Newswires
ENCOMPASS HEALTH CORP – 10-K – Management's Discussion and Analysis of Financial Condition and Results of Operations
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations ("MD&A") should be read in conjunction with the
accompanying consolidated financial statements and related notes. This MD&A is
designed to provide the reader with information that will assist in
understanding our consolidated financial statements, the changes in certain key
items in those financial statements from year to year, and the primary factors
that accounted for those changes, as well as how certain accounting principles
affect our consolidated financial statements. See "Cautionary Statement
Regarding Forward-Looking Statements and Summary of Risk Factors" on page ii of
this report for a description of important factors that could cause actual
results to differ from expected results. See also Item 1A, Risk Factors.
In addition, management's discussion and analysis of our results of operations
and cash flows for the year ended December 31, 2020 compared to the year ended
December 31, 2019 may be found in, Part II, Item 7, Management's Discussion and
Analysis of Financial Condition and Results of Operations of our Annual Report
on Form 10-K for the year ended December 31, 2020 , filed with the Securities and
Exchange Commission on February 26, 2021 .
Executive Overview
Our Business
We are a national leader in integrated healthcare services, offering both facility-based and home-based patient care through our network of inpatient rehabilitation hospitals, home health agencies, and hospice agencies. As ofDecember 31, 2021 , our national footprint spans 42 states andPuerto Rico . As discussed in this Item, "Segment Results of Operations," we currently manage our operations in two operating segments which are also our reportable segments: (1) inpatient rehabilitation and (2) home health and hospice. For additional information about our business and reportable segments, see Item 1, Business and Item 1A, Risk Factors, of this report, Note 19, Segment Reporting, to the accompanying consolidated financial statements, and the "Segment Results of Operations" section of this Item. OnDecember 9, 2020 , we announced a formal process to explore strategic alternatives for our home health and hospice business. As a result of this process, we expect to separate the home health and hospice business fromEncompass Health into an independent public company through a spin-off distribution in the first half of 2022. OnJanuary 19, 2022 , we announced the home health and hospice business would be rebranded and operate under the nameEnhabit Home Health & Hospice . The rebranding of agency locations is expected to begin inmid-April 2022 and to be largely completed by the consummation of the spin off. Inpatient Rehabilitation 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 both an inpatient and outpatient basis. We operate hospitals in 35 states andPuerto Rico , with concentrations in the eastern half ofthe United States andTexas . As ofDecember 31, 2021 , we operate 145 inpatient rehabilitation hospitals and manage three inpatient rehabilitation units through management contracts. Our inpatient rehabilitation segment represented approximately 78% of our Net operating revenues for the year endedDecember 31, 2021 .Home Health and Hospice Our home health business is the nation's fourth largest provider of Medicare-certified skilled home health services in terms of revenues. Our home health services include a comprehensive range of Medicare-certified home nursing services to adult patients in need of care. Our hospice business is the nation's twelfth largest provider of Medicare-certified hospice services in terms of revenues. Hospice care focuses on the quality of life for patients who are experiencing an advanced, life limiting illness while treating the person and symptoms of the disease, rather than the disease itself. As ofDecember 31, 2021 , we provide home health services in 251 locations and hospice services in 96 locations across 34 states, with a concentration in the southern half ofthe United States . Our home health and hospice segment represented approximately 22% of our Net operating revenues for the year endedDecember 31, 2021 .
2021 Overview
The rapid onset of the COVID-19 Pandemic (the "pandemic") inthe United States has resulted in significant changes to our operating environment. For discussion of the financial and operational impacts we have experienced as a result of the 58
--------------------------------------------------------------------------------
Table of Contents
pandemic, see Item 1, Business, Item 1A, Risk Factors, and the "Results of
Operations" and "Segment Results of Operations" sections of this Item.
We continued our development and expansion efforts during 2021. In our inpatient
rehabilitation segment, we:
•began operating our new 40-bed inpatient rehabilitation hospital in
Texas
•began operating our new 50-bed inpatient rehabilitation hospital in
Tampa, Florida
•began operating our new 50-bed inpatient rehabilitation hospital in
Georgia
•began operating our new 40-bed inpatient rehabilitation hospital in
in
•began operating our new 40-bed inpatient rehabilitation hospital in
Louisiana
•began operating our new 40-bed inpatient rehabilitation hospital in
South Carolina
•began operating our new 40-bed inpatient rehabilitation hospital in
Florida
•began operating our new 50-bed inpatient rehabilitation hospital in
County, Georgia
•continued our capacity expansions by adding 117 new beds to existing hospitals;
and
•announced or continued the development of the following hospitals:
Number of New Beds
2022 2023 2024
Shiloh, Illinois(1) 40 - -
St. Augustine, Florida 40 - -
Libertyville, Illinois 60 - -
Lakeland, Florida 50 - -
Cape Coral, Florida 40 - -
Jacksonville, Florida 50 - -
Moline, Illinois(1) 40 - -
Naples, Florida 50 - -
Grand Forks, North Dakota(1) 40 - -
Eau Claire, Wisconsin(1) - 36 -
Owasso, Oklahoma(1) - 40 -
Clermont, Florida - 50 -
Knoxville, Tennessee(1) - 73 -
Bowie, Maryland - 60 -
Columbus, Georgia(1)(2) - 40 -
Prosper, Texas - 40 -
Strongville, Ohio - 40 -
Fitchburg, Wisconsin - 40 -
Louisville, Kentucky(1) - 40 -
Kissimmee, Florida - - 50
Fort Mill, South Carolina - - 39
Amarillo, Texas - - 40
Atlanta, Georgia(1)(2) - - 40
Palm Beach Gardens, Florida - - 50
Lake Worth, Florida - - 50
(1) Expected joint venture
(2) Piedmont Healthcare , our joint venture partner in these hospitals, assumed
50% ownership in our existing hospital in Newnan, Georgia during the second
quarter of 2021.
59
--------------------------------------------------------------------------------
Table of Contents
We also continued our expansion efforts in our home health and hospice segment. OnJune 1, 2021 , we completed the acquisition of the home health and hospice assets ofFrontier Home Health and Hospice ("Frontier") inAlaska ,Colorado ,Montana ,Washington , andWyoming for a cash purchase price of approximately$99 million . The Frontier acquisition included the purchase of a 50% equity interest in the Heart of theRockies Home Health joint venture and a 90% equity interest in theHospice of Southwest Montana joint venture (inclusive of an additional 40% equity interest purchased for approximately$4 million ). We consolidate both of these joint ventures. On the acquisition date, nine home health and eleven hospice locations became part of our national network of home health and hospice locations. This acquisition was made to expand our existing presence inColorado andWyoming and extend our services toAlaska ,Montana andWashington . We funded this transaction using cash on hand and borrowings under our revolving credit facility. For additional information regarding this transaction, see Note 2, Business Combinations, to the accompanying consolidated financial statements. In addition to the Frontier acquisition, we began accepting patients at our new hospice locations inLas Cruces, New Mexico (May 2021 ),Abilene, Texas (September 2021 ), andTyler, Texas (November 2021 ). During 2021, Net operating revenues increased 10.3% over 2020 due primarily to volume and pricing growth in our inpatient rehabilitation segment. See the "Results of Operations" and "Segment Results of Operations" section of this Item for additional financial information. We also continued taking steps to further increase the strength and flexibility of our balance sheet as well as augment returns from investments in operations with shareholder distributions via common stock dividends. 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 both of our business segments. 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 and home-based post-acute care services in markets where we currently do not have a presence by constructing or acquiring new hospitals and by acquiring or opening home health and hospice agencies in those fragmented industries. We are a leading provider of post-acute healthcare services, offering both facility-based and home-based patient care through our network of inpatient rehabilitation hospitals, home health agencies, and hospice agencies. 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. As the fourth largest provider of Medicare-certified skilled home health services in terms of revenues, we believe we differentiate ourselves from our competitors by the application of a highly integrated technology platform, our ability to manage a variety of care pathways, and a proven track record of consummating and integrating acquisitions. 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. 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." 60 -------------------------------------------------------------------------------- Table of Contents Key Challenges Healthcare is a highly-regulated industry facing many well-publicized regulatory and reimbursement challenges. The Medicare reimbursement systems for both inpatient rehabilitation and home health have 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.
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 and agencies. Ensuring continuous compliance with
extensive laws and regulations is an operating requirement for all healthcare
providers. See Item 1, Business, "Regulation," and Item 1A, Risk Factors, for
detailed discussions of the most important regulations we face and our programs
intended to ensure we comply with those regulations.
Reimbursement claims made by healthcare providers, including inpatient
rehabilitation hospitals as well as home health and hospice agencies, are
subject to audit from time to time by governmental payors and their agents, such
as the Medicare Administrative Contractors ("MACs"), fiscal intermediaries and
carriers, as well as the Office of Inspector General , Centers for Medicare &
Medicaid Services ("CMS"), and state Medicaid programs. These audits as well as
the ordinary course claim reviews of our billings result in payment denials,
including recoupment of previously paid claims from current accounts receivable.
