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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, which is incorporated herein by reference, for a description of
important factors that could cause actual results to differ from expected
results. See also Item 1A, Risk Factors.
Executive Overview
Our Business
We are the nation's largest owner and operator of inpatient rehabilitation hospitals in terms of patients treated, revenues, and number of hospitals. We provide specialized rehabilitative treatment on an inpatient basis. We operate hospitals in 36 states andPuerto Rico , with concentrations in the eastern half ofthe United States andTexas . As ofDecember 31, 2022 , we operate 153 inpatient rehabilitation hospitals. For additional information about our business, see Item 1, Business and Item 1A, Risk Factors, of this report. The onset of the COVID-19 Pandemic (the "pandemic") inthe United States resulted in significant changes to our operating environment. For discussion of the financial and operational impacts we have experienced as a result of the pandemic, see Item 1, Business, Item 1A, Risk Factors, and the "Key Challenges" and "Results of Operations" sections of this Item.
Spin Off of
OnJuly 1, 2022 , we completed the previously announced separation of our home health and hospice business through the distribution (the "Spin Off") of all of the outstanding shares of common stock, par value$0.01 per share, of Enhabit, Inc. ("Enhabit") to the stockholders of record ofEncompass Health as of the close of business onJune 24, 2022 (the "Record Date"). The Spin Off was effective at12:01 a.m., Eastern Time , onJuly 1, 2022 . The Spin Off was structured as a pro rata distribution of one share of Enhabit common stock for every two shares ofEncompass Health common stock held of record as of the Record Date. No fractional shares were distributed. A cash payment was made in lieu of any fractional shares. As a result of the Spin Off, Enhabit is now an independent public company and its common stock is listed under the symbol "EHAB" on theNew York Stock Exchange . In accordance with applicable accounting guidance, the historical results of Enhabit have been presented as discontinued operations and, as such, have been excluded from continuing operations for all periods presented. Our presentation of discontinued operations excludes any allocation of general corporate and overhead costs as well as interest expense. Prior toJuly 1, 2022 , we operated under two reporting segments. We now operate under a single reporting segment. For additional information see Note 2, Spin Off ofHome Health and Hospice Business, to the consolidated financial statements. In connection with the Spin Off, onJune 30, 2022 , we entered into several agreements with Enhabit that govern the relationship of the parties following the Spin Off, including a Separation and Distribution Agreement, a Transition Services Agreement, a Tax Matters Agreement and an Employee Matters Agreement. See also Note 2, Spin Off ofHome Health and Hospice Business, to the consolidated financial statements.
2022 Overview
During 2022, Net operating revenues increased 8.3% over 2021 due primarily to volume growth and increased pricing. See the "Results of Operations" section of this Item for additional financial information.
We continued our development and expansion efforts in 2022. We:
•began operating our new 40-bed inpatient rehabilitation hospital in
Illinois
•began operating our new 40-bed inpatient rehabilitation hospital in
Augustine, Florida
•began operating our new 60-bed inpatient rehabilitation hospital in
47 -------------------------------------------------------------------------------- Table of Contents •began operating our new 50-bed inpatient rehabilitation hospital inLakeland, Florida inMay 2022 ;
•began operating our new 40-bed inpatient rehabilitation hospital in
Florida
2022
•began operating our new 50-bed inpatient rehabilitation hospital in
•began operating our new 40-bed inpatient rehabilitation hospital in
Forks, North Dakota
•began operating our new 40-bed inpatient rehabilitation hospital inMoline, Illinois with our joint venture partnerUnityPoint Health - Trinity inAugust 2022 ; •began operating our new 50-bed inpatient rehabilitation hospital inNaples, Florida inSeptember 2022 (joint venture partnership withNCH Healthcare System began inDecember 2022 );
•continued our capacity expansions by adding 87 new beds to existing hospitals;
and
•announced or continued the development of the following hospitals:
Number of New Beds
2023 2024(2) 2025(2)
Eau Claire, Wisconsin(1) 36 - -
Knoxville, Tennessee(1) 73 - -
Owasso, Oklahoma(1) 40 - -
Clermont, Florida 50 - -
Bowie, Maryland 60 - -
Prosper, Texas 40 - -
Columbus, Georgia(1) 40 - -
Fitchburg, Wisconsin 56 - -
Atlanta, Georgia(1) - 40 -
Kissimmee, Florida - 50 -
Fort Mill, South Carolina - 39 -
Louisville, Kentucky(1) - 40 -
Johnston, Rhode Island - 50 -
Houston, Texas - 61 -
Lake Worth, Florida - 50 -
Fort Myers, Florida(1) - 60 -
Palm Beach Gardens, Florida - - 50
Amarillo, Texas - - 40
Strongsville, Ohio - - 40
Norristown, Pennsylvania - - 50
Wildwood, Florida - - 50
Athens, Georgia(1) - - 40
St. Petersburg, Florida - - 50
Daytona Beach, Florida - - 50
(1) Expected joint venture
(2) Opening dates are tentative
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.
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Business Outlook
We remain optimistic regarding the intermediate and long-term prospects of our
business. Demographic trends, such as population aging, should continue to
increase long-term demand for the services we provide. While we treat patients
of all ages, most of our patients are 65 and older, and the number of Medicare
enrollees is expected to grow approximately 3% per year for the foreseeable
future, reaching approximately 73 million people over the age of 65 by 2030.
