.0 9.0 %
General and administrative expenses 37.9 38.9 (2.6) % 111.5 123.7 (9.9) %
Depreciation and amortization 62.1 55.5 11.9 % 180.3 162.9 10.7 %
Total operating expenses 941.1 844.0 11.5 % 2,760.8 2,464.1 12.0 %
Loss on early extinguishment of debt - - - % 1.4 1.0 40.0 %
Interest expense and amortization of debt
discounts and fees 38.2 39.9 (4.3) % 138.2 124.3 11.2 %
Other expense (income) 3.6 (0.5) (820.0) % 13.6 (4.8) (383.3) %
Equity in net income of nonconsolidated
affiliates (0.7) (0.9) (22.2) % (2.6) (2.5) 4.0 %
Income from continuing operations before
income tax expense 107.3 128.3 (16.4) % 299.9 390.3 (23.2) %
Provision for income tax expense 21.8 26.2 (16.8) % 68.2 79.4 (14.1) %
Income from continuing operations 85.5 102.1 (16.3) % 231.7 310.9 (25.5) %
(Loss) income from discontinued
operations, net of tax (18.5) 24.6 (175.2) % 16.7 90.6 (81.6) %
Net income 67.0 126.7 (47.1) % 248.4 401.5 (38.1) %
Less: Net income attributable to
noncontrolling interests included in
continuing operations (21.6) (26.3) (17.9) % (65.5) (79.6) (17.7) %
Less: Net income attributable to
noncontrolling interests included in
discontinued operations - (0.4) (100.0) % (1.3) (1.3) - %
Less: Net and comprehensive income
attributable to noncontrolling interests (21.6) (26.7) (19.1) % (66.8) (80.9) (17.4) %
Net income attributable to Encompass
Health $ 45.4 $ 100.0 (54.6) % $ 181.6 $ 320.6 (43.4) %
24
--------------------------------------------------------------------------------
Operating Expenses as a % of Net Operating Revenues
Three Months Ended September 30, Nine Months Ended September 30,
2022 2021 2022 2021
Operating expenses:
Salaries and benefits 55.6 % 53.1 % 55.4 % 52.3 %
Other operating expenses 15.8 % 15.0 % 15.6 % 14.9 %
Occupancy costs 1.1 % 1.4 % 1.3 % 1.5 %
Supplies 4.7 % 4.6 % 4.6 % 4.6 %
General and administrative expenses 3.5 % 3.8 % 3.5 % 4.2 %
Depreciation and amortization 5.7 % 5.5 % 5.6 % 5.5 %
Total operating expenses 86.4 % 83.5 % 86.0 % 82.9 %
Additional information regarding our operating results is as follows:
Three Months Ended September 30, Percentage Change Nine Months Ended September 30, Percentage Change
2022 2021 2022 vs. 2021 2022 2021 2022 vs. 2021
(In Millions, Except Percentage Change)
Net operating revenues:
Inpatient $ 1,064.6 $ 983.7 8.2 % $ 3,138.6 $ 2,902.9 8.1 %
Outpatient and other 24.9 27.1 (8.1) % 72.7 69.5 4.6 %
Net operating revenues $ 1,089.5 $ 1,010.8 7.8 % $ 3,211.3 $ 2,972.4 8.0 %
(Actual Amounts)
Discharges 53,743 49,983 7.5 % 156,416 146,662 6.7 %
Net patient revenue per discharge $ 19,809 $ 19,681 0.7 % $ 20,066 $ 19,793 1.4 %
Outpatient visits 34,348 38,904 (11.7) % 105,506 123,118 (14.3) %
Average length of stay (days) 12.7 12.8 (0.8) % 12.8 12.8 - %
Occupancy % 71.4 % 70.6 % 1.1 % 70.6 % 70.0 % 0.9 %
# of licensed beds 10,356 9,846 5.2 % 10,356 9,846 5.2 %
Full-time equivalents* 24,580 23,054 6.6 % 23,847 22,657 5.3 %
Employees per occupied bed 3.39 3.37 0.6 % 3.34 3.33 0.3 %
* Full-time equivalents included in the above table represent our employees who participate in or support the operations of our hospitals and exclude an estimate of full-time equivalents related to contract labor.