Healthcare providers can challenge any denials through an administrative appeals
process that can be extremely lengthy, taking several years. For additional
details of these claim reviews, See Item 1, Business, "Sources of Revenues,"
Item 1A, Risk Factors, and Note 1, Summary of Significant Accounting Policies,
"Net Operating Revenues" and "Accounts Receivable," to the accompanying
consolidated financial statements.
See also Item 1, Business, "Regulation," and Item 1A, Risk Factors, to this
report.
•Changes to Our Operating Environment Resulting from the COVID-19 pandemic. In response to the public health emergency associated with the pandemic,Congress and 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 . OnDecember 27, 2020 , the Consolidated Appropriations Act, 2021 (the "2021 Budget Act") extended the sequestration suspension throughMarch 31, 2021 . OnApril 14, 2021 ,Congress further extended the sequestration suspension period throughDecember 31, 2021 . OnDecember 10, 2021 President Biden signed the Protecting Medicare and American Farmers from Sequester Cuts Act, which suspends sequestration cuts untilApril 1, 2022 , set sequestration at 1% for the periodApril 1, 2022 throughJune 30, 2022 and reinstated the full 2% sequestration effectiveJuly 1, 2022 . During 2021, the sequestration suspension provided additional revenues in our inpatient rehabilitation segment and home health and hospice segment of approximately$62 million and$20 million , respectively. The CARES Act also authorized the cash distribution of relief funds from theUnited States Department of Health and Human Services ("HHS") to healthcare providers. We did not accept any CARES Act relief funds. We intend to refuse any additional provider relief funds distributed in the future whether authorized under the 2021 Budget Act or other legislation. The CARES Act, the 2021 Budget Act, and CMS regulatory actions include a number of other provisions affecting our reimbursement and operations in both segments. The provisions are discussed in Item 1, Business, "Sources of Revenue," Item 1A, Risk Factors, and the "Results of Operations" section of this Item. Additional Medicare payment reductions are also possible under the Statutory Pay-As-You-Go Act of 2010 ("Statutory PAYGO"). For further discussion of Statutory PAYGO, see Item 1, Business, "Sources of Revenue," and Item 1A, Risk Factors. 61 -------------------------------------------------------------------------------- Table of Contents •Changes to Our Operating Environment Resulting from Healthcare Reform. Concerns held by federal policymakers about the federal deficit, national debt levels, and the solvency of the Medicare trust fund, as well as other healthcare policy priorities, could result in enactment of legislation affecting portions of the Medicare program, including post-acute care services we provide. It is not clear what, if any, Medicare-related changes may ultimately be enacted and signed into law or otherwise implemented, but it is possible that any reductions in Medicare spending will have a material impact on reimbursements for healthcare providers generally and post-acute providers specifically. We cannot predict what, if any, changes in Medicare spending or modifications to the healthcare laws and regulations will result from future budget or other legislative or regulatory initiatives. Many provisions within the Patient Protection and Affordable Care Act (as subsequently amended, the "ACA") have impacted or could in the future impact our business, including Medicare reimbursement reductions, such as reductions to annual market basket updates to providers and reimbursement rate rebasing adjustments and promotion of alternative payment models, such as accountable care organizations ("ACOs") and bundled payment initiatives including the Bundled Payments for Care Improvement Initiative Advanced ("BPCI Advanced") and the Comprehensive Care for Joint Replacement ("CJR") program.The Center for Medicare and Medicaid Innovation ("CMMI") plays a key role in the development of many of these new payment and service delivery models. Our challenges related to healthcare reform are discussed in Item 1, Business, "Sources of Revenues," and Item 1A, Risk Factors. As discussed in Item 1, Business, healthcare will almost certainly be the subject of significant regulatory and legislative changes regardless of party in control of the executive and legislative branches of state and federal governments. We will continue to evaluate these laws and regulations and position the Company for this industry shift. Based on our track record, we believe we can adapt to these regulatory and industry changes. Further, we have engaged, and will continue to engage, actively in discussions with key legislators and regulators to attempt to ensure any healthcare laws or regulations adopted or amended promote our goal of high-quality, cost-effective care. Each year, CMS adopts rules that update pricing and otherwise amend the respective payment systems. OnJuly 29, 2021 , CMS released its notice of final rulemaking for fiscal year 2022 under the inpatient rehabilitation facility prospective payment system (the "2022 IRF Rule"). Based on our analysis that utilizes, among other things, the acuity of our patients annualized over a six-month prior period, our experience with outlier payments over this same time frame, and other factors, we believe the 2022 IRF Rule will result in a net increase to our Medicare payment rates of approximately 1.9% effectiveOctober 1, 2021 . OnNovember 2, 2021 , CMS released its notice of final rulemaking for calendar year 2022 for home health agencies under the home health prospective payment system (the "2022 HH Rule"). Based on our preliminary analysis, which utilizes, among other things, our patient mix annualized over an eleven-month prior period, our specific geographic coverage area, and other factors, we believe the 2022 HH Rule will result in a net increase to our Medicare payment rates of approximately 3.4% effective for 30-day payment periods ending on or afterJanuary 1, 2022 . For additional details of the 2022 IRF Rule, 2022 HH Rule, and other proposed and adopted legislative and regulatory actions that may be material to our business, see Item 1, Business, and Item 1A, Risk Factors. •Maintaining Strong Volume Growth. Various factors, including competition and increasing regulatory and administrative burdens, may impact our ability to maintain and grow our hospital, home health, and hospice volumes. In any particular market, we may encounter competition from local or national entities with longer operating histories or other competitive advantages, such as acute care hospitals who provide post-acute services similar to ours or other post-acute providers with relationships with referring acute care hospitals or physicians. Aggressive payment review practices by Medicare contractors, aggressive enforcement of regulatory policies by government agencies, and restrictive or burdensome rules, regulations or statutes governing admissions practices may lead us to not accept patients who would be appropriate for and would benefit from the services we provide. In addition, from time to time, we must get regulatory approval to expand our services and locations in states with certificate of need laws. This approval may be withheld or take longer than expected. In the case of new-store volume growth, the addition of hospitals, home health agencies, and hospice agencies to our portfolio also may be difficult and take longer than expected. In addition to the factors described above, we believe a number of factors related to the pandemic negatively impacted volumes in 2021, predominately in the home health and hospice segment as discussed in the "Results of Operations" and "Segment Results of Operations" sections of this Item. While we continue to see our volumes recover in our inpatient rehabilitation segment, a current or future resurgence of COVID-19 infections could cause disruptions to our volume growth in both segments. 62
--------------------------------------------------------------------------------
Table of Contents
•Recruiting and Retaining High-Quality Personnel. See Item 1A, Risk Factors, for a discussion of competition for staffing, shortages of qualified personnel, and other factors that may increase our labor costs. Recruiting and retaining qualified personnel, including management, for our inpatient hospitals and home health and hospice agencies remain a high priority for us. We attempt to maintain a comprehensive compensation and benefits package that allows us to remain competitive in this challenging staffing environment while remaining consistent with our goal of being a high-quality, cost-effective provider of post-acute services. 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 or where employees are unavailable due to a lack of childcare or care for elderly family. These factors have resulted in increased labor costs and increased use of contract labor as discussed in the "Results of Operations" and "Segment Results of Operations" sections of this Item. We remain confident in the prospects of both of our business segments 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.
Results of Operations
Payor Mix
During 2021, 2020, and 2019, we derived consolidated Net operating revenues from
the following payor sources:
For the Year Ended December 31,
2021 2020 2019
Medicare 68.2 % 70.5 % 75.1 %
Medicare Advantage 14.2 % 14.2 % 10.6 %
Managed care 10.7 % 9.0 % 8.3 %
Medicaid 3.5 % 3.4 % 2.8 %
Other third-party payors 0.9 % 0.9 % 0.9 %
Workers' compensation 0.5 % 0.5 % 0.7 %
Patients 0.4 % 0.4 % 0.5 %
Other income 1.6 % 1.1 % 1.1 %
Total 100.0 % 100.0 % 100.0 %
Our payor mix is weighted heavily towards Medicare. We receive Medicare
reimbursements under the inpatient rehabilitation facility prospective payment
system, the home health prospective payment system, and the hospice payment
system. For additional information regarding Medicare reimbursement, see the
"Sources of Revenues" section of Item 1, Business.
As part of the Balanced Budget Act of 1997, Congress created a program of
private, managed healthcare coverage for Medicare beneficiaries. This program
has been referred to as Medicare Part C, or "Medicare Advantage." The program
offers beneficiaries a range of Medicare coverage options by providing a choice
between the traditional fee-for-service program (under Medicare Parts A and B)
or enrollment in a health maintenance organization, preferred provider
organization, point-of-service plan, provider sponsor organization, or an
insurance plan operated in conjunction with a medical savings account.
Our consolidated Net operating revenues consist primarily of revenues derived
from patient care services. Net operating revenues also include other revenues
generated from management and administrative fees and other non-patient care
services. These other revenues are included in "other income" in the above
table.