More specifically, the average age of our Medicare 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 the U.S. population ages. We believe
these factors align with our strengths in, and focus on, inpatient
rehabilitation services.
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, among other
things, the quality of our clinical outcomes, our cost-effectiveness, our
financial strength, and our extensive application of technology. We also believe
our competitive strengths discussed in Item 1, Business, "Competitive
Strengths," give us the ability to adapt and succeed in a healthcare industry
facing regulatory uncertainty around attempts to improve outcomes and reduce
costs.
The healthcare industry 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 goal is to position the Company in a prudent
manner to be responsive to industry shifts. We have invested in our core
business and created an infrastructure that enables us to provide high-quality
care on a cost-effective basis. We have been disciplined in creating a capital
structure that is flexible with no significant debt maturities prior to 2025. We
continue to have a strong, well-capitalized balance sheet, including a
substantial portfolio of owned real estate, and ample availability under our
revolving credit facility, which along with the cash flows generated from
operations should, we believe, provide sufficient support for our ability to
adapt to changes in reimbursement, sustain our business model, and grow through
de novo and bed additions. See also Item 1, Business, "Competitive Strengths"
and "Strategy and 2023 Strategic Priorities."
Key Challenges
Healthcare is a highly-regulated industry facing many well-publicized regulatory
and reimbursement challenges. Medicare reimbursement for inpatient
rehabilitation facilities ("IRFs") has recently undergone significant changes.
The future of many aspects of healthcare regulation generally and Medicare
reimbursement specifically 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 key
challenges we face.
•Operating in a Highly Regulated Industry. We are required to comply with
extensive and complex laws and regulations at the federal, state, and local
government levels. More specifically, because Medicare comprises a significant
portion of our Net operating revenues, failure to comply with the laws and
regulations governing the Medicare program and related matters, including
anti-kickback and anti-fraud requirements, could materially and adversely affect
us. These rules and regulations have affected, or could in the future affect,
our business activities by having an impact on the reimbursement we receive for
services provided or the costs of compliance, mandating new documentation
standards, requiring additional licensure or certification, regulating our
relationships with physicians and other referral sources, regulating the use of
our properties, and limiting our ability to enter new markets or add new
capacity to existing hospitals. Ensuring continuous compliance with extensive
laws and regulations is an operating requirement for all healthcare providers.
See Item 1, Business, "Regulation" and Item 1A, Risk Factors, "Reimbursement
Risks" and "Other Regulatory Risks" for detailed discussions of the most
important regulations we face and our programs intended to ensure we comply with
those regulations.
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Reimbursement claims made by healthcare providers, including inpatient
rehabilitation hospitals, are subject to audit from time to time by governmental
payors, such as Centers for Medicare & Medicaid Services ("CMS") and state
Medicaid programs, their agents, such as the Medicare Administrative Contractors
("MACs") that act as fiscal intermediaries for all Medicare billings, other
auditors contracted by CMS, and private insurance carriers, as well as the
United States Department of Health and Human Services Office of Inspector
General . 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, "Reimbursement Risks,"
and Note 1, Summary of Significant Accounting Policies, "Net Operating Revenues"
and "Accounts Receivable," to the accompanying consolidated financial
statements.
•Changes in Medicare Reimbursement and Regulatory Requirements for Operating
IRFs. Substantially all of our business consists of inpatient rehabilitation
services. From a payor perspective, our reimbursement and regulatory risk is
concentrated in the Medicare inpatient rehabilitation rules and regulations. We
derive approximately 65% of our Net operating revenues from fee-for-service
Medicare.
As part of its annual rulemaking process for various healthcare provider
categories, CMS adopts IRF reimbursement rate changes effective from October
through the following September. On July 27, 2022 , CMS released its notice of
final rulemaking for fiscal year 2023 for IRFs (the "2023 IRF Rule") under the
inpatient rehabilitation facility prospective payment system (the "IRF-PPS").
Based on our analysis that utilizes, among other things, the acuity of our
patients annualized over a twelve-month period ended June 30, 2022 , our
experience with outlier payments over this same time frame, and other factors,
we believe the 2023 IRF Rule will result in a net increase to our Medicare
payment rates of approximately 4.0% effective October 1, 2022 .
Congress also regularly adopts legislation that directly affects Medicare
reimbursement. These reimbursement changes can result in limitations on the
increases in and, in some cases, significant roll-backs or reductions in the
levels of payments for IRF services. For example, the Patient Protection and
Affordable Care Act (the "ACA") enacted in 2010 provides for specific reductions
to healthcare providers' annual reimbursement rate updates and other payment
policy changes. The Budget Control Act of 2011 provides for an automatic 2%
reduction, or "sequestration," of Medicare program payments for all healthcare
providers. Sequestration took effect April 1, 2013 and, as a result of
subsequent legislation, will continue through mid-year 2032 unless Congress and
the President take further action. In response to the public health emergency
associated with the pandemic, Congress and the President suspended sequestration
through March 31, 2022 . Additional Medicare payment reductions are also possible
under the Statutory Pay-As-You-Go Act of 2010 ("Statutory PAYGO"). Statutory
PAYGO requires, among other things, that mandatory spending and revenue
legislation not increase the federal budget deficit over a 5- or 10-year period.
There can be no assurance that future federal rulemaking and legislation will
not result in reimbursement freezes or reductions, or reimbursement increases
that are less than the increases we experience in our costs of operation.
