UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 ______________________________

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2020

OR 

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 001-10315

______________________________ 

Encompass Health Corporation

(Exact name of Registrant as specified in its Charter)

Delaware	63-0860407
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)

9001 Liberty Parkway

Birmingham, Alabama 35242

(Address of Principal Executive Offices)

(205) 967-7116

(Registrant’s telephone number)

 Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, par value $0.01 per share	EHC	New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	☒	Accelerated filer	☐	Non-Accelerated filer	☐
Smaller reporting company	☐	Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   ☐

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes ☐ No ☒

The registrant had 99,432,464 shares of common stock outstanding, net of treasury shares, as of October 22, 2020.

TABLE OF CONTENTS

		Page
PART I	Financial Information
Item 1.	Financial Statements (Unaudited)	1
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	47
Item 4.	Controls and Procedures	47
PART II	Other Information
Item 1.	Legal Proceedings	48
Item 1A.	Risk Factors	48
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	50
Item 6.	Exhibits	50

NOTE TO READERS

As used in this report, the terms “Encompass Health,” “we,” “us,” “our,” and the “Company” refer to Encompass Health Corporation and its consolidated subsidiaries, unless otherwise stated or indicated by context. This drafting style is suggested by the Securities and Exchange Commission and is not meant to imply that Encompass Health Corporation, the publicly traded parent company, owns or operates any specific asset, business, or property. The hospitals, operations, and businesses described in this filing are primarily owned and operated by subsidiaries of the parent company. In addition, we use the term “Encompass Health Corporation” to refer to Encompass Health Corporation alone wherever a distinction between Encompass Health Corporation and its subsidiaries is required or aids in the understanding of this filing.

i

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This quarterly report contains historical information, as well as forward-looking statements that involve known and unknown risks and relate to, among other things, future events, the spread and impact of the COVID-19 pandemic, changes to Medicare reimbursement and other healthcare laws and regulations from time to time, our business strategy, our dividend and stock repurchase strategies, our financial plans, our growth plans, our future financial performance, our projected business results, or our projected capital expenditures. In some cases, the reader can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “targets,” “potential,” or “continue” or the negative of these terms or other comparable terminology. Such forward-looking statements are necessarily estimates based upon current information and involve a number of risks and uncertainties, many of which are beyond our control. Any forward-looking statement is based on information current as of the date of this report and speaks only as of the date on which such statement is made. Actual events or results may differ materially from the results anticipated in these forward-looking statements as a result of a variety of factors. While it is impossible to identify all such factors, factors that could cause, and in the case of the COVID-19 pandemic has already caused, actual results to differ, such as decreases in revenues or increases in costs or charges, materially from those estimated by us include, but are not limited to, the following:

•each of the factors discussed in Item 1A, Risk Factors, of our Annual Report on Form 10-K for the year ended December 31, 2019 and Part II, Item 1A, Risk Factors, of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2020, as well as uncertainties and factors, if any, discussed elsewhere in this Form 10-Q, including in the “Executive Overview—Key Challenges” section of Part I, Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, in our other filings from time to time with the SEC, or in materials incorporated therein by reference;

•a pandemic, epidemic, or other widespread outbreak of an infectious disease or other public health crisis, such as the COVID-19 pandemic, which could decrease our patient volumes, pricing, and revenues, lead to staffing and supply shortages and associated cost increases, or otherwise interrupt operations;

•governmental actions in response to the COVID-19 pandemic, such as shelter-in-place orders, facility closures and quarantines, which could impair our ability to operate and provide care;

•our ability to maintain infectious disease prevention and control efforts that are required and effectively minimize the spread of COVID-19 among patients and employees;

•changes in the rules and regulations of the healthcare industry at either or both of the federal and state levels, including those contemplated now and in the future as part of national healthcare reform and deficit reduction (such as the re-basing of payment systems, the introduction of site neutral payments or case-mix weightings across post-acute settings, the Patient-Driven Groupings Model for home health, the new patient assessment measures, which we refer to as “Section GG functional measures,” for inpatient rehabilitation, and other payment system reforms), which may decrease revenues and increase the costs of complying with the rules and regulations;

•reductions or delays in, or suspension of, reimbursement for our services by governmental or private payors, including our ability to obtain and retain favorable arrangements with third-party payors;

•restrictive interpretations of the regulations governing the claims that are reimbursable by Medicare;

•our ability to comply with extensive and changing healthcare regulations as well as the increased costs of regulatory compliance and compliance monitoring in the healthcare industry, including the costs of investigating and defending asserted claims, whether meritorious or not;

•any adverse outcome of various lawsuits, claims, and legal or regulatory proceedings, including disclosed and undisclosed qui tam suits;

•the use by governmental agencies and contractors of statistical sampling and extrapolation to expand claims of overpayment or noncompliance;