63
--------------------------------------------------------------------------------
Table of Contents
Our Results
From 2019 through 2021, our consolidated results of operations were as follows:
For the Year Ended December 31, Percentage Change
2021 2020 2019 2021 vs. 2020 2020 vs. 2019
(In Millions)
Net operating revenues $ 5,121.6 $ 4,644.4 $ 4,605.0 10.3 % 0.9 %
Operating expenses:
Salaries and benefits 2,886.5 2,682.0 2,573.0 7.6 % 4.2 %
Other operating expenses 685.2 634.4 623.6 8.0 % 1.7 %
Occupancy costs 80.2 81.2 82.3 (1.2) % (1.3) %
Supplies 209.3 200.5 167.9 4.4 % 19.4 %
General and administrative expenses 197.3 155.5 247.0 26.9 % (37.0) %
Depreciation and amortization 256.6 243.0 218.7 5.6 % 11.1 %
Government, class action, and related settlements - 2.8 - (100.0) %
N/A
Total operating expenses 4,315.1 3,999.4 3,912.5 7.9 % 2.2 % Loss on early extinguishment of debt 1.0 2.3 7.7 (56.5) % (70.1) % Interest expense and amortization of debt discounts and fees 164.6 184.2 159.7 (10.6) % 15.3 % Other income (12.3) (10.6) (30.5) 16.0 % (65.2) % Equity in net income of nonconsolidated affiliates (4.0) (3.5) (6.7) 14.3 % (47.8) % Income from continuing operations before income tax expense 657.2 472.6 562.3 39.1 % (16.0) % Provision for income tax expense 139.6 103.8 115.9 34.5 % (10.4) % Income from continuing operations 517.6 368.8 446.4 40.3 % (17.4) % Loss from discontinued operations, net of tax (0.4) - (0.6) N/A (100.0) % Net income 517.2 368.8 445.8 40.2 % (17.3) % Less: Net income attributable to noncontrolling interests (105.0) (84.6) (87.1) 24.1 % (2.9) % Net income attributable to Encompass Health$ 412.2 $ 284.2 $ 358.7 45.0 % (20.8) % Operating Expenses as a % of Net Operating Revenues
For the Year Ended
2021 2020 2019
Operating expenses:
Salaries and benefits 56.4 % 57.7 % 55.9 %
Other operating expenses 13.4 % 13.7 % 13.5 %
Occupancy costs 1.6 % 1.7 % 1.8 %
Supplies 4.1 % 4.3 % 3.6 %
General and administrative expenses 3.9 % 3.3 % 5.4 %
Depreciation and amortization 5.0 % 5.2 % 4.7 %
Government, class action, and related settlements - % 0.1 % - %
Total operating expenses 84.3 % 86.1 % 85.0 %
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 and home
health and hospice locations open throughout both the full current period and
prior periods presented. These comparisons include the
64
--------------------------------------------------------------------------------
Table of Contents
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.
2021 Compared to 2020
Net Operating Revenues
Our consolidated Net operating revenues increased in 2021 compared to 2020
primarily from volume and pricing growth in our inpatient rehabilitation
segment. See additional discussion in the "Segment Results of Operations"
section of this Item.
For various quarterly periods during the pandemic, we experienced decreased patient volumes in one or more of our business lines when compared to the prior year periods. Beginning inmid-March 2020 , we experienced decreased volumes in both segments which resulted from a number of conditions related to the COVID-19 pandemic including: lower acute-care hospital censuses due to the deferral of elective surgeries and shelter-in-place orders, restrictive visitation policies in place at acute-care hospitals that severely limit access to patients and caregivers by our clinical rehabilitation liaisons and care transition coordinators, policies in assisted living facilities that prevent staff from visiting patients, and heightened anxiety among patients and their family members regarding the risk of exposure to COVID-19 during acute-care and post-acute care treatment. Inpatient rehabilitation patient census and home health starts of episodes reached a low point the week endedApril 12, 2020 (Easter weekend). These factors have contributed, and could in the future contribute, to a decline in new patients for both of our operating segments as well as decreases in visits per episode in our home health business.
Salaries and Benefits
Salaries and benefits are the most significant cost to us and represent an investment in our most important asset: our employees. Salaries and benefits include all amounts paid to full- and part-time employees who directly participate in or support the operations of our hospitals and home health and hospice agencies, including all related costs of benefits provided to employees. It also includes amounts paid for contract labor. Salaries and benefits in terms of dollars increased in 2021 compared to 2020 primarily due to salary and benefit cost increases for our employees, increased contract labor to meet higher patient volumes, and the ramping up of new stores. Salaries and benefits as a percent of Net operating revenues decreased in 2021 compared to 2020 primarily due to the additional paid-time-off awarded to employees in the second quarter of 2020 (discussed below) and improved labor productivity partially offset by higher clinician compensation costs due to staffing challenges resulting from the pandemic. See additional discussion in the "Segment Results of Operations" section of this Item. InApril 2020 , we initiated a program for eligible frontline employees to earn additional paid time off in recognition of their outstanding efforts responding to the pandemic. We accrued approximately$43 million in salary and benefits expense in the second quarter of 2020 in connection with this award (approximately$29 million in the inpatient rehabilitation segment; approximately$14 million in the home health and hospice segment).
Other Operating Expenses
Other operating expenses include costs associated with managing and maintaining
our hospitals and home health and hospice agencies. These expenses include such
items as contract services, non-income related taxes, professional fees,
utilities, insurance, and repairs and maintenance.
Other operating expenses decreased as a percent of Net operating revenues during
2021 compared to 2020 primarily due to the increase in Net operating revenues as
discussed above.
Supplies
Supplies expense includes all costs associated with supplies used while
providing patient care. Specifically, these costs include personal protective
equipment ("PPE"), pharmaceuticals, food, needles, bandages, and other similar
items.
Supplies decreased as a percent of Net operating revenues during 2021 compared
to 2020 primarily due to the increase in Net operating revenues as discussed
above. We expect to continue to see elevated utilization and cost of medical
supplies in 2022 as a result of the pandemic.
65
--------------------------------------------------------------------------------
Table of Contents
General and Administrative Expenses
General and administrative expenses primarily include administrative expenses
such as information technology services, human resources, corporate accounting,
legal services, and internal audit and controls that are managed from our home
office in Birmingham, Alabama . These expenses also include stock-based
compensation expenses and transaction costs.
General and administrative expenses increased in terms of dollars and as a
percent of Net operating revenues during 2021 compared to 2020 primarily due to
the transaction costs associated with the spin off of our home health and
hospice business and higher costs associated with incentive compensation. See
the "Executive Overview" section of this Item for additional information on the
spin off.
Depreciation and Amortization
Depreciation and amortization increased during 2021 compared to 2020 due to our capital expenditures and development activities throughout 2020 and 2021. 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 decrease in Interest expense and amortization of debt discounts and fees in 2021 compared to 2020 primarily resulted from the redemption of approximately$700 million inNovember 2020 for the remaining 5.75% Senior Notes due 2024 (the "2024 Notes") as well as the April andJune 2021 redemptions of$100 million in outstanding principal amount of the 5.125% Senior Notes due 2023 (the "2023 Notes"). Cash paid for interest approximated$168 million in 2021 and 2020, respectively. For additional information, see Note 10, Long-term Debt, to the accompanying consolidated financial statements.
Income from Continuing Operations Before Income Tax Expense
Our pre-tax income from continuing operations in 2021 increased compared to 2020 primarily due to the increase in earnings, as discussed in the "Segment Results of Operations" section of this Item.
Provision for Income Tax Expense
Our Provision for income tax expense increased in 2021 compared to 2020
primarily due to higher Income from continuing operations before income tax
expense. See also Note 16, Income Taxes, to the accompanying consolidated
financial statements.
In addition to the CARES Act provisions previously discussed in the "Executive Overview" section of this Item, the CARES Act also includes provisions relating to net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations, technical corrections to tax depreciation methods for qualified improvement property, and deferral of employer payroll taxes. The CARES Act did not materially impact our effective tax rate for the year endedDecember 31, 2020 and 2021, although it has impacted the timing of future cash payments for taxes. Our cash payments for income taxes approximated$130 and$33 million , net of refunds, in 2021 and 2020, respectively. These payments were based on estimates of taxable income. We estimate we will pay approximately$80 million to$100 million of cash income taxes, net of refunds, in 2022. These payments are expected to primarily result from federal and state income tax expenses based on estimates of taxable income for 2022. In 2021 and 2020, current income tax expense was$111.8 million and$51.4 million , respectively. 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 16, Income Taxes, to the accompanying consolidated financial statements
and the "Critical Accounting Estimates" section of this Item.
66 -------------------------------------------------------------------------------- Table of Contents Net Income Attributable to Noncontrolling Interests The increase in Net income attributable to noncontrolling interests during 2021 compared to 2020 resulted from increased profitability of our existing joint ventures due to the impact of the pandemic on 2020.
Impact of Inflation
The impact of inflation on the Company will be primarily in the area of labor costs. The healthcare industry is labor intensive. Wages and other expenses increase during periods of inflation and when labor shortages occur in the marketplace. There can be no guarantee we will not experience increases in the cost of labor, as the need for clinical healthcare professionals is expected to grow. In addition, increases in healthcare costs are typically higher than inflation and impact our costs under our employee benefit plans. Managing these costs remains a significant challenge and priority for us. Suppliers pass along rising costs to us in the form of higher prices. In addition, we have experienced higher prices for our medical supplies, including PPE, as a result of the pandemic. Our supply chain efforts and our continual focus on monitoring and actively managing medical supplies and pharmaceutical costs has enabled us to accommodate increased pricing related to supplies and other operating expenses over the past few years. However, we cannot predict our ability to cover future cost increases including increase in the cost of PPE. It should be noted that we have little or no ability to pass on these increased costs associated with providing services to Medicare and Medicaid patients due to federal and state laws that establish fixed reimbursement rates.