In addition to direct changes to Medicare reimbursement rates, other federal
regulatory and legislative actions affect healthcare generally and our business
specifically. For example, the ACA also included provisions intended to promote
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. Likewise, CMS regulatory proposals can affect our
operations. On December 14, 2020 , CMS announced a five-year review choice
demonstration for inpatient rehabilitation services (the "IRF RCD"). The IRF RCD
would affect the process in which we submit, and receive reimbursement for,
Medicare claims. A number of key details on this demonstration have yet to be
released, and it is not clear how or when CMS will implement this demonstration.
For additional discussion of changes to Medicare reimbursement, including the
2023 IRF Rule and Statutory PAYGO, and other proposed and adopted legislative
and regulatory actions, including alternative payment models and the IRF RCD,
that may be material to our business, see Item 1, Business, and Item 1A, Risk
Factors, "Reimbursement Risks" and "Other Regulatory Risks."
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 further federal spending
reductions, further entitlement reform legislation affecting the Medicare
program, and further reductions to provider payments. 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.
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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.
•Maintaining Strong Volume Growth. Various factors, including competition and
increasing regulatory and administrative burdens, may impact our ability to
maintain and grow our hospital 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 to our portfolio also may be difficult
and take longer than expected. Clinical staffing shortages, recently exacerbated
by the pandemic, can also limit our ability to admit patients in a given market.
•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 and constrain our ability to
take new patients. Recruiting and retaining qualified personnel, including
management, for our inpatient hospitals 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 an infectious disease, where employees are
unavailable due to a lack of childcare or care for elderly family, or where
competition creates a nursing shortage in a given market. These factors have
resulted in increased labor costs, including significant sign-on and shift
bonuses, and increased use of contract labor as discussed in the "Results of
Operations" section of this Item.
We remain confident in the prospects of our business based on the increasing
demands for the services we provide to an aging population. This confidence is
further supported by our strong financial foundation and the substantial
investments we have made in our business. 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
We derived consolidated Net operating revenues from the following payor sources:
For the Year Ended December 31,
2022 2021 2020
Medicare 65.3 % 64.4 % 66.7 %
Medicare Advantage 15.1 % 15.2 % 15.3 %
Managed care 11.6 % 12.1 % 10.4 %
Medicaid 4.2 % 4.1 % 3.9 %
Other third-party payors 0.9 % 1.1 % 1.2 %
Workers' compensation 0.6 % 0.6 % 0.6 %
Patients 0.4 % 0.5 % 0.5 %
Other income 1.9 % 2.0 % 1.4 %
Total 100.0 % 100.0 % 100.0 %
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-------------------------------------------------------------------------------- Table of Contents Our payor mix is weighted heavily towards Medicare. We receive Medicare reimbursements under the IRF-PPS. 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 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.
Our Results
Our consolidated results of operations were as follows:
For the Year Ended December 31, Percentage Change
2022 2021 2020 2022 vs. 2021 2021 vs. 2020
(In Millions)
Net operating revenues $ 4,348.6 $ 4,014.9 $ 3,566.3 8.3 % 12.6 %
Operating expenses:
Salaries and benefits 2,393.3 2,127.3 1,903.8 12.5 % 11.7 %
Other operating expenses 670.4 595.9 545.1 12.5 % 9.3 %
Occupancy costs 54.7 59.0 61.4 (7.3) % (3.9) %
Supplies 202.1 184.2 171.0 9.7 % 7.7 %
General and administrative expenses 154.3 169.5 151.6 (9.0) % 11.8 %
Depreciation and amortization 243.6 219.6 203.0 10.9 % 8.2 %
Government, class action, and related settlements - - 2.8 - %
(100.0) %
Total operating expenses 3,718.4 3,355.5 3,038.7 10.8 % 10.4 %
Loss on early extinguishment of debt 1.4 1.0 2.3 40.0 % (56.5) %
Interest expense and amortization of debt
discounts and fees 175.7 164.3 183.7 6.9 % (10.6) %
Other expense (income) 5.2 (7.5) (8.4) (169.3) % (10.7) %
Equity in net income of nonconsolidated
affiliates (2.9) (3.4) (2.9) (14.7) % 17.2 %
Income from continuing operations before income
tax expense 450.8 505.0 352.9 (10.7) % 43.1 %
Provision for income tax expense 100.1 101.9 74.7 (1.8) % 36.4 %
Income from continuing operations 350.7 403.1 278.2 (13.0) % 44.9 %
Income from discontinued operations, net of tax 15.2 114.1 90.6 (86.7) % 25.9 %
Net income 365.9 517.2 368.8 (29.3) % 40.2 %
Less: Net income attributable to noncontrolling
interests included in continuing operations (93.6) (103.2) (83.3) (9.3) % 23.9 %
Less: Net income attributable to noncontrolling
interests included in discontinued operations (1.3) (1.8) (1.3) (27.8) % 38.5 %
Less: Net and comprehensive income attributable
to noncontrolling interests (94.9) (105.0) (84.6) (9.6) % 24.1 %
Net income attributable to Encompass Health 271.0 412.2 284.2 (34.3) % 45.0 %
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Operating Expenses as a % of Net Operating Revenues
For the Year Ended
2022 2021 2020 Operating expenses: Salaries and benefits 55.0 % 53.0 % 53.4 % Other operating expenses 15.4 % 14.8 % 15.3 % Occupancy costs 1.3 % 1.5 % 1.7 % Supplies 4.6 % 4.6 % 4.8 % General and administrative expenses 3.5 % 4.2 % 4.3 % Depreciation and amortization 5.6 % 5.5 % 5.7 % Government, class action, and related settlements - % - % 0.1 % Total operating expenses 85.5 % 83.6 % 85.2 %
Additional information regarding our operating results is as follows:
For the Year Ended December 31, Percentage Change
2022 2021 2020 2022 vs. 2021 2021 vs. 2020
(In Millions, Except Percentage Change)
Net operating revenues:
Inpatient $ 4,251.6 $ 3,918.0 $ 3,496.1 8.5 % 12.1 %
Outpatient and other 97.0 96.9 70.2 0.1 % 38.0 %
Net operating revenues 4,348.6 4,014.9 3,566.3 8.3 % 12.6 %
(Actual Amounts)
Discharges 211,116 197,639 181,897 6.8 % 8.7 %
Net patient revenue per discharge
$ 19,220 1.6 % 3.1 % Outpatient visits 138,644 161,070 186,257 (13.9) % (13.5) % Average length of stay (days) 12.7 12.8 12.9 (0.8) % (0.8) % Occupancy % 70.9% 70.0% 67.7% 1.3 % 3.4 % # of licensed beds 10,356 9,924 9,505 4.4 % 4.4 % Full-time equivalents* 24,627 23,193 22,076 6.2 % 5.1 % Employees per occupied bed 3.35 3.34 3.43 0.3 % (2.6) %
* 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.