We actively manage the productive portion of our Salaries and benefits utilizing certain metrics, including employees per occupied bed, or "EPOB." This metric is determined by dividing the number of full-time equivalents, including an estimate of full-time equivalents from the utilization of contract labor, by the number of occupied beds during each period. The number of occupied beds is determined by multiplying the number of licensed beds by our occupancy percentage. In the discussion that follows, we use "same-store" comparisons to explain the changes in certain performance metrics and line items within our financial statements. We calculate same-store comparisons based on hospitals open throughout both the full current periods and prior periods presented. These comparisons include the financial results of market consolidation transactions in existing markets, as it is difficult to determine, with precision, the incremental impact of these transactions on our results of operations.
Net Operating Revenues
Inpatient revenue increased during the three months endedSeptember 30, 2022 compared to the same period of 2021 primarily due to increased volumes. Discharge growth included a 4.1% increase in same-store discharges. Discharge growth 25
-------------------------------------------------------------------------------- from new stores during the three months endedSeptember 30, 2022 compared to the same period of 2021 resulted from our joint ventures inHenry County, Georgia (October 2021 ),Shiloh, Illinois (February 2022 ),Cape Coral, Florida (June 2022 ),Moline, Illinois (August 2022 ), andGrand Forks, North Dakota (August 2022 ), as well as wholly owned hospitals inWaco, Texas (August 2021 ),Shreveport, Louisiana (August 2021 ),Greenville, South Carolina (August 2021 ),Pensacola, Florida (September 2021 ),St. Augustine, Florida (March 2022 ),Libertyville, Illinois (March 2022 ),Lakeland, Florida (May 2022 ), andJacksonville, Florida (June 2022 ). Growth in net patient revenue per discharge during the three months endedSeptember 30, 2022 compared to the same period of 2021 primarily resulted from an increase in reimbursement rates offset by the resumption of sequestration onApril 1, 2022 . Growth in revenues, discharges, and net patient revenue per discharge for the nine months endedSeptember 30, 2022 were impacted primarily by the same factors as discussed above for the third quarter of 2022. Discharge growth included a 2.9% increase in same-store discharges. Discharge growth from new stores during the nine months endedSeptember 30, 2022 compared to the same period of 2021 also resulted from our joint venture inSan Angelo, Texas (March 2021 ) as well as wholly owned hospitals inNorth Tampa, Florida (April 2021 ) andCumming, Georgia (June 2021 ).
Salaries and Benefits
Salaries and benefits increased during the three and nine months endedSeptember 30, 2022 compared to the same periods of 2021 and as a percent of Net operating revenues primarily due to increases in contract labor and clinician compensation, including sign-on and shift bonuses, to meet higher patient volumes and paid time off usage ($49.0 million and$168.9 million during the three and nine months endedSeptember 30, 2022 , respectively, compared to approximately$33.3 million and$82.9 million in the same periods of 2021, respectively), and the ramp up of new stores.
Other Operating Expenses
Other operating expenses increased in terms of dollars and as a percent of revenue during the three and nine months endedSeptember 30, 2022 compared to the same periods of 2021 primarily due to increased provider taxes and higher costs associated with travel, recruiting, and utilities.
General and Administrative Expenses
General and administrative expenses decreased in terms of dollars and as a percent of revenue during the three and nine months endedSeptember 30, 2022 compared to the same periods of 2021 primarily due to the mark-to-market adjustments on non-qualified 401k plan, approximately$1 million of transition services revenue, and lower incentive compensation. For additional information of the transition services agreement with Enhabit, see Note 2, Separation ofHome Health and Hospice Business, to the condensed consolidated financial statements included in Part I, Item 1, Financial Statements (Unaudited), of this report.
Depreciation and Amortization
Depreciation and amortization increased during the three and nine months endedSeptember 30, 2022 compared to the same periods of 2021 due to our capital investments. We expect Depreciation and amortization to increase going forward as a result of our recent and ongoing capital investments.