See Item 1A, Risk Factors, for additional information.
Relationships and Transactions with Related Parties
Related party transactions were not material to our operations in 2021, 2020, or
2019, and therefore, are not presented as a separate discussion within this
Item.
Segment Results of Operations
Our internal financial reporting and management structure is focused on the major types of services provided byEncompass Health . We manage our operations using two operating segments which are also our reportable segments: (1) inpatient rehabilitation and (2) home health and hospice. For additional information regarding our business segments, including a detailed description of the services we provide, financial data for each segment, and a reconciliation of total segment Adjusted EBITDA to income from continuing operations before income tax expense, see Note 19, Segment Reporting, to the accompanying consolidated financial statements.
Inpatient Rehabilitation
During the years endedDecember 31, 2021 , 2020, and 2019, our inpatient rehabilitation segment derived its Net operating revenues from the following payor sources: For the Year Ended December 31, 2021 2020 2019 Medicare 64.4 % 66.7 % 72.2 % Medicare Advantage 15.2 % 15.3 % 10.7 % Managed care 12.1 % 10.4 % 9.8 % Medicaid 4.1 % 3.9 % 3.1 % Other third-party payors 1.1 % 1.2 % 1.2 % Workers' compensation 0.6 % 0.6 % 0.8 % Patients 0.5 % 0.5 % 0.7 % Other income 2.0 % 1.4 % 1.5 % Total 100.0 % 100.0 % 100.0 % 67
-------------------------------------------------------------------------------- Table of Contents Additional information regarding our inpatient rehabilitation segment's operating results for the years endedDecember 31, 2021 , 2020, and 2019, is as follows: For the Year Ended December 31, Percentage Change 2021 2020 2019 2021 vs. 2020 2020 vs. 2019 (In Millions, Except Percentage Change) Net operating revenues: Inpatient$ 3,918.1 $ 3,496.1 $ 3,423.5 12.1 % 2.1 % Outpatient and other 96.9 70.1 89.5 38.2 % (21.7) % Inpatient rehabilitation segment revenues 4,015.0 3,566.2 3,513.0 12.6 % 1.5 % Operating expenses: Salaries and benefits 2,127.3 1,903.8 1,813.1 11.7 % 5.0 % Other operating expenses 594.8 534.7 521.9 11.2 % 2.5 % Supplies 184.2 171.0 147.0 7.7 % 16.3 % Occupancy costs 59.0 61.4 64.8 (3.9) % (5.2) % Other income (6.9) (8.0) (10.5) (13.8) % (23.8) % Equity in net income of nonconsolidated affiliates (3.4) (3.0) (5.5) 13.3 % (45.5) % Noncontrolling interests 103.2 83.3 82.6 23.9 % 0.8 % Segment Adjusted EBITDA$ 956.8 $ 823.0 $ 899.6 16.3 % (8.5) % (Actual Amounts) Discharges 197,639 181,897 186,842 8.7 % (2.6) %
Net patient revenue per discharge
$ 18,323 3.1 % 4.9 % Outpatient visits 161,070 186,257 375,525 (13.5) % (50.4) % Average length of stay (days) 12.8 12.9 12.6 (0.8) % 2.4 % Occupancy % 70.0% 67.7% 69.5% 3.4 % (2.6) % # of licensed beds 9,924 9,505 9,249 4.4 % 2.8 % Full-time equivalents* 23,193 22,076 21,967 5.1 % 0.5 % Employees per occupied bed 3.34 3.43 3.42 (2.6) % 0.3 %
* Full-time equivalents included in the above table represent our employees who
participate in or support the operations of our hospitals and include 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.
Operating Expenses as a % of Net Operating Revenues
For the Year Ended December 31,
2021 2020 2019
Operating expenses:
Salaries and benefits 53.0 % 53.4 % 51.6 %
Other operating expenses 14.8 % 15.0 % 14.9 %
Supplies 4.6 % 4.8 % 4.2 %
Occupancy costs 1.5 % 1.7 % 1.8 %
68
--------------------------------------------------------------------------------
Table of Contents 2021 Compared to 2020 Net Operating Revenues Inpatient revenue increased during 2021 compared to 2020 primarily due to increased volumes and favorable pricing. Discharge growth included a 6.2% increase in same-store discharges. Discharge growth from new stores during 2021 resulted from our joint ventures inCoralville, Iowa (June 2020 ),San Angelo, Texas (March 2021 ), andHenry County, Georgia (October 2021 ), as well as wholly owned hospitals inMurrieta, California (February 2020 ),Sioux Falls, South Dakota (June 2020 ),Toledo, Ohio (November 2020 ),North Tampa, Florida (April 2021 ),Cumming, Georgia (June 2021 ),Waco, Texas (August 2021 ),Shreveport, Louisiana (August 2021 ),Greenville, South Carolina (August 2021 ), andPensacola, Florida (September 2021 ). Growth in net patient revenue per discharge during 2021 compared to 2020 primarily resulted from an increase in reimbursement rates, a higher acuity patient mix and the suspension of sequestration starting inMay 2020 . The increase in outpatient and other revenue during 2021 compared to 2020 primarily resulted from an increase of$29.7 million in provider tax revenues (offset by$17.8 million of provider tax expense increases included in Other operating expenses).
See Note 2, Business Combinations, to the accompanying consolidated financial
statements for information regarding our joint ventures discussed above.
Adjusted EBITDA
The increase in Adjusted EBITDA during 2021 compared to 2020 primarily resulted from the increase in net patient revenue as discussed above. Salaries and benefits as a percent of Net operating revenues decreased in 2021 compared to 2020 due to the additional paid-time-off awarded to employees in the second quarter of 2020 (discussed above) and improved labor productivity (contributed to lower employees per occupied bed) partially offset by higher clinician compensation costs due to staffing shortages resulting from the pandemic. Other operating expenses, Supplies, and Occupancy costs as a percent of Net operating revenues decreased during 2021 compared to 2020 primarily due the increase in net patient revenue.Home Health and Hospice During the years endedDecember 31, 2021 , 2020, and 2019, our home health and hospice segment derived its Net operating revenues from the following payor sources: For the Year Ended December 31, 2021 2020 2019 Medicare 81.9 % 83.1 % 84.2 % Medicare Advantage 10.6 % 10.8 % 10.2 % Managed care 5.9 % 4.4 % 3.6 % Medicaid 1.4 % 1.4 % 1.7 % Workers' compensation - % 0.1 % 0.1 % Patients 0.1 % 0.1 % 0.1 % Other income 0.1 % 0.1 % 0.1 % Total 100.0 % 100.0 % 100.0 % 69
-------------------------------------------------------------------------------- Table of Contents Additional information regarding our home health and hospice segment's operating results for the years endedDecember 31, 2021 , 2020, and 2019, is as follows: For the Year Ended December 31, Percentage Change 2021 2020 2019 2021 vs. 2020 2020 vs. 2019 (In Millions, Except Percentage Change) Net operating revenues: Home health$ 897.3 $ 877.6 $ 918.0 2.2 % (4.4) % Hospice 209.3 200.6 174.0 4.3 % 15.3 % Home health and hospice segment revenues 1,106.6 1,078.2 1,092.0 2.6 % (1.3) % Operating expenses: Cost of services (excluding depreciation and amortization) 489.3 511.3 506.2 (4.3) % 1.0 % Support and overhead costs 406.2 402.8 381.7 0.8 % 5.5 % Other income (1.6) - - N/A - % Equity in net income of nonconsolidated affiliates (0.6) (0.5) (1.2) 20.0 % (58.3) % Noncontrolling interests 1.8 1.3 9.5 38.5 % (86.3) % Segment Adjusted EBITDA$ 211.5 $ 163.3 $ 195.8 29.5 % (16.6) % (Actual Amounts) Home health: Total admissions 200,626 194,249 194,498 3.3 % (0.1) % Episodic admissions 155,357 158,912 159,727 (2.2) % (0.5) % Total recertifications 131,259 128,698 129,989 2.0 % (1.0) % Episodic recertifications 111,394 114,775 116,084 (2.9) % (1.1) % Episodes 264,581 268,508 275,578 (1.5) % (2.6) % Total starts of care 331,885 322,947 324,487 2.8 % (0.5) % Revenue per episode$ 2,954 $ 2,905 $ 2,972 1.7 % (2.3) % Episodic visits per episode 15.4 16.4 17.1 (6.1) % (4.1) % Total visits 4,969,699 5,139,472 5,431,621 (3.3) % (5.4) % Cost per visit $ 79$ 80 $ 77 (1.3) % 3.9 % Hospice: Admissions 13,113 12,878 10,452 1.8 % 23.2 % Patient days 1,372,980 1,367,060 1,197,927 0.4 % 14.1 % Average daily census 3,762 3,735 3,282 0.7 % 13.8 % Revenue per day$ 152 $ 147 $ 145 3.4 % 1.4 % Operating Expenses as a % of Net Operating Revenues
For the Year Ended
2021 2020 2019
Operating expenses:
Cost of services (excluding depreciation and amortization) 44.2 % 47.4 % 46.4 %
Support and overhead costs 36.7 % 37.4 % 35.0 %
70
--------------------------------------------------------------------------------
Table of Contents 2021 Compared to 2020 Net Operating Revenues Revenue growth during 2021 compared to 2020 was driven by increased volumes and pricing. Total starts of care increased during 2021 compared to 2020 primarily due to the acquisition of Frontier onJune 1, 2021 and increased non-episodic admissions and recertifications as a result of our national contract withUnited Healthcare . Episodic admissions declined during 2021 compared to 2020 primarily due to the conversion of admissions to non-episodic under the national contract discussed above. The increase in revenue per episode during 2021 compared to 2020 resulted from an increase in reimbursement rates and the suspension of sequestration partially offset by the mix between early and late payment periods.