In the discussion that follows, we use "same-store" comparisons to explain the
changes in certain performance metrics and line items within our financial
statements. We calculate same-store comparisons based on hospitals open
throughout both the full current period and prior periods presented. These
comparisons include the financial results of market consolidation transactions
in existing markets, as it is difficult to determine, with precision, the
incremental impact of these transactions on our results of operations.
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Table of Contents 2022 Compared to 2021 Net Operating Revenues Our consolidated Net operating revenues increased during 2022 compared to 2021 primarily due to increased volumes and favorable pricing. Discharge growth included a 3.1% increase in same-store discharges. Discharge growth from new stores during 2022 compared to 2021 resulted from our joint ventures inSan Angelo, Texas (March 2021 ),Henry County, Georgia (October 2021 ),Shiloh, Illinois (February 2022 ),Cape Coral, Florida (June 2022 ),Moline, Illinois (August 2022 ),Grand Forks, North Dakota (August 2022 ), andNaples, Florida (September 2022 ), as well as wholly owned hospitals inNorth Tampa, Florida (April 2021 ),Cumming, Georgia (June 2021 ),Waco, Texas (August 2021 ),Shreveport, Louisiana (August 2021 ),Greenville, South Carolina (August 2021 ),Pensacola, Florida (September 2021 ),St. Augustine, Florida (March 2022 ),Libertyville, Illinois (March 2022 ),Lakeland, Florida (May 2022 ), andJacksonville, Florida (June 2022 ). Growth in net patient revenue per discharge during 2022 compared to 2021 primarily attributable to an increase in reimbursement rates partially offset by the resumption of sequestration onApril 1, 2022 . 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, including all related costs of benefits provided to employees. It also includes amounts paid for contract labor. Salaries and benefits increased in terms of dollars and as a percent of revenue in 2022 compared to 2021 primarily due to increases in contract labor and clinician compensation, including sign-on and shift bonuses, to meet higher patient volumes, and the ramping up of new stores. Total contract labor plus sign-on and shift bonuses increased approximately$70 million from$134.2 million in 2021 to$204.3 million in 2022
Other Operating Expenses
Other operating expenses include costs associated with managing and maintaining our hospitals. These expenses include such items as contract services, non-income related taxes, professional fees, utilities, insurance, and repairs and maintenance.
Other operating expenses increased in terms of dollars and as a percent of Net
operating revenues during 2022 compared to 2021 primarily due to increased
provider taxes of approximately
recruiting, utilities, and travel of approximately
Supplies
Supplies expense includes all costs associated with supplies used while
providing patient care. Specifically, these costs include personal protective
equipment ("PPE"), pharmaceuticals, food, syringes, bandages, and other similar
items.
Supplies increased during 2022 compared to 2021 primarily due to higher costs
for food and medical supplies.
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 inBirmingham, Alabama . These expenses also include stock-based compensation expenses and transaction costs. General and administrative expenses decreased in terms of dollars and as a percent of Net operating revenues during 2022 compared to 2021 primarily due to the mark-to-market adjustments on our non-qualified 401k plan, approximately$2 million related to our transition services agreement with Enhabit, and lower incentive compensation costs. For additional information on the transition services agreement with Enhabit, see Note 2, Spin Off ofHome Health and Hospice Business, to the accompanying consolidated financial statements.
Depreciation and Amortization
Depreciation and amortization increased during 2022 compared to 2021 due to our
capital investments throughout 2021 and 2022. See "Executive Overview" section
of this Item for information related to our development activity. We expect
Depreciation and amortization to increase going forward as a result of our
recent and ongoing capital investments.
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Interest Expense and Amortization of Debt Discounts and Fees
The increase in Interest expense and amortization of debt discounts and fees in
2022 compared to 2021 primarily resulted from the $20.5 million consent
solicitation fee paid to bond holders in June 2022 related to the Spin Off of
Enhabit partially offset by the March 2022 redemption of the remaining $100
million in outstanding principal amount of the 5.125% Senior Notes due 2023.