Interest Expense and Amortization of Debt Discounts and Fees
The increase in Interest expense and amortization of debt discounts and fees during the nine months endedSeptember 30, 2022 compared to the same period of 2021 primarily resulted from the$20.5 million consent solicitation fee paid inJune 2022 partially offset by theMarch 2022 redemption of the remaining$100 million in outstanding principal amount of the 5.125% Senior Notes due 2023 (the "2023 Notes"). For additional information, see Note 5, Long-term Debt, to the condensed consolidated financial statements included in Part I, Item 1, Financial Statements (Unaudited), of this report.
Income from Continuing Operations Before Income Tax Expense
Our pre-tax income from continuing operations decreased during the three and
nine months ended
26
--------------------------------------------------------------------------------Provision for Income Tax Expense
Our Provision for income tax expense decreased during the three months endedSeptember 30, 2022 compared to the same period of 2021 primarily due to lower Income from continuing operations before income tax expense and the release of a portion of an uncertain tax position related to the separation of our home health and hospice business, partially offset by state rate and apportionment changes. Our Provision for income tax expense decreased during the nine months endedSeptember 30, 2022 compared to the same period of 2021 primarily due to lower Income from continuing operations before income tax expense, partially offset by the establishment of an uncertain tax position related to the separation of our home health and hospice business. We currently estimate our cash payments for income taxes to be approximately$50 million to$60 million , net of refunds, for 2022. These payments are expected to primarily result from federal and state income tax expenses based on estimates of taxable income for 2022. In certain jurisdictions, we do not expect to generate sufficient income to use all of the available state net operating losses and other credits prior to their expiration. This determination is based on our evaluation of all available evidence in these jurisdictions including results of operations during the preceding three years, our forecast of future earnings, and prudent tax planning strategies. It is possible we may be required to increase or decrease our valuation allowance at some future time if our forecast of future earnings varies from actual results on a consolidated basis or in the applicable tax jurisdiction, if the timing of future tax deductions differs from our expectations, or pursuant to changes in state tax laws and rates. See Note 9, Income Taxes, to the condensed consolidated financial statements included in Part I, Item 1, Financial Statements (Unaudited), of this report and Note 16, Income Taxes, to the consolidated financial statements accompanying the 2021 Form 10K.
Net Income Attributable to Noncontrolling Interests
The decrease in Net income attributable to noncontrolling interests during the three and nine months endedSeptember 30, 2022 compared to the same periods of 2021 resulted from the ramp up of new joint venture de novo locations and decreased profitability from certain existing joint venture hospitals.
Liquidity and Capital Resources
Our primary sources of liquidity are cash on hand, cash flows from operations, and borrowings under our revolving credit facility.
The objectives of our capital structure strategy are to ensure we maintain adequate liquidity and flexibility. Pursuing and achieving those objectives allow us to support the execution of our operating and strategic plans and weather temporary disruptions in the capital markets and general business environment. Maintaining adequate liquidity is a function of our unrestricted Cash and cash equivalents and our available borrowing capacity. Maintaining flexibility in our capital structure is a function of, among other things, the amount of debt maturities in any given year, the options for debt prepayments without onerous penalties, and limiting restrictive terms and maintenance covenants in our debt agreements. Consistent with these objectives, inMarch 2022 , we redeemed the remaining$100 million in outstanding principal amount of the 2023 Notes using capacity under our revolving credit facility. Pursuant to the terms of the 2023 Notes, this optional redemption was made at a price of par. As a result of this redemption, we recorded a$0.3 million Loss on early extinguishment of debt during the three months endedMarch 31, 2022 . InJune 2022 , we amended our credit agreement primarily in preparation for the separation of the home health and hospice business. The modifications are described in Note 5, Long-term Debt, to the accompanying condensed consolidated financial statements included in Part I, Item 1, Financial Statements (Unaudited), of this report. OnJune 30, 2022 , Enhabit distributed$566.6 million toEncompass Health who used it to fully repay both the$250 million outstanding balance of theEncompass Health revolving credit facility and approximately$236 million of theEncompass Health term loan. As a result of this repayment, we recorded a$1.1 million Loss on early extinguishment of debt during the three months endedJune 30, 2022 . InOctober 2022 ,Encompass Health entered into the Sixth Amended and Restated Credit Agreement primarily to extend the maturity date toOctober 7, 2027 . 27 -------------------------------------------------------------------------------- We have been disciplined in creating a capital structure that is flexible with no significant debt maturities prior to 2025. We continue to have a strong, well-capitalized balance sheet, including a substantial portfolio of owned real estate, and we have significant availability under our revolving credit facility. We continue to generate strong cash flows from operations and we have significant flexibility with how we choose to invest our cash and return capital to shareholders.