Adjusted EBITDA
The increase in Adjusted EBITDA during 2021 compared to 2020 resulted from the increase in net patient revenues as discussed above and a decrease in Cost of services as a percent of revenue. Cost of services decreased as a percent of revenues for 2021 compared to 2020 primarily due to lower visits per episode and lower cost per visit resulting from additional paid-time-off awarded to employees in the second quarter of 2020 (discussed above) partially offset by higher clinician compensation due to staffing shortages.
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. To further enhance our liquidity and ensure availability under our credit agreement, in both April andJune 2021 , we redeemed$100 million in outstanding principal amount of the 2023 Notes using cash on hand and capacity under our revolving credit facility. Pursuant to the terms of the 2023 Notes, these optional redemptions were made at a price of par. As a result of this redemption, we recorded a$1.0 million Loss on early extinguishment of debt in 2021. InFebruary 2022 , we issued notice for redemption of the remaining$100 million in outstanding principal amount of the 2023 Notes. Pursuant to the terms of the 2023 Notes, this full redemption will settle onMarch 15, 2022 and will be made at a price of par. We plan to use cash on hand and capacity under our revolving credit facility to fund the redemption. We expect to record an approximate$0.3 million Loss on early extinguishment of debt in the first quarter of 2022. InApril 2020 we amended our credit agreement primarily to provide covenant relief due to business disruptions from the pandemic. The amendment included, among other things, the carve-out of the pandemic from the definition of material adverse effect for 364 days and modifications to the interest coverage and leverage ratios under the agreement. InMay 2020 , we issued an additional$300 million of our existing 4.50% Senior Notes due 2028 at a price of 99.0% of the principal amount and an additional$300 million of our existing 4.75% Senior Notes due 2030 at a price of 98.5% of the principal amount, which resulted in approximately$583 million in net proceeds. We used a portion of the net proceeds from this borrowing, together with cash on hand, to repay borrowings under our revolving credit facility. InOctober 2020 , we issued$400 million aggregate principal amount of 4.625% Senior Notes due 2031 at par. We used the net proceeds from this borrowing plus approximately$300 million of cash on hand to fully redeem approximately$700 million of the 2024 Notes at par inNovember 2020 . As a result of this redemption, we recorded a$2.3 million Loss on early extinguishment of debt in 2020. We have been disciplined in creating a capital structure that is flexible with no significant debt maturities prior to 2024. 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.
See Note 10, Long-term Debt, to the accompanying consolidated financial
statements.
71 -------------------------------------------------------------------------------- Table of Contents Current Liquidity As ofDecember 31, 2021 , we had$54.8 million in Cash and cash equivalents. This amount excludes$65.5 million in restricted cash ($65.1 million included in Restricted cash and$0.4 million included in Other long-term assets in our consolidated balance sheet) and$82.2 million of restricted marketable securities (included in Other long-term assets in our 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 accompanying consolidated financial statements. In addition to Cash and cash equivalents, as ofDecember 31, 2021 , we had approximately$762 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 up to$300 million of 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 resulting from (1) the dispositions and repayments or incurrence of debt and (2) the investments, acquisitions, mergers, amalgamations, consolidations and operational changes from acquisitions 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 ofDecember 31, 2021 , the maximum leverage ratio requirement per our credit agreement was 5.0x and the minimum interest coverage ratio requirement was 2.0x, and we were in compliance with these covenants. Based on Adjusted EBITDA for 2021 and the interest rate in effect under our credit agreement during the three-month period endedDecember 31, 2021 , if we had drawn on the first day and maintained the maximum amount of outstanding draws under our revolving credit facility for the entire year, 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 2025 Notes, 2028 Notes, 2030 Notes, and 2031 Notes (collectively the "Notes") for the adoption of certain amendments to the Indenture, which will provide 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 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 million of this amount inJanuary 2022 . The remaining payment is contingent upon the execution of a Distribution and will be paid at such time. We do not face near-term refinancing risk, as the amounts outstanding under our credit agreement do not mature until 2024, and after theMarch 2022 redemption of the 2023 Notes discussed above, our bonds all mature in 2025 and beyond. See the "Contractual Obligations" section below for information related to our contractual obligations as ofDecember 31, 2021 . We acquired a significant portion of our home health and hospice business when we purchasedEHHI Holdings, Inc. ("EHHI") onDecember 31, 2014 . In the acquisition, we acquired all of the issued and outstanding equity interests of EHHI, other than equity interests contributed toEncompass Health Home Health Holdings, Inc. ("Holdings"), a subsidiary ofEncompass Health and an indirect parent of EHHI, by certain sellers in exchange for shares of common stock of Holdings. Those sellers were members of EHHI management, and they contributed a portion of their shares of common stock of EHHI, valued at approximately$64 million on the acquisition date, in exchange for approximately 16.7% of the outstanding shares of common stock of Holdings. At any time afterDecember 31, 2017 , each management investor had the right (but not the obligation) to have his or her shares of Holdings stock repurchased byEncompass Health for a cash purchase price per share equal to the fair value. The fair value was determined using the product of the trailing twelve-month adjusted EBITDA measure for Holdings and a specified median market price multiple based on a basket of public home health companies and transactions, after adding cash and deducting indebtedness that included the outstanding principal balance under any intercompany notes. InFebruary 2018 , each management investor exercised the right to sell one-third of his or her shares of Holdings stock to 72 -------------------------------------------------------------------------------- Table of ContentsEncompass Health , representing approximately 5.6% of the outstanding shares of the common stock of Holdings. OnFebruary 21, 2018 ,Encompass Health settled the acquisition of those shares upon payment of approximately$65 million in cash. InJuly 2019 , we received additional exercise notices, representing approximately 5.6% of the outstanding shares of the common stock of Holdings. InSeptember 2019 ,Encompass Health settled the acquisition of those shares upon payment of approximately$163 million in cash. As ofDecember 31, 2019 , the value of those outstanding shares of Holdings owned by management investors was approximately$208 million . InJanuary 2020 , we received additional exercise notices, representing approximately 4.3% of the outstanding shares of the common stock of Holdings. InFebruary 2020 ,Encompass Health settled the acquisition of those shares upon payment of approximately$162 million in cash. Upon settlement of these exercises, approximately$46 million of the shares of Holdings held by two management investors remained outstanding. OnFebruary 20, 2020 ,Encompass Health entered into exchange agreements (each, an "Exchange Agreement") with these two management investors, pursuant to which they had the right to exchange all of the remaining shares of Holdings held by them for shares of common stock ofEncompass Health (the "EHC Shares"). Each of the Exchange Agreements provided that the management investor must deliver a written exchange notice (an "Exchange Notice") toEncompass Health in order to exchange his or her remaining shares of Holdings for EHC Shares. Each Exchange Agreement further provided that the number of EHC Shares to be delivered to the management investor was to be determined by dividing the fair value of the shares of Holdings held by the management investor on the date of the Exchange Agreement by the last reported sales price ofEncompass Health's common stock on theNew York Stock Exchange (the "NYSE") on the date of delivery of the Exchange Notice. OnFebruary 20, 2020 ,Encompass Health received an Exchange Notice from each of the management investors. Based on the last sales price ofEncompass Health's common stock on the NYSE onFebruary 20, 2020 ,Encompass Health delivered an aggregate 560,957 EHC Shares to the management investors. The total number of EHC Shares issued pursuant to the exchange agreements onMarch 6, 2020 represented less than 0.6% of the outstanding shares ofEncompass Health common stock.Encompass Health issued the EHC Shares from its treasury shares.Encompass Health now owns 100% of Holdings and EHHI. See also Note 12, Redeemable Noncontrolling Interests, to the accompanying consolidated financial statements. In conjunction with the EHHI acquisition, we granted stock appreciation rights ("SARs") based on Holdings common stock to certain members of EHHI management at closing. Half of the SARs vested onDecember 31, 2018 and the remainder vested onDecember 31, 2019 . Upon exercise, each SAR must be settled for cash in the amount by which the per share fair value of Holdings' common stock on the exercise date exceeds the per share fair value on the grant date. InFebruary 2019 , members of the management team exercised a portion of their vested SARs for approximately$13 million in cash. InJuly 2019 , members of the management team exercised the remainder of the vested SARs, which resulted in cash distributions of approximately$55 million . As ofDecember 31, 2019 , the fair value of the remaining 115,545 SARs was approximately$101 million , all of which was included in Other current liabilities in the accompanying consolidated balance sheet. InJanuary 2020 , members of the management team exercised the remaining SARs and inFebruary 2020 , we settled those awards upon payment of approximately$101 million in cash. See also Note 14, Share-Based Payments, to the accompanying consolidated financial statements. We anticipate we will continue to generate strong cash flows from operations that, together with availability under our revolving credit facility, will allow us to invest in growth opportunities and continue to improve our existing business. We also will continue to consider additional shareholder value-enhancing strategies such as repurchases of our common stock and distribution of common stock dividends, including the potential growth of the quarterly cash dividend on our common stock, recognizing that these actions may increase our leverage ratio. See also the "Authorizations forReturning Capital to Stakeholders" section of this Item.