Cash paid for interest approximated $178 million and $168 million in 2022 and
2021, respectively. For additional information, see Note 10, Long-term Debt, to
the accompanying consolidated financial statements.
Provision for Income Tax Expense
Our Provision for income tax expense decreased in 2022 compared to 2021 primarily due to lower Income from continuing operations before income tax expense offset by increases to the valuation allowance and equity compensation shortfalls. See also Note 16, Income Taxes, to the accompanying consolidated financial statements. The Coronavirus Aid, Relief, and Economic Security Act of 2020 (the "CARES Act") included 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, 2022 and 2021, although it has impacted the timing of cash payments for taxes. Our cash payments for income taxes approximated$50 and$130 million , net of refunds, in 2022 and 2021, respectively. These payments were based on estimates of taxable income. We estimate we will pay approximately$85 million to$100 million of cash income taxes, net of refunds, in 2023. These payments are expected to primarily result from federal and state income tax expenses based on estimates of taxable income for 2023. In 2022 and 2021, current income tax expense was$72.2 million and$84.5 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.
Net Income Attributable to Noncontrolling Interests
The decrease in Net income attributable to noncontrolling interests during 2022 compared to 2021 resulted from the ramp up of new joint venture de novo locations. For additional information see the "Executive Overview" section of this Item. 2021 Compared to 2020 Net Operating Revenues Our consolidated Net operating revenues increased in 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). 55 -------------------------------------------------------------------------------- Table of Contents Salaries and Benefits 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 (contributing to lower EPOB) partially offset by higher clinician compensation costs due to staffing challenges resulting from the pandemic. 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$29 million in salary and benefits expense in the second quarter of 2020 in connection with this award.
Other Operating Expenses
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 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.
General and Administrative Expenses
General and administrative expenses increased in terms of dollars during 2021 compared to 2020 primarily due to higher costs associated with incentive compensation. General and administrative 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.
Depreciation and Amortization
Depreciation and amortization increased during 2021 compared to 2020 due to our
capital expenditures and development activities throughout 2020 and 2021.
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 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.
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. The CARES Act, as discussed above, did not materially
impact our effective tax rate for the year ended
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. In 2021 and 2020, current income tax expense was$84.5 million and$40.2 million , respectively. See Note 16, Income Taxes, to the accompanying consolidated financial statements and the "Critical Accounting Estimates" section of this Item. 56 -------------------------------------------------------------------------------- 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) and food 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 2022, 2021, or
2020, and therefore, are not presented as a separate discussion within this
Item.
Liquidity and Capital Resources
Our primary sources of liquidity are cash on hand, cash flows from operations,
and borrowings under our revolving credit facility.
The objectives of our capital structure strategy are to ensure we maintain adequate liquidity and flexibility. Pursuing and achieving those objectives allow us to support the execution of our operating and strategic plans and weather temporary disruptions in the capital markets and general business environment. Maintaining adequate liquidity is a function of our unrestricted Cash and cash equivalents and our available borrowing capacity. Maintaining flexibility in our capital structure is a function of, among other things, the amount of debt maturities in any given year, the options for debt prepayments without onerous penalties, and limiting restrictive terms and maintenance covenants in our debt agreements. Consistent with these objectives, inMarch 2022 , we redeemed the remaining$100 million in outstanding principal amount of the 2023 Notes using capacity under our revolving credit facility. Pursuant to the terms of the 2023 Notes, this optional redemption was made at a price of par. As a result of this redemption, we recorded a$0.3 million Loss on early extinguishment of debt in the first quarter of 2022. InJune 2022 , we amended our credit agreement primarily in preparation for the Spin Off of the home health and hospice business. The modifications are described in Note 10, Long-term Debt, to the accompanying consolidated financial statements. OnJune 30, 2022 , Enhabit distributed$566.6 million toEncompass Health who used it to fully repay both the$250 million outstanding balance of theEncompass Health revolving credit facility and approximately$236 million of theEncompass Health term loan. As a result of this repayment, we recorded a$1.1 million Loss on early extinguishment of debt in the second quarter of 2022. InOctober 2022 , we further amended the credit agreement primarily to extend the maturity date toOctober 2027 . For further details on theJune 2022 andOctober 2022 amendments to our credit agreement, see Note 10, Long-term Debt, to the accompanying consolidated financial statements. We have been disciplined in creating a capital structure that is flexible with no significant debt maturities prior to 2025. We continue to have a strong, well-capitalized balance sheet, including a substantial portfolio of owned real estate, and we have significant availability under our revolving credit facility. We continue to generate strong cash flows from operations, and we have significant flexibility with how we choose to invest our cash and return capital to shareholders.
See Note 10, Long-term Debt, to the accompanying consolidated financial
statements.