•delays and other substantive and procedural deficiencies in the administrative appeals process associated with denied Medicare reimbursement claims, including from various Medicare audit programs, and our exposure to any related delay or reduction in the receipt of the reimbursement amounts for services previously provided, including through recoupment of ongoing claims reimbursement by CMS;

ii

•the ongoing evolution of the healthcare delivery system, including alternative payment models and value-based purchasing initiatives, which may decrease our reimbursement rate or increase costs associated with our operations;

•our ability to attract and retain nurses, therapists, and other healthcare professionals in a highly competitive environment with often severe staffing shortages, including as a result of the COVID-19 pandemic, and the impact on our labor expenses from potential union activity and staffing recruitment and retention;

•competitive pressures in the healthcare industry, including from other providers that may be participating in integrated delivery payment arrangements in which we do not participate, and our response to those pressures;

•our ability to successfully complete and integrate de novo developments, acquisitions, investments, and joint ventures consistent with our growth strategy, including realization of anticipated revenues, cost savings, productivity improvements arising from the related operations and avoidance of unanticipated difficulties, costs or liabilities that could arise from acquisitions or integrations;

•increased costs of defending and insuring against alleged professional liability and other claims, including claims relating to actions or omissions in connection with the COVID-19 pandemic, and the ability to predict the costs related to claims;

•potential incidents affecting the proper operation, availability, or security of our or our vendors’ or partners’ information systems, including the patient information stored there;

•new or changing quality reporting requirements impacting operational costs or our Medicare reimbursement;

•the price of our common stock as it affects our willingness and ability to repurchase shares and the financial and accounting effects of any repurchases;

•our ability and willingness to continue to declare and pay dividends on our common stock, which could be affected by reduced cash flow resulting from the COVID-19 pandemic;

•our ability to maintain proper local, state and federal licensing, including compliance with the Medicare conditions of participation and provider enrollment requirements, which is required to participate in the Medicare program;

•our ability to attract and retain key management personnel;

•changes in our payor mix or the acuity of our patients affecting reimbursement rates; and

•general conditions in the economy and capital markets, including any disruption, instability, or uncertainty related to armed conflict or an act of terrorism, a governmental impasse over approval of the United States federal budget, an increase to the debt ceiling, an international trade war, a sovereign debt crisis, or a widespread outbreak of an infectious disease such as COVID-19.

The cautionary statements referred to in this section also should be considered in connection with any subsequent written or oral forward-looking statements that may be issued by us or persons acting on our behalf. We undertake no duty to update these forward-looking statements, even though our situation may change in the future. Furthermore, we cannot guarantee future results, events, levels of activity, performance, or achievements.

iii

PART I. FINANCIAL INFORMATION

Item 1.Financial Statements (Unaudited)

Encompass Health Corporation and Subsidiaries

Condensed Consolidated Statements of Comprehensive Income

(Unaudited)

	Three Months Ended September 30,				Nine Months Ended September 30,
	2020		2019		2020		2019
	(In Millions, Except Per Share Data)
Net operating revenues	$	1,173.9	$	1,161.6	$	3,430.0	$	3,420.6
Operating expenses:
Salaries and benefits	664.9		660.8		1,995.9		1,904.5
Other operating expenses	163.4		156.6		471.3		456.5
Occupancy costs	20.3		21.8		60.8		61.7
Supplies	52.5		42.9		148.8		124.7
General and administrative expenses	39.1		52.5		117.7		183.0
Depreciation and amortization	61.2		55.1		180.7		160.3
Government, class action, and related settlements	—		—		2.8		—
Total operating expenses	1,001.4		989.7		2,978.0		2,890.7
Loss on early extinguishment of debt	—		—		—		2.3
Interest expense and amortization of debt discounts and fees	49.0		40.3		138.0		115.2
Other income	(2.5)		(21.0)		(6.4)		(26.9)
Equity in net income of nonconsolidated affiliates	(1.0)		(1.2)		(2.5)		(5.5)
Income from continuing operations before income tax expense	127.0		153.8		322.9		444.8
Provision for income tax expense	26.9		34.3		65.8		88.6
Income from continuing operations	100.1		119.5		257.1		356.2
Loss from discontinued operations, net of tax	—		—		—		(0.6)
Net and comprehensive income	100.1		119.5		257.1		355.6
Less: Net and comprehensive income attributable to noncontrolling interests	(22.4)		(21.9)		(58.9)		(64.5)
Net and comprehensive income attributable to Encompass Health	$	77.7	$	97.6	$	198.2	$	291.1
Weighted average common shares outstanding:
Basic	98.7		97.8		98.5		98.1
Diluted	99.9		99.4		99.7		99.5
Earnings per common share:
Basic earnings per share attributable to Encompass Health common shareholders:
Continuing operations	$	0.78	$	0.99	$	2.01	$	2.97
Discontinued operations	—		—		—		(0.01)
Net income	$	0.78	$	0.99	$	2.01	$	2.96
Diluted earnings per share attributable to Encompass Health common shareholders:
Continuing operations	$	0.78	$	0.98	$	1.99	$	2.94
Discontinued operations	—		—		—		(0.01)
Net income	$	0.78	$	0.98	$	1.99	$	2.93
Amounts attributable to Encompass Health common shareholders:
Income from continuing operations	$	77.7	$	97.6	$	198.2	$	291.7
Loss from discontinued operations, net of tax	—		—		—		(0.6)
Net income attributable to Encompass Health	$	77.7	$	97.6	$	198.2	$	291.1