For additional information, see Note 5, Long-term Debt, to the accompanying condensed consolidated financial statements included in Part I, Item 1, Financial Statements (Unaudited), of this report, and Note 10, Long-term Debt, to the consolidated financial statements accompanying the 2021 Form 10K.
Current Liquidity
As ofSeptember 30, 2022 , we had$59.8 million in Cash and cash equivalents. This amount excludes$44.3 million in Restricted cash and$98.5 million of restricted marketable securities ($28.5 million included in Other current assets and$70.0 million included in Other long-term assets in our condensed consolidated balance sheet). Our restricted assets pertain primarily to obligations associated with our captive insurance company, as well as obligations we have under agreements with joint venture partners. See Note 4,Cash and Marketable Securities , to the consolidated financial statements accompanying the 2021 Form 10K. In addition to Cash and cash equivalents, as ofSeptember 30, 2022 , we had approximately$927 million available to us under our revolving credit facility. Our credit agreement governs the substantial majority of our senior secured borrowing capacity and contains a leverage ratio and an interest coverage ratio as financial covenants. Our leverage ratio is defined in our credit agreement as the ratio of consolidated total debt (less cash on hand) to Adjusted EBITDA for the trailing four quarters. In calculating the leverage ratio under our credit agreement, we are permitted to use pro forma Adjusted EBITDA, the calculation of which includes historical income statement items and pro forma adjustments, subject to certain limitations, resulting from (1) dispositions and repayments or incurrence of debt and (2) investments, acquisitions, mergers, amalgamations, consolidations and other operational changes to the extent such items or effects are not yet reflected in our trailing four-quarter financial statements. Our interest coverage ratio is defined in our credit agreement as the ratio of Adjusted EBITDA to consolidated interest expense, excluding the amortization of financing fees, for the trailing four quarters. As ofSeptember 30, 2022 , the maximum leverage ratio requirement per our credit agreement was 4.75x and the minimum interest coverage ratio requirement was 3.0x, and we were in compliance with these covenants. Based on Adjusted EBITDA for the trailing four quarters and the interest rate in effect under our credit agreement during the three-month period endedSeptember 30, 2022 , if we had drawn on the first day and maintained the maximum amount of outstanding draws under our revolving credit facility for that entire period, we would still be in compliance with the maximum leverage ratio and minimum interest coverage ratio requirements. OnDecember 9, 2021 , we announced the commencement of a consent solicitation of holders of our 5.75% Senior Notes due 2025, 4.50% Senior Notes due 2028 (the "2028 Notes"), 4.75% Senior Notes due 2030 (the "2030 Notes"), and 4.625% Senior Notes due 2031 (the "2031 Notes" and collectively the "Notes") for the adoption of certain amendments to an indenture (the "Base Indenture") dated as ofDecember 1, 2009 , as supplemented by each Notes' respective supplemental indenture (together with the Base Indenture, the "Indenture"), which provided us with greater flexibility in effecting the spin off discussed in the "Executive Overview" section of this Item. Each Indenture contains restrictive covenants that, among other things, limit our ability and the ability of certain of our subsidiaries to make certain asset dispositions, investments, and distributions to holders of our capital stock. The amendments to the Indentures permit us, subject to the leverage ratio condition set forth below, to distribute to our equity holders in one or more transactions (a "Distribution") some or all of the common stock of a subsidiary that holds substantially all of the assets of our home health and hospice business. We may make any such distribution so long as the Leverage Ratio (as defined in each Indenture) is no more than 3.5 to 1.0 on a pro forma basis after giving effect thereto. The amendments also reduce the capacity under our restricted payments