See Item 1A, Risk Factors, for a discussion of risks and uncertainties facing
us.
73 -------------------------------------------------------------------------------- Table of Contents Sources and Uses of Cash The following table shows the cash flows provided by or used in operating, investing, and financing activities for the years endedDecember 31, 2021 , 2020, and 2019 (in millions): For the Year Ended December 31, 2021 2020 2019 Net cash provided by operating activities$ 715.8 $ 704.7 $ 635.3 Net cash used in investing activities (666.3) (407.5) (657.4) Net cash (used in) provided by financing activities (240.1) (145.9) 48.2
Increase in cash, cash equivalents, and restricted cash
$ 151.3 $ 26.1 2021 Compared to 2020 Operating activities. The increase in Net cash provided by operating activities during 2021 compared to 2020 primarily resulted from the increase in Net income (see the "Results of Operations" section of this Item) partially offset by the decrease in payroll accruals. The decrease in payroll accruals was attributable to the award of additional paid time off to employees during the second quarter of 2020 in response to the pandemic and the deferral of payroll taxes resulting from government relief efforts during the pandemic. Half of the payroll taxes were paid inDecember 2021 , with the remaining half due inDecember 2022 . Investing activities. The increase in Net cash used in investing activities during 2021 compared to 2020 primarily resulted from the acquisition of assets from Frontier and increased purchases of property and equipment. For additional information on the Frontier acquisition, see Note 2, Business Combinations, to the accompanying consolidated financial statements. Financing activities. The increase in Net cash used in financing activities during 2021 compared to 2020 primarily resulted from increased net debt payments partially offset by the purchase of equity interests held by the home health and hospice management team during the first quarter of 2020. See also Note 12, Redeemable Noncontrolling Interest and Note 10, Long-term Debt, to the accompanying consolidated financial statements.
Contractual Obligations
Our consolidated contractual obligations as ofDecember 31, 2021 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)$ 2,699.9 $ 19.7 $ 2,680.2 Revolving credit facility 200.0 - 200.0 Interest on long-term debt (b) 814.5 130.6 683.9 Finance lease obligations (c) 606.3 52.1 554.2 Operating lease obligations (d) 326.6 51.4 275.2 Purchase obligations (e) 148.8 55.4 93.4 Total$ 4,796.1 $ 309.2 $ 4,486.9
(a)Included in long-term debt are amounts owed on our bonds payable and other
notes payable. These borrowings are further explained in Note 10, Long-term
Debt, to the accompanying consolidated financial statements.
(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 ofDecember 31, 2021 . 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 (see Note 7, Leases, and Note 10, Long-term Debt, to the accompanying consolidated financial statements). 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 consolidated statements of comprehensive income.
(c)Amounts include interest portion of future minimum finance lease payments.
74
--------------------------------------------------------------------------------
Table of Contents
(d)Our inpatient rehabilitation segment leases approximately 10% of its hospitals as well as other property and equipment under operating leases in the normal course of business. Our home health and hospice segment leases relatively small office spaces in the localities it serves, space for its corporate office, and other 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 accompanying consolidated financial statements. (e)Purchase obligations include agreements to purchase goods or services that are enforceable and legally binding onEncompass 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 consolidated balance sheet. Our capital expenditures include costs associated with our hospital refresh program, de novo projects, capacity expansions, technology initiatives, and building and equipment upgrades and purchases. During the year endedDecember 31, 2021 , we made capital expenditures of approximately$551 million for property and equipment, intangible assets, and capitalized software. These expenditures in 2021 are exclusive of approximately$119 million in net cash related to our acquisition activity. During 2022, we expect to spend approximately$570 million to$660 million for capital expenditures using cash on hand and borrowings under our revolving credit facility. Approximately$200 million to$250 million of this budgeted amount is considered nondiscretionary expenditures, which we may refer to in other filings as "maintenance" expenditures. In addition, we expect to spend approximately$50 million to$100 million on home health and hospice acquisitions during 2022. Actual amounts spent will be dependent upon the timing of construction projects and acquisition opportunities for our home health and hospice business.
Authorizations for
InOctober 2020 ,February 2021 ,May 2021 ,July 2021 , andOctober 2021 , our board of directors declared cash dividends of$0.28 per share that were paid inJanuary 2021 ,April 2021 ,July 2021 ,October 2021 , andJanuary 2022 , respectively. 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. OnOctober 28, 2013 , we announced our board of directors authorized the repurchase of up to$200 million of our common stock, which amount was subsequently increased to$250 million . OnJuly 24, 2018 , our board approved resetting the aggregate common stock repurchase authorization to$250 million . As ofDecember 31, 2021 , 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.
Supplemental Guarantor Financial Information
Our indebtedness under our credit agreement and the 5.125% Senior Notes due 2023, 5.75% Senior Notes due 2025, 4.50% Senior Notes due 2028, 4.75% Senior Notes due 2030, and 4.625% Senior Notes due 2031, (collectively, the "Senior 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 Senior 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 Senior 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) there is capacity under the Available Amount as defined in the credit agreement. The terms of our Senior 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 10, Long-term Debt, to the accompanying consolidated financial statements. 75 -------------------------------------------------------------------------------- Table of Contents 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. For the Year Ended December 31, 2021 (In Millions) Net operating revenues $ 3,692.7 Intercompany revenues generated from non-guarantor subsidiaries 19.0 Total net operating revenues $ 3,711.7 Operating expenses $ 3,184.5 Intercompany expenses incurred in transactions with non-guarantor subsidiaries 30.8 Total operating expenses $ 3,215.3 Income from continuing operations $
258.8
Net income $
258.4
Net income attributable to Encompass Health $ 258.7
As of December 31,
2021
(In Millions)
Total current assets $ 664.3
Property and equipment, net $ 1,896.1
Goodwill 2,053.2
Intercompany receivable due from non-guarantor subsidiaries 166.1
Other noncurrent assets 662.9
Total noncurrent assets $ 4,778.3
Total current liabilities $ 624.7
Long-term debt, net of current portion $ 3,194.5
Other noncurrent liabilities 327.9
Total noncurrent liabilities $ 3,522.4
Redeemable noncontrolling interests $ 2.3
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 accompanying consolidated financial statements.
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 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,
76
--------------------------------------------------------------------------------
Table of Contents
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 not in excess of 20% 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 accompanying consolidated financial statements.
77
--------------------------------------------------------------------------------
Table of Contents
Our Adjusted EBITDA for the years ended December 31, 2021 , 2020, and 2019 was as
follows (in millions):
Reconciliation of Net Income to Adjusted EBITDA
For the Year Ended
2021 2020 2019
Net income $
517.2
Loss from discontinued operations, net of tax, attributable to
0.4 - 0.6 Provision for income tax expense 139.6 103.8 115.9
Interest expense and amortization of debt discounts and fees 164.6
184.2 159.7 Loss on early extinguishment of debt 1.0 2.3 7.7 Government, class action, and related settlements - 2.8 - Loss on disposal or impairment of assets 0.4 11.6 11.1 Depreciation and amortization 256.6 243.0 218.7 Stock-based compensation expense 32.8 29.5 114.4 Net income attributable to noncontrolling interests (105.0) (84.6) (87.1) Costs associated with the strategic alternatives review 22.9 - - Costs associated with the Frontier acquisition 1.3 - - Transaction costs - - 2.1
Gain on consolidation of joint venture formerly accounted for
under the equity method of accounting
(3.2) (2.2) (19.2) SARs mark-to-market impact on noncontrolling interests - - (5.0) Change in fair market value of equity securities (0.6) (0.4) (0.8) Payroll taxes on SARs exercise - 1.5 1.0 Adjusted EBITDA$ 1,028.0 $ 860.3 $ 964.9
Reconciliation of Net Cash Provided by Operating Activities to Adjusted EBITDA
For the Year Ended
2021 2020 2019
Net cash provided by operating activities $
715.8
Interest expense and amortization of debt discounts and fees 164.6 184.2 159.7 Equity in net income of nonconsolidated affiliates 4.0 3.5 6.7
Net income attributable to noncontrolling interests in
continuing operations
(105.0) (84.6) (87.1) Amortization of debt-related items (7.8) (7.2) (4.5) Distributions from nonconsolidated affiliates (2.9) (3.8) (6.6) Current portion of income tax expense 111.8 51.4 75.9 Change in assets and liabilities 118.0 7.3 180.1 Cash used in operating activities of discontinued operations 0.5 0.2 4.4 Costs associated with the strategic alternatives review 22.9 - - Costs associated with the Frontier acquisition 1.3 - - Transaction costs - - 2.1 SARs mark-to-market impact on noncontrolling interests - - (5.0) Change in fair market value of equity securities (0.6) (0.4) (0.8) Payroll taxes on SARs exercise - 1.5 1.0 Other 5.4 3.5 3.7 Adjusted EBITDA$ 1,028.0 $ 860.3 $ 964.9 78
-------------------------------------------------------------------------------- Table of Contents For additional information see the "Results of Operations" and "Segment Results of Operations" sections of this Item.