57 -------------------------------------------------------------------------------- Table of Contents Current Liquidity As ofDecember 31, 2022 , we had$21.8 million in Cash and cash equivalents. This amount excludes$31.6 million in Restricted cash and$110.0 million of restricted marketable securities ($30.9 million included in Other current assets and$79.1 million 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 5,Cash and Marketable Securities , to the accompanying consolidated financial statements. In addition to Cash and cash equivalents, as ofDecember 31, 2022 , we had approximately$912 million available to us under our revolving credit facility. Our credit agreement governs the substantial majority of our senior secured borrowing capacity and contains a leverage ratio and an interest coverage ratio as financial covenants. Our leverage ratio is defined in our credit agreement as the ratio of consolidated total debt (less cash on hand) to Adjusted EBITDA for the trailing four quarters. In calculating the leverage ratio under our credit agreement, we are permitted to use pro forma Adjusted EBITDA, the calculation of which includes historical income statement items and pro forma adjustments, subject to certain limitations, resulting from (1) dispositions and repayments or incurrence of debt and (2) investments, acquisitions, mergers, amalgamations, consolidations and other operational changes to the extent such items or effects are not yet reflected in our trailing four-quarter financial statements. Our interest coverage ratio is defined in our credit agreement as the ratio of Adjusted EBITDA to consolidated interest expense, excluding the amortization of financing fees, for the trailing four quarters. As ofDecember 31, 2022 , the maximum leverage ratio requirement per our credit agreement was 4.75x and the minimum interest coverage ratio requirement was 3.0x, and we were in compliance with these covenants. Based on Adjusted EBITDA for 2022 and the interest rate in effect under our credit agreement during the three-month period endedDecember 31, 2022 , 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 5.75% Senior Notes due 2025, 4.50% Senior Notes due 2028 (the "2028 Notes"), 4.75% Senior Notes due 2030 (the "2030 Notes"), and 4.625% Senior Notes due 2031 (the "2031 Notes" and collectively the "Notes") for the adoption of certain amendments to an indenture (the "Base Indenture") dated as ofDecember 1, 2009 , as supplemented by each Notes' respective supplemental indenture (together with the Base Indenture, the "Indenture"), which provided us with greater flexibility in effecting the Spin Off discussed in the "Executive Overview" section of this Item. Each Indenture contains restrictive covenants that, among other things, limit our ability and the ability of certain of our subsidiaries to make certain asset dispositions, investments, and distributions to holders of our capital stock. The amendments to the Indentures permit us, subject to the leverage ratio condition set forth below, to distribute to our equity holders in one or more transactions (a "Distribution") some or all of the common stock of a subsidiary that holds substantially all of the assets of our home health and hospice business. We may make any such distribution so long as the Leverage Ratio (as defined in each Indenture) is no more than 3.5 to 1.0 on a pro forma basis after giving effect thereto. The amendments also reduce the capacity under our restricted payments builder basket under each existing Indenture for the 2028 Notes, 2030 Notes, and 2031 Notes by$200 million and amends the definition of "Consolidated Net Income" to allow us to exclude from Consolidated Net Income (a component of the Leverage Ratio) any fees, expenses or charges related to any Distribution and the solicitation of consents from the holders of the Notes. InDecember 2021 andJanuary 2022 , we received the requisite consents for the adoption of these amendments. Under the terms of the amendments, we agreed to pay the holders of the Notes a total of$40.5 million , excluding fees. We paid$20.0 million and$20.5 million in January andJune 2022 , respectively. We do not face near-term refinancing risk, as the amounts outstanding under our credit agreement do not mature until 2027, and our bonds all mature in 2025 and beyond. See the "Contractual Obligations" section below for information related to our contractual obligations as ofDecember 31, 2022 . 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.
58 -------------------------------------------------------------------------------- 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 of continuing operations (in millions):
For
the Year Ended
2022 2021 2020
Net cash provided by operating activities $ 653.5 $ 564.7 $ 668.9
Net cash used in investing activities (623.5) (547.1) (404.5)
Net cash used in financing activities (660.8) (229.9) (134.3)
(Decrease) increase in cash, cash equivalents, and
restricted cash $ (630.8) $ (212.3) $ 130.1
2022 Compared to 2021
Operating activities. The increase in Net cash provided by operating activities
of continuing operations during 2022 compared to 2021 primarily resulted from
lower cash tax payments and improved collection of accounts receivable,
including the recovery of $12.5 million of previously denied Medicare claims (as
discussed in Note 1, Summary of Significant Accounting Policies, "Net Operating
Revenues," to the accompanying consolidated financial statements).
Investing activities. The increase in Net cash used in investing activities of
continuing operations during 2022 compared to 2021 primarily resulted from
increased purchases of property and equipment and restricted investments.
Financing activities. The increase in Net cash used in financing activities of continuing operations during 2022 compared to 2021 primarily resulted from increased net debt payments. For additional information, see Note 10, Long-term Debt, to the accompanying consolidated financial statements.
2021 Compared to 2020
Operating activities. The decrease in Net cash provided by operating activities of continuing operations during 2021 compared to 2020 primarily resulted from the decrease in payroll accruals partially offset by the increase in Net income (see the "Results of Operations" section of this Item). 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 paid inDecember 2022 . Investing activities. The increase in Net cash used in investing activities of continuing operations during 2021 compared to 2020 primarily resulted from the increased purchases of property and equipment. Financing activities. The increase in Net cash used in financing activities of continuing operations during 2021 compared to 2020 primarily resulted from increased net debt payments partially offset by the purchase of equity interests held by management investors of our former home health and hospice business during the first quarter of 2020. For additional information, see Note 10, Long-term Debt, and Note 12, Redeemable Noncontrolling Interests, to the accompanying consolidated financial statements. 59 -------------------------------------------------------------------------------- Table of Contents Contractual Obligations Our consolidated contractual obligations as ofDecember 31, 2022 are as follows (in millions): Total Current Long-term Long-term debt obligations: Long-term debt, excluding revolving credit facility and finance lease obligations (a)$ 2,352.2 $ 5.7 $ 2,346.5 Revolving credit facility 55.0 - 55.0 Interest on long-term debt (b) 687.9 120.5 567.4 Finance lease obligations (c) 551.0 45.6 505.4 Operating lease obligations (d) 302.4 38.4 264.0 Purchase obligations (e) 91.7 29.6 62.1 Total$ 4,040.2 $ 239.8 $ 3,800.4
(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, 2022 . Interest pertaining to our credit agreement and bonds is included to their respective ultimate maturity dates. Interest related to finance lease obligations is excluded from this line (see Note 8, 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.