builder basket under each existing Indenture for the 2028 Notes, 2030 Notes, and 2031 Notes by$200 million and amends the definition of "Consolidated Net Income" to allow us to exclude from Consolidated Net Income (a component of the Leverage Ratio) any fees, expenses or charges related to any Distribution and the solicitation of consents from the holders of the Notes. InDecember 2021 andJanuary 2022 , we received the requisite consents for the adoption of these amendments. Under the terms of the amendments, we agreed to pay the holders of the Notes a total of$40.5 million , excluding fees. We paid$20.0 million and$20.5 million in January andJune 2022 , respectively. We do not face near-term refinancing risk, as the amounts outstanding under our credit agreement do not mature until 2027, and our bonds all mature in 2025 and beyond. See the "Contractual Obligations" section below for information related to our contractual obligations as ofSeptember 30, 2022 . For a discussion of risks and uncertainties facing us see Item 1A, Risk Factors, under Part II, Other Information, of this report and Item 1A, Risk Factors, of the 2021 Form 10K. 28
--------------------------------------------------------------------------------
Sources and Uses of Cash
The following table shows the cash flows provided by or used in operating, investing, and financing activities of continuing operations (in millions):
Nine Months Ended
2022 2021
Net cash provided by operating activities $ 477.6 $ 458.5
Net cash used in investing activities (417.0) (346.0)
Net cash used in financing activities (645.3) (273.2)
Decrease in cash, cash equivalents, and restricted cash $
(584.7)
Operating activities. The increase in Net cash provided by operating activities of continuing operations for the nine months endedSeptember 30, 2022 compared to the same period of 2021 primarily resulted from improved collection of accounts receivable. Investing activities. The increase in Net cash used in investing activities of continuing operations during the nine months endedSeptember 30, 2022 compared to the same period of 2021 primarily resulted from higher payments related to our capital investments. Financing activities. The increase in Net cash used in financing activities of continuing operations during the nine months endedSeptember 30, 2022 compared to the same period of 2021 primarily resulted from higher net debt payments in 2022. For additional information on debt borrowings and payments, see Note 5, Long-term Debt, to the accompanying condensed consolidated financial statements included in Part I, Item 1, Financial Statements (Unaudited), of this report.
Contractual Obligations
Our consolidated contractual obligations as ofSeptember 30, 2022 are as follows (in millions): Total Current Long-term Long-term debt obligations: Long-term debt, excluding revolving credit facility and finance lease obligations (a)$ 2,339.1 $ 5.4$ 2,333.7 Revolving credit facility 40.0 - 40.0 Interest on long-term debt (b) 698.6 117.7 580.9 Finance lease obligations (c) 563.5 48.6 514.9 Operating lease obligations (d) 276.3 36.8 239.5 Purchase obligations (e) 88.4 27.7 60.7 Total$ 4,005.9 $ 236.2 $ 3,769.7 (a) Included in long-term debt are amounts owed on our bonds payable and other notes payable. These borrowings are further explained in Note 5, Long-term Debt, accompanying the condensed consolidated financial statements included in Part I, Item 1, Financial Statements (Unaudited), of this report, and Note 10, Long-term Debt, to the consolidated financial statements accompanying the 2021 Form 10K. (b) Interest on our fixed rate debt is presented using the stated interest rate. Interest expense on our variable rate debt is estimated using the rate in effect as ofSeptember 30, 2022 . Interest pertaining to our credit agreement and bonds is included to their respective ultimate maturity dates. Interest related to finance lease obligations is excluded from this line. Amounts exclude amortization of debt discounts, amortization of loan fees, or fees for lines of credit that would be included in interest expense in our condensed consolidated statements of comprehensive income.
(c) Amounts include interest portion of future minimum finance lease payments.