Critical Accounting Estimates
Our consolidated financial statements are prepared in accordance with GAAP. In connection with the preparation of our financial statements, we are required to make assumptions and estimates about future events and apply judgments that affect the reported amounts of assets, liabilities, revenue, expenses, and the related disclosures. We base our assumptions, estimates, and judgments on historical experience, current trends, and other factors we believe to be relevant at the time we prepared our consolidated financial statements. On a regular basis, we review the accounting policies, assumptions, estimates, and judgments to ensure our consolidated financial statements are presented fairly and in accordance with GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material. Our significant accounting policies are discussed in Note 1, Summary of Significant Accounting Policies, to the accompanying consolidated financial statements. We believe the following accounting estimates are the most critical to aid in fully understanding and evaluating our reported financial results, as they require our most difficult, subjective, or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain. We have reviewed these critical accounting estimates and related disclosures with the audit committee of our board of directors.
Revenue Recognition
We recognize net operating revenue in the reporting period in which we perform
the service based on our best estimate of the transaction price for the type of
service provided to the patient. Our estimate of the transaction price includes
estimates of price concessions for such items as contractual allowances
(principally for patients covered by Medicare, Medicare Advantage, Medicaid, and
other third-party payors), potential adjustments that may arise from payment and
other reviews, and uncollectible amounts. See Note 1, Summary of Significant
Accounting Policies, "Net Operating Revenues," to the accompanying consolidated
financial statements of this report for a complete discussion of our revenue
recognition policies.
Our patient accounting systems calculate contractual allowances on a
patient-by-patient basis based on the rates in effect for each primary
third-party payor. Certain other factors that are considered and could influence
the estimated transaction price are assumed to remain consistent with the
experience for patients discharged in similar time periods for the same payor
classes, and additional adjustments are provided to account for these factors.
Management continually reviews the revenue transaction price estimation process
to consider and incorporate updates to laws and regulations and the frequent
changes in managed care contractual terms that result from contract
renegotiations and renewals. In addition, laws and regulations governing the
Medicare and Medicaid programs are complex and subject to interpretation. If
actual results are not consistent with our assumptions and judgments, we may be
exposed to gains or losses that could be material.
Due to complexities involved in determining amounts ultimately due under
reimbursement arrangements with third-party payors, which are often subject to
interpretation and review, we may receive reimbursement for healthcare services
authorized and provided that is different from our estimates, and such
differences could be material. However, we continually review the amounts
actually collected in subsequent periods in order to determine the amounts by
which our estimates differed. Historically, such differences have not been
material from either a quantitative or qualitative perspective.
The collection of outstanding receivables from third-party payors and patients
is our primary source of cash and is critical to our operating performance. Our
primary collection risks relate to patient responsibility amounts and claims
reviews conducted by MACs or other contractors.
79
--------------------------------------------------------------------------------
Table of Contents
The table below shows a summary of our net accounts receivable balances as of
December 31, 2021 and 2020. Information on the concentration of total patient
accounts receivable by payor class can be found in Note 1, Summary of
Significant Accounting Policies, "Accounts Receivable," to the accompanying
consolidated financial statements.
As of December 31,
2021 2020
(In Millions)
Current:
0 - 30 Days $ 469.6 $ 409.4
31 - 60 Days 70.1 54.3
61 - 90 Days 37.6 30.6
91 - 120 Days 21.1 16.9
120 + Days 68.2 51.8
Patient accounts receivable 666.6 563.0
Other accounts receivable 13.7 9.8
680.3 572.8
Noncurrent patient accounts receivable 83.5 123.8
Accounts receivable $ 763.8 $ 696.6
Changes in general economic conditions (such as increased unemployment rates or
periods of recession), business office operations, payor mix, or trends in
federal or state governmental and private employer healthcare coverage could
affect our collection of accounts receivable. Our collection risks include
patient accounts for which the primary insurance carrier has paid the amounts
covered by the applicable agreement, but patient responsibility amounts
(deductibles and co-payments) remain outstanding, pre-payment claim reviews by
our respective MACs, and reimbursement claims audits by governmental or other
payors and their agents. As of December 31, 2021 and 2020, $77.8 million and
$117.8 million of our patient accounts receivable represented denials that were
under review or audit in our inpatient rehabilitation segment. If actual results
are not consistent with our assumptions and judgments, we may be exposed to
gains or losses that could be material. See Note 1, Summary of Significant
Accounting Policies, "Net Operating Revenues" and "Accounts Receivable," to the
accompanying consolidated financial statements of this report.
Self-Insured Risks
We are self-insured for certain losses related to professional liability,
general liability, and workers' compensation risks. Although we obtain
third-party insurance coverage to limit our exposure to these claims, a
substantial portion of our professional liability, general liability, and
workers' compensation risks are insured through a wholly owned insurance
subsidiary. See Note 11, Self-Insured Risks, to the accompanying consolidated
financial statements for a more complete discussion of our self-insured risks.
Our self-insured liabilities contain uncertainties because management must make
assumptions and apply judgment to estimate the ultimate cost of reported claims
and claims incurred but not reported as of the balance sheet date. Our reserves
and provisions for professional liability, general liability, and workers'
compensation risks are based largely upon semi-annual actuarial calculations
prepared by third-party actuaries.
Periodically, we review our assumptions and the valuations provided by
third-party actuaries to determine the adequacy of our self-insurance reserves.
The following are certain of the key assumptions and other factors that
significantly influence our estimate of self-insurance reserves: historical
claims experience; trending of loss development factors; trends in the frequency
and severity of claims; coverage limits of third-party insurance; demographic
information; statistical confidence levels; medical cost inflation; payroll
dollars; and hospital patient census.
The time period to resolve claims can vary depending upon the jurisdiction, the
nature, and the form of resolution of the claims. The estimation of the timing
of payments beyond a year can vary significantly. In addition, if current and
future claims differ from historical trends, our estimated reserves for
self-insured claims may be significantly affected. Our self-insurance reserves
are not discounted.
80
--------------------------------------------------------------------------------
Table of Contents
Given the number of factors used to establish our self-insurance reserves, we
believe there is limited benefit to isolating any individual assumption or
parameter from the detailed computational process and calculating the impact of
changing that single item. Instead, we believe the sensitivity in our reserve
estimates is best illustrated by changes in the statistical confidence level
used in the computations. Using a higher statistical confidence level increases
the estimated self-insurance reserves. The following table shows the sensitivity
of our recorded self-insurance reserves to the statistical confidence level (in
millions):
Net self-insurance reserves as of December 31, 2021 :
As reported, with 50% statistical confidence level 139.4
With 70% statistical confidence level 148.6
We believe our efforts to improve patient safety and overall quality of care, as
well as our efforts to reduce workplace injuries, have helped contain our
ultimate claim costs. See Note 11, Self-Insured Risks, to the accompanying
consolidated financial statements for additional information.
We believe our self-insurance reserves are adequate to cover projected costs. Due to the considerable variability that is inherent in such estimates, there can be no assurance the ultimate liability will not exceed management's estimates. If actual results are not consistent with our assumptions and judgments, we may be exposed to gains or losses that could be material.
Absent any impairment indicators, we evaluate goodwill for impairment as ofOctober 1st of each year. We test goodwill for impairment at the reporting unit level and are required to make certain subjective and complex judgments on a number of matters, including assumptions and estimates used to determine the fair value of our inpatient rehabilitation and home health and hospice reporting units. We assess qualitative factors in each reporting unit to determine whether it is necessary to perform the quantitative goodwill impairment test. The quantitative impairment test is required only if we conclude it is more likely than not a reporting unit's fair value is less than its carrying amount. If, based on our qualitative assessment, we were to believe we must perform the quantitative goodwill impairment test, we would determine the fair value of the applicable reporting unit using generally accepted valuation techniques including the income approach and the market approach. We would validate our estimates under the income approach by reconciling the estimated fair value of the reporting units determined under the income approach to our market capitalization and estimated fair value determined under the market approach. Values from the income approach and market approach would then be evaluated and weighted to arrive at the estimated aggregate fair value of the reporting units. The income approach includes the use of each reporting unit's projected operating results and cash flows that are discounted using a weighted-average cost of capital that reflects market participant assumptions. The projected operating results use management's best estimates of economic and market conditions over the forecasted period including assumptions for pricing and volume, operating expenses, and capital expenditures. Other significant estimates and assumptions include cost-saving synergies and tax benefits that would accrue to a market participant under a fair value methodology. The market approach estimates fair value through the use of observable inputs, including the Company's stock price.