(d)We lease approximately 10% of our hospitals as well as other property and equipment under operating leases in the normal course of business. Amounts include interest portion of future minimum operating lease payments. For more information, see Note 8, 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, 2022 , we made capital expenditures of approximately$584 million for property and equipment, capitalized software, and other intangible assets. During 2023, we expect to spend approximately$565 million to$605 million for capital expenditures using cash on hand and borrowings under our revolving credit facility. Approximately$230 million to$240 million of this budgeted amount is considered nondiscretionary expenditures, which we may refer to in other filings as "maintenance" expenditures. Actual amounts spent will be dependent upon the timing of development projects.
Authorizations for
InOctober 2021 ,February 2022 , andMay 2022 , our board of directors declared cash dividends of$0.28 per share that were paid inJanuary 2022 ,April 2022 , andJuly 2022 , respectively. InJuly 2022 , our board of directors revised our quarterly dividend in response to the Spin Off of Enhabit and declared a cash dividend of$0.15 per share that was paid inOctober 2022 . Also inOctober 2022 , our board of directors declared cash dividends of$0.15 per share that was paid inJanuary 2023 . We expect quarterly dividends to be paid in January, April, July, and October. However, the actual declaration of any future cash dividends, and the setting of record and payment dates as well as the per share amounts, will be at the discretion of our board of directors after consideration of various factors, including our capital position and alternative uses of funds. Cash dividends are expected to be funded using cash flows from operations, cash on hand, and availability under our revolving credit facility. 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, 2022 , approximately$198 million remained under this authorization. The repurchase authorization does not require the repurchase of a specific number of shares, 60 -------------------------------------------------------------------------------- Table of Contents 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 Notes are guaranteed by certain consolidated subsidiaries. These guarantees are full and unconditional and joint and several, subject to certain customary conditions for release. The Notes are guaranteed on a senior, unsecured basis by all of our existing and future subsidiaries that guarantee borrowings under our credit agreement and other capital markets debt. The other subsidiaries ofEncompass Health do not guarantee the Notes (such subsidiaries are referred to as the "non-guarantor subsidiaries"). The terms of our credit agreement allow us to declare and pay cash dividends on our common stock so long as: (1) we are not in default under our credit agreement, and (2) either (a) our senior secured leverage ratio (as defined in our credit agreement) remains less than or equal to 2x and our leverage ratio (as defined in our credit agreement) remains less than or equal to 4.50x or (b) our leverage ratio remains in compliance with the leverage ratio covenant and there is capacity under the Available Amount as defined in the credit agreement. The terms of our Notes indenture allow us to declare and pay cash dividends on our common stock so long as (1) we are not in default, (2) the consolidated coverage ratio (as defined in the indenture) exceeds 2x or we are otherwise allowed under the indenture to incur debt, and (3) we have capacity under the indenture's restricted payments covenant to declare and pay dividends. See Note 10, Long-term Debt, to the accompanying consolidated financial statements. 61 -------------------------------------------------------------------------------- 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, 2022 (In Millions) Net operating revenues $ 2,819.4 Intercompany revenues generated from non-guarantor subsidiaries 78.7 Total net operating revenues $ 2,898.1 Operating expenses $ 2,496.0 Intercompany expenses incurred in transactions with non-guarantor subsidiaries 31.9 Total operating expenses $ 2,527.9 Income from continuing operations $
135.7
Net income $ 98.0
Net income attributable to Encompass Health $ 96.8
As of December 31,
2022
(In Millions)
Total current assets $ 469.2
Property and equipment, net $ 2,004.5
Goodwill 902.6
Intercompany receivable due from non-guarantor subsidiaries 255.0
Other noncurrent assets 509.1
Total noncurrent assets $ 3,671.2
Total current liabilities $ 438.4
Long-term debt, net of current portion $ 2,670.6
Other noncurrent liabilities
349.7
Total noncurrent liabilities$ 3,020.3 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 cash provided by operating
activities and to Net income.
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, making
certain payments, and acquiring and disposing of assets. Consequently, Adjusted
EBITDA is critical to our assessment of our liquidity.
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In general terms, the credit agreement definition of Adjusted EBITDA, therein
referred to as "Adjusted Consolidated EBITDA," allows us to add back to
consolidated Net income interest expense, income taxes, and depreciation and
amortization and then add back to consolidated Net income (1) all unusual or
nonrecurring items reducing consolidated Net income (of which only up to $10
million in a year may be cash expenditures), (2) any losses from discontinued
operations, (3) non-ordinary course fees, costs and expenses incurred with
respect to any litigation or settlement, (4) share-based compensation expense,
(5) costs and expenses associated with changes in the fair value of marketable
securities, (6) costs and expenses associated with the issuance or prepayment
debt and acquisitions, and (7) any restructuring charges and certain pro forma
cost savings and synergies related to transactions and initiatives, which in the
aggregate are not in excess of 25% of Adjusted Consolidated EBITDA. We also
subtract from consolidated Net income all unusual or nonrecurring items to the
extent they increase consolidated Net income.