29
--------------------------------------------------------------------------------
(d) We lease approximately 8% of our hospitals as well as other property and
equipment under operating leases in the normal course of business. Amounts
include interest portion of future minimum operating lease payments. For more
information, see Note 7, Leases, to the consolidated financial statements
accompanying the 2021 Form 10K.
(e) Purchase obligations include agreements to purchase goods or services that
are enforceable and legally binding on Encompass Health and that specify all
significant terms, including: fixed or minimum quantities to be purchased;
fixed, minimum, or variable price provisions; and the approximate timing of the
transaction. Purchase obligations exclude agreements that are cancelable without
penalty. Our purchase obligations primarily relate to software licensing and
support and medical equipment. Purchase obligations are not recognized in our
condensed consolidated balance sheet.
Our capital expenditures include costs associated with our hospital renovation
program, de novo projects, capacity expansions, technology initiatives, and
building and equipment upgrades and purchases. During the nine months ended
September 30, 2022 , we made capital expenditures of approximately $390 million
for property and equipment, capitalized software, and other intangible assets.
During 2022, we expect to spend approximately $537 million to $582 million for
capital expenditures using cash on hand and borrowings under our revolving
credit facility. Approximately $195 million to $215 million of this budgeted
amount is considered nondiscretionary expenditures, which we may refer to in
other filings as "maintenance" expenditures. Actual amounts spent will be
dependent upon the timing of development projects.
Authorizations for
InOctober 2021 ,February 2022 , andMay 2022 , our board of directors declared cash dividends of$0.28 per share that were paid inJanuary 2022 ,April 2022 , andJuly 2022 respectively. InJuly 2022 , our board of directors declared a cash dividend of$0.15 per share that was paid onOctober 17, 2022 . OnOctober 19, 2022 , our board of directors declared a cash dividend of$0.15 per share, payable onJanuary 17, 2023 to stockholders of record onJanuary 3, 2023 . We expect quarterly dividends to be paid in January, April, July, and October. However, the actual declaration of any future cash dividends, and the setting of record and payment dates as well as the per share amounts, will be at the discretion of our board of directors after consideration of various factors, including our capital position and alternative uses of funds. Cash dividends are expected to be funded using cash flows from operations, cash on hand, and availability under our revolving credit facility. OnJuly 24, 2018 , our board approved resetting the aggregate common stock repurchase authorization to$250 million . As ofSeptember 30, 2022 , approximately$198 million remained under this authorization. The repurchase authorization does not require the repurchase of a specific number of shares, has an indefinite term, and is subject to termination at any time by our board of directors. Subject to certain terms and conditions, including a maximum price per share and compliance with federal and state securities and other laws, the repurchases may be made from time to time in open market transactions, privately negotiated transactions, or other transactions, including trades under a plan established in accordance with Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. For additional information, see Part II, Item 2, Unregistered Sales ofEquity Securities and Use of Proceeds, of this report.
Supplemental Guarantor Financial Information
Our indebtedness under our credit agreement and the Notes are guaranteed by certain consolidated subsidiaries. These guarantees are full and unconditional and joint and several, subject to certain customary conditions for release. The Notes are guaranteed on a senior, unsecured basis by all of our existing and future subsidiaries that guarantee borrowings under our credit agreement and other capital markets debt. The other subsidiaries ofEncompass Health do not guarantee the Notes (such subsidiaries are referred to as the "non-guarantor subsidiaries"). The terms of our credit agreement allow us to declare and pay cash dividends on our common stock so long as: (1) we are not in default under our credit agreement, and (2) either (a) our senior secured leverage ratio (as defined in our credit agreement) remains less than or equal to 2x and our leverage ratio (as defined in our credit agreement) remains less than or equal to 4.50x or (b) our leverage ratio remains in compliance with the leverage ratio covenant and there is capacity under the Available Amount as defined in the credit agreement. The terms of our Notes indenture allow us to declare and pay cash dividends on our common stock so long as (1) we are not in default, (2) the consolidated coverage ratio (as defined in the indenture) exceeds 2x or we are otherwise allowed under the indenture to incur debt, and (3) we have capacity under