See Note 1, Summary of Significant Accounting Policies, "
Intangibles," and Note 8,
accompanying consolidated financial statements for additional information.
The following events and circumstances are certain of the qualitative factors we consider in evaluating whether it is more likely than not the fair value of a reporting unit is less than its carrying amount: •macroeconomic conditions, such as deterioration in general economic conditions, limitations on accessing capital, or other developments in equity and credit markets;
•industry and market considerations and changes in healthcare regulations,
including reimbursement and compliance requirements under the Medicare and
Medicaid programs;
•cost factors, such as an increase in labor, supply, or other costs;
•overall financial performance, such as negative or declining cash flows or a
decline in actual or forecasted revenue or earnings;
81 -------------------------------------------------------------------------------- Table of Contents •other relevant company-specific events, such as material changes in management or key personnel or outstanding litigation;
•material events, such as a change in the composition or carrying amount of each
reporting unit's net assets, including acquisitions and dispositions;
•consideration of the relationship of our market capitalization to our book
value, as well as a sustained decrease in our share price; and
•length of time since most recent quantitative analysis.
In the fourth quarter of 2021, we performed our annual evaluation of goodwill and determined no adjustment to impair goodwill was necessary. If actual results are not consistent with our assumptions and estimates, we may be exposed to goodwill impairment charges. However, at this time, we continue to believe our inpatient rehabilitation and home health and hospice reporting units are not at risk for any impairment charges.
Income Taxes
We provide for income taxes using the asset and liability method. We also evaluate our tax positions and establish assets and liabilities in accordance with the applicable accounting guidance on uncertainty in income taxes. See Note 1, Summary of Significant Accounting Policies, "Income Taxes," and Note 16, Income Taxes, to the accompanying consolidated financial statements for a more complete discussion of income taxes and our policies related to income taxes. The application of income tax law is inherently complex. Laws and regulations in this area are voluminous and are often ambiguous. We are required to make many subjective assumptions and judgments regarding our income tax exposures. Interpretations of and guidance surrounding income tax laws and regulations change over time. As such, changes in our subjective assumptions and judgments can materially affect amounts recognized in our consolidated financial statements. The ultimate recovery of certain of our deferred tax assets is dependent on the amount and timing of taxable income we will ultimately generate in the future, as well as other factors. A high degree of judgment is required to determine the extent a valuation allowance should be provided against deferred tax assets. On a quarterly basis, we assess the likelihood of realization of our deferred tax assets considering all available evidence, both positive and negative. Our operating performance in recent years, the scheduled reversal of temporary differences, our forecast of taxable income in future periods in each applicable tax jurisdiction, our ability to sustain a core level of earnings, and the availability of prudent tax planning strategies are important considerations in our assessment. Our forecast of future earnings includes assumptions about patient volumes, payor reimbursement, labor costs, hospital operating expenses, and interest expense. Based on the weight of available evidence, we determine if it is more likely than not our deferred tax assets will be realized in the future. Our liability for unrecognized tax benefits contains uncertainties because management is required to make assumptions and to apply judgment to estimate the exposures associated with our various filing positions which are periodically audited by tax authorities. In addition, our effective income tax rate is affected by changes in tax law, the tax jurisdictions in which we operate, and the results of income tax audits. During the year endedDecember 31, 2021 , we decreased our valuation allowance by$(3.1) million . As ofDecember 31, 2021 , we had a remaining valuation allowance of$43.1 million which primarily related to state net operating losses. At the state jurisdiction level, we determined it was necessary to maintain a valuation allowance due to uncertainties related to our ability to utilize a portion of the net operating losses before they expire. The amount of the valuation allowance has been determined for each tax jurisdiction based on the weight of all available evidence, as described above, including management's estimates of taxable income for each jurisdiction in which we operate over the periods in which the related deferred tax assets will be recoverable. While management believes the assumptions included in its forecast of future earnings are reasonable and it is more likely than not the net deferred tax asset balance as ofDecember 31, 2021 will be realized, no such assurances can be provided. If management's expectations for future operating results on a consolidated basis or at the state jurisdiction level vary from actual results due to changes in healthcare regulations, general economic conditions, or other factors, we may need to increase our valuation allowance, or reverse amounts recorded currently in the valuation allowance, for all or a portion of our deferred tax assets. Similarly, future adjustments to our valuation allowance may be necessary if the timing of future tax deductions is different than currently expected. Our income tax expense in future periods will be reduced or increased to the extent of offsetting decreases or increases, respectively, in our valuation allowance in the period when the change in circumstances occurs. These changes could have a significant impact on our future earnings. 82 -------------------------------------------------------------------------------- Table of Contents Assessment of Loss Contingencies We have legal and other contingencies that could result in significant losses upon the ultimate resolution of such contingencies. See Note 1, Summary of Significant Accounting Policies, "Litigation Reserves," and Note 18, Contingencies and Other Commitments, to the accompanying consolidated financial statements for additional information. We have provided for losses in situations where we have concluded it is probable a loss has been or will be incurred and the amount of loss is reasonably estimable. A significant amount of judgment is involved in determining whether a loss is probable and reasonably estimable due to the uncertainty involved in determining the likelihood of future events and estimating the financial statement impact of such events. If further developments or resolution of a contingent matter are not consistent with our assumptions and judgments, we may need to recognize a significant charge in a future period related to an existing contingent matter. Business Combinations We account for acquisitions of entities that qualify as business combinations under the acquisition method of accounting. Under the acquisition method of accounting, the total consideration is allocated to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values at the acquisition date. The excess of the purchase price over the fair values of these identifiable assets and liabilities is recorded as goodwill. During the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. In determining the fair value of assets acquired and liabilities assumed in a business combination, we primarily use the income and multi-period excess earnings approaches to estimate the value of our most significant acquired intangible assets. Both income approaches utilize projected operating results and cash flows and include significant assumptions such as base revenue, revenue growth rate, projected EBITDA margin, discount rates, rates of increase in operating expenses, and the future effective income tax rates. The valuations of our significant acquired businesses have been performed by a third-party valuation specialist under our management's supervision. We believe that the estimated fair value assigned to the assets acquired and liabilities assumed is based on reasonable assumptions and estimates that marketplace participants would use. However, such assumptions are inherently uncertain and actual results could differ from those estimates. Future changes in our assumptions or the interrelationship of those assumptions may result in purchase price allocations that are different than those recorded in recent years. Acquisition related costs are not considered part of the consideration paid and are expensed as operating expenses as incurred. Contingent consideration, if any, is measured at fair value initially on the acquisition date as well as subsequently at the end of each reporting period until the contingency is resolved and settlement occurs. Subsequent adjustments to contingent considerations are recorded in our consolidated statements of comprehensive income. We include the results of operations of the businesses acquired as of the beginning of the acquisition dates.
Recent Accounting Pronouncements
For information regarding recent accounting pronouncements, see Note 1, Summary of Significant Accounting Policies, to the accompanying consolidated financial statements.
Best’s Commentary: Economic Shocks From Ukraine Invasion Fallout to Pressure Global Insurance Industry
NATIONAL STORAGE AFFILIATES TRUST – 10-K – Management's Discussion and Analysis of Financial Condition and Results of Operations
Advisor News
- Investors aren’t waiting out uncertainty
- Transamerica and Advo(k)ate Advisors launch pooled employer plan
- ‘I wish I’d met him sooner:’ Karlan Tucker remembered for integrity, faith
- Why women must be more engaged in investing
- SEC moves to simplify electronic delivery of investor communications
More Advisor NewsAnnuity News
- LIMRA: Annuity sales set new quarterly record with $123.9B in Q2
- CANNEX names Gary Baker as its new CEO
- Corebridge adds options to its Power Series of indexed annuities
- Corebridge Financial enhances The Power Series of Index Annuities
- LIMRA predicts strong life and annuity sales for the rest of 2026
More Annuity NewsHealth/Employee Benefits News
- Employers are considering ICHRAs, but barriers to adoption remain
- AI belongs on your organizational chart, and that’s a good thing
- New dashboard tracks Kansas Affordable Care Act enrollment by legislative district, county
- ICYMI – CANDIDATE COOPER NOW TRYING TO BLAME HIS HEALTH INSURANCE PALS FOR GOVERNOR COOPER'S 57% INCREASE IN HEALTHCARE COSTS IN NC
- Business People: Edric Funk to take over as Toro Co. CEO
More Health/Employee Benefits NewsLife Insurance News
- LIMRA predicts strong life and annuity sales for the rest of 2026
- Best’s Market Segment Report: AM Best Maintains Stable Outlook on Vietnam’s Non-Life Insurance Segment
- AM Best Comments on Credit Ratings of Horace Mann Educators Corporation and Its Subsidiaries Following Announced Transaction with Medical Mutual of Ohio
- AM Best Affirms Credit Ratings of Hanwha General Insurance Company Limited
- Globe Life boosts Q2 earnings, eyes AI shift for long-term growth
More Life Insurance News