Under the credit agreement, the Adjusted EBITDA calculation does not require us
to deduct net income attributable to noncontrolling interests or gains on fair
value adjustments of hedging and equity instruments, disposal of assets, and
development activities. It also does not allow us to add back losses on fair
value adjustments of hedging instruments or unusual or nonrecurring cash
expenditures in excess of $10 million . These items and amounts, in addition to
the items falling within the credit agreement's "unusual or nonrecurring"
classification, may occur in future periods, but can vary significantly from
period to period and may not directly relate to, or be indicative of, our
ongoing liquidity or operating performance. Accordingly, the Adjusted EBITDA
calculation presented here includes adjustments for them.
Adjusted EBITDA is not a measure of financial performance under generally
accepted accounting principles in the United States of America , and the items
excluded from Adjusted EBITDA are significant components in understanding and
assessing financial performance. Therefore, Adjusted EBITDA should not be
considered a substitute for Net income or cash flows from operating, investing,
or financing activities. Because Adjusted EBITDA is not a measurement determined
in accordance with GAAP and is thus susceptible to varying calculations,
Adjusted EBITDA, as presented, may not be comparable to other similarly titled
measures of other companies. Revenues and expenses are measured in accordance
with the policies and procedures described in Note 1, Summary of Significant
Accounting Policies, to the accompanying consolidated financial statements.
Our Adjusted EBITDA for the years ended
follows (in millions):
Reconciliation of Net Cash Provided by Operating Activities to Adjusted EBITDA
For the Year Ended
2022 2021 2020
Net cash provided by operating activities $ 705.8
Interest expense and amortization of debt discounts and fees 175.7
164.3 183.7 (Loss) gain on sale of investments, excluding impairments (15.5) 3.8 3.6 Equity in net income of nonconsolidated affiliates 2.9 3.4 2.9
Net income attributable to noncontrolling interests in
continuing operations
(93.6) (103.2) (83.3) Amortization of debt-related items (9.7) (7.8) (7.2) Distributions from nonconsolidated affiliates (4.0) (2.6) (3.4) Current portion of income tax expense 72.2 84.5 40.2 Change in assets and liabilities 30.4 109.9 (108.0)
Cash provided by operating activities of discontinued
operations
(52.3) (151.1) (35.8) Change in fair market value of equity securities 7.4 (0.6) (0.4) Other - - 0.1 Adjusted EBITDA$ 819.3 $ 816.4 $ 697.1 63
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Reconciliation of Net Income to Adjusted EBITDA
For the Year Ended December 31,
2022 2021 2020
Net income $ 365.9
Income from discontinued operations, net of tax, attributable
to
(15.2) (114.1) (90.6)
Net income attributable to noncontrolling interests included
in continuing operations
(93.6) (103.2) (83.3) Provision for income tax expense 100.1 101.9 74.7
Interest expense and amortization of debt discounts and fees 175.7
164.3 183.7 Loss on early extinguishment of debt 1.4 1.0 2.3 Government, class action, and related settlements - - 2.8 Loss on disposal or impairment of assets 4.8 1.2 10.5 Depreciation and amortization 243.6 219.6 203.0 Stock-based compensation expense 29.2 29.1 25.6 Change in fair market value of equity securities 7.4 (0.6) (0.4) Adjusted EBITDA$ 819.3 $ 816.4 $ 697.1
For additional information see the "Results of Operations" section 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.
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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.
The table below shows a summary of our net accounts receivable balances as of
December 31, 2022 and 2021. 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,
2022 2021
(In Millions)
Current:
0 - 30 Days $ 381.9 $ 356.4
31 - 60 Days 48.0 47.8
61 - 90 Days 22.0 27.4
91 - 120 Days 16.3 16.5
120 + Days 56.6 54.0
Patient accounts receivable 524.8 502.1
Other accounts receivable 12.0 13.7
536.8 515.8
Noncurrent patient accounts receivable 73.3 77.4
Accounts receivable $ 610.1 $ 593.2
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, 2022 and 2021, $73.6 million and
$77.8 million , respectively, of our patient accounts receivable represented
denials that were under review or audit. 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.
65
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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.
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, 2022 :
As reported, with 50% statistical confidence level 142.8
With 70% statistical confidence level 153.9
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 reporting unit. We assess qualitative factors in our 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 our 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 unit 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 unit. The income approach includes the use of our 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 9,
accompanying consolidated financial statements for additional information.
66 -------------------------------------------------------------------------------- Table of Contents 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;
•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 2022, 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 unit is 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, 2022 , we decreased our valuation allowance by$7.3 million . As ofDecember 31, 2022 , we had a remaining valuation allowance of$35.8 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 67 -------------------------------------------------------------------------------- Table of Contents 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, 2022 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.
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.
Recent Accounting Pronouncements
For information regarding recent accounting pronouncements, see Note 1, Summary of Significant Accounting Policies, to the accompanying consolidated financial statements.
ProAssurance Reports Results for Fourth Quarter and Full Year 2022
UNIVERSAL HEALTH REALTY INCOME TRUST – 10-K – Management's Discussion and Analysis of Financial Condition and Results of Operations
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