the indenture's restricted payments covenant to declare and pay dividends. See Note 5, Long-term Debt, to the accompanying condensed consolidated financial statements included in Part I, Item 1, Financial Statements (Unaudited), of this report, and Note 10, Long-term Debt, to the consolidated financial statements accompanying the 2021 Form 10K. 30 -------------------------------------------------------------------------------- Summarized financial information is presented below forEncompass Health , the parent company, and the subsidiary guarantors on a combined basis after elimination of intercompany transactions and balances amongEncompass Health and the subsidiary guarantors and does not include investments in and equity in the earnings of non-guarantor subsidiaries. Amounts for prior periods have been revised to reflect the status of guarantors and non-guarantors as ofSeptember 30, 2022 . The subsidiaries associated with our home health and hospice business (collectively, the "HH&H Subsidiaries") were guarantors as ofJune 30, 2022 . OnJuly 1, 2022 , we completed the previously announced separation of our home health and hospice business through the distribution (the "Distribution") of all of the outstanding shares of common stock of Enhabit, Inc. toEncompass Health stockholders. The Distribution was effective at12:01 a.m., Eastern Time , onJuly 1, 2022 , at which time the HH&H Subsidiaries were released from their guarantees of our indebtedness. Nine Months Ended September 30, 2022 (In Millions) Net operating revenues $ 2,128.4 Intercompany revenues generated from non-guarantor subsidiaries 15.1 Total net operating revenues $ 2,143.5 Operating expenses $ 1,856.0 Intercompany expenses incurred in transactions with non-guarantor subsidiaries 23.9 Total operating expenses $ 1,879.9 Income from continuing operations $ 83.0 Net income $ 44.8 Net income attributable to Encompass Health $ 44.1 As of As of September 30, 2022 December 31, 2021 (In Millions) Total current assets $ 515.0 $ 501.1 Property and equipment, net $ 1,981.0 $ 1,852.3 Goodwill 902.6 902.6 Intercompany receivable due from non-guarantor subsidiaries 174.4 28.1 Other noncurrent assets 479.8 337.1 Total noncurrent assets $ 3,537.8 $ 3,120.1 Total current liabilities $ 484.3 $ 491.8 Long-term debt, net of current portion $ 2,673.4 $ 3,191.0 Other noncurrent liabilities 277.5 237.4 Total noncurrent liabilities $ 2,950.9 $ 3,428.4 Adjusted EBITDA
Management believes Adjusted EBITDA as defined in our credit agreement is a measure of our ability to service our debt and our ability to make capital expenditures. We reconcile Adjusted EBITDA to Net income and to Net cash provided by operating activities.
We use Adjusted EBITDA on a consolidated basis as a liquidity measure. We
believe this financial measure on a consolidated basis is important in analyzing
our liquidity because it is the key component of certain material covenants
contained within our credit agreement, which is discussed in more detail in
Note 10, Long-term Debt, to the consolidated financial statements accompanying
the 2021 Form 10K. These covenants are material terms of the credit agreement.
Noncompliance with these financial covenants under our credit agreement-our
interest coverage ratio and our leverage ratio-could result in our lenders
requiring us to immediately repay all amounts borrowed. If we anticipated a
potential covenant
31
--------------------------------------------------------------------------------
violation, we would seek relief from our lenders, which would have some cost to
us, and such relief might be on terms less favorable to us than those in our
existing credit agreement. In addition, if we cannot satisfy these financial
covenants, we would be prohibited under our credit agreement from engaging in
certain activities, such as incurring additional indebtedness, paying common
stock dividends, making certain payments, and acquiring and disposing of assets.
Consequently, Adjusted EBITDA is critical to our assessment of our liquidity.
In general terms, the credit agreement definition of Adjusted EBITDA, therein
referred to as "Adjusted Consolidated EBITDA," allows us to add back to
consolidated Net income interest expense, income taxes, and depreciation and
amortization and then add back to consolidated Net income (1) all unusual or
nonrecurring items reducing consolidated Net income (of which only up to $10
million in a year may be cash expenditures), (2) any losses from discontinued
operations, (3) non-ordinary course fees, costs and expenses incurred with
respect to any litigation or settlement, (4) share-based compensation expense,
(5) costs and expenses associated with changes in the fair value of marketable
securities, (6) costs and expenses associated with the issuance or prepayment
debt and acquisitions, and (7) any restructuring charges and certain pro forma
cost savings and synergies related to transactions and initiatives, which in the
aggregate are not in excess of 25% of Adjusted Consolidated EBITDA. We also
subtract from consolidated Net income all unusual or nonrecurring items to the
extent they increase consolidated Net income.
Under the credit agreement, the Adjusted EBITDA calculation does not require us
to deduct net income attributable to noncontrolling interests or gains on fair
value adjustments of hedging and equity instruments, disposal of assets, and
development activities. It also does not allow us to add back losses on fair
value adjustments of hedging instruments or unusual or nonrecurring cash
expenditures in excess of $10 million . These items and amounts, in addition to
the items falling within the credit agreement's "unusual or nonrecurring"
classification, may occur in future periods, but can vary significantly from
period to period and may not directly relate to, or be indicative of, our
ongoing liquidity or operating performance. Accordingly, the Adjusted EBITDA
calculation presented here includes adjustments for them.
Adjusted EBITDA is not a measure of financial performance under generally
accepted accounting principles in the United States of America , and the items
excluded from Adjusted EBITDA are significant components in understanding and
assessing financial performance. Therefore, Adjusted EBITDA should not be
considered a substitute for Net income or cash flows from operating, investing,
or financing activities. Because Adjusted EBITDA is not a measurement determined
in accordance with GAAP and is thus susceptible to varying calculations,
Adjusted EBITDA, as presented, may not be comparable to other similarly titled
measures of other companies. Revenues and expenses are measured in accordance
with the policies and procedures described in Note 1, Summary of Significant
Accounting Policies, to the consolidated financial statements accompanying the
2021 Form 10K.
Our Adjusted EBITDA was as follows (in millions):
Reconciliation of Net Income to Adjusted EBITDA
Three Months Ended September Nine Months Ended September
30, 30,
2022 2021 2022 2021
Net income $ 67.0
18.5 (24.6) (16.7) (90.6)
Net income attributable to noncontrolling interests included in continuing operations
(21.6) (26.3) (65.5) (79.6)
Provision for income tax expense 21.8 26.2 68.2 79.4
Interest expense and amortization of debt discounts and fees
38.2 39.9 138.2 124.3
(Gain) loss on disposal or impairment of assets (1.1) (5.0) 2.4 (1.7)
Depreciation and amortization 62.1 55.5 180.3 162.9
Loss on early extinguishment of debt - - 1.4 1.0
Stock-based compensation 7.3 6.6 21.1 19.6
Change in fair market value of equity securities 3.1 0.3 8.8 (0.3)
Adjusted EBITDA $ 195.3 $ 199.3 $ 586.6 $ 616.5
32--------------------------------------------------------------------------------
Reconciliation of Net Cash Provided by Operating Activities to Adjusted EBITDA
Nine Months Ended
2022 2021
Net cash provided by operating activities $
533.6
Interest expense and amortization of debt discounts and fees 138.2 124.3 (Loss) gain on sale of investments, excluding impairments (16.5) 1.8 Equity in net income of nonconsolidated affiliates 2.6 2.5
Net income attributable to noncontrolling interests in continuing operations
(65.5) (79.6)
Amortization of debt-related items (7.4) (5.8)
Distributions from nonconsolidated affiliates (3.7) (2.4)
Current portion of income tax expense 75.9 77.8
Change in assets and liabilities (23.5) 39.8
Cash provided by operating activities of discontinued operations (56.0) (133.5)
Change in fair market value of equity securities 8.8 (0.3)
Other 0.1 (0.1)
Adjusted EBITDA $ 586.6 $ 616.5 For additional information see the "Results of Operations" section of this Item.
Recent Accounting Pronouncements
For information regarding recent accounting pronouncements, see Note 1, Basis of Presentation, to our condensed consolidated financial statements included under Part I, Item 1, Financial Statements (Unaudited), of this report.
© Edgar Online, source