The accompanying notes to condensed consolidated financial statements are an integral part of these condensed statements.

1

Encompass Health Corporation and Subsidiaries

Condensed Consolidated Balance Sheets

(Unaudited)

	September 30, 2020		December 31, 2019
	(In Millions)
Assets
Current assets:
Cash and cash equivalents	$	450.0	$	94.8
Restricted cash	57.2		57.4
Accounts receivable	593.3		506.1
Other current assets	73.9		97.5
Total current assets	1,174.4		755.8
Property and equipment, net	2,094.9		1,959.3
Operating lease right-of-use assets	267.2		276.5
Goodwill	2,318.7		2,305.2
Intangible assets, net	441.9		476.3
Deferred income tax assets	7.5		2.9
Other long-term assets	305.9		304.7
Total assets(1)	$	6,610.5	$	6,080.7
Liabilities and Shareholders’ Equity
Current liabilities:
Current portion of long-term debt	$	37.0	$	39.3
Current operating lease liabilities	47.1		40.4
Accounts payable	119.6		94.6
Accrued expenses and other current liabilities	478.8		546.7
Total current liabilities	682.5		721.0
Long-term debt, net of current portion	3,539.4		3,023.3
Long-term operating lease liabilities	228.9		243.8
Other long-term liabilities	230.0		159.9
	4,680.8		4,148.0
Commitments and contingencies
Redeemable noncontrolling interests	34.0		239.6
Shareholders’ equity:
Encompass Health shareholders’ equity	1,520.8		1,352.2
Noncontrolling interests	374.9		340.9
Total shareholders’ equity	1,895.7		1,693.1
Total liabilities(1) and shareholders’ equity	$	6,610.5	$	6,080.7

(1)Our consolidated assets as of September 30, 2020 and December 31, 2019 include total assets of variable interest entities of $222.0 million and $215.0 million, respectively, which cannot be used by us to settle the obligations of other entities. Our consolidated liabilities as of September 30, 2020 and December 31, 2019 include total liabilities of the variable interest entities of $44.6 million and $41.1 million, respectively. See Note 3, Variable Interest Entities.

The accompanying notes to condensed consolidated financial statements are an integral part of these condensed statements.

2

Encompass Health Corporation and Subsidiaries

Condensed Consolidated Statements of Shareholders’ Equity

(Unaudited)

	Three Months Ended September 30, 2020
	(In Millions)
	Encompass Health Common Shareholders
	Number of Common Shares Outstanding	Common Stock		Capital in Excess of Par Value		Accumulated Deficit		Treasury Stock		Noncontrolling Interests		Total
Balance at beginning of period	99.4	$	1.1	$	2,362.4	$	(406.0)	$	(494.7)	$	368.6	$	1,831.4
Net income	—	—		—		77.7		—		20.2		97.9
Dividends declared ($0.28 per share)	—	—		(28.0)		—		—		—		(28.0)
Stock-based compensation	—	—		8.3		—		—		—		8.3
Distributions declared	—	—		—		—		—		(21.8)		(21.8)
Capital contributions from consolidated affiliates	—	—		—		—		—		7.8		7.8
Other	—	—		0.4		—		(0.4)		0.1		0.1
Balance at end of period	99.4	$	1.1	$	2,343.1	$	(328.3)	$	(495.1)	$	374.9	$	1,895.7

	Three Months Ended September 30, 2019
	(In Millions)
	Encompass Health Common Shareholders
	Number of Common Shares Outstanding	Common Stock		Capital in Excess of Par Value		Accumulated Deficit		Treasury Stock		Noncontrolling Interests		Total
Balance at beginning of period	98.6	$	1.1	$	2,455.6	$	(691.7)	$	(489.1)	$	307.9	$	1,583.8
Net income	—	—		—		97.6		—		18.2		115.8
Receipt of treasury stock	—	—		—		—		(0.1)		—		(0.1)
Dividends declared ($0.28 per share)	—	—		(27.8)		—		—		—		(27.8)
Stock-based compensation	—	—		7.8		—		—		—		7.8
Distributions declared	—	—		—		—		—		(20.2)		(20.2)
Capital contributions from consolidated affiliates	—	—		—		—		—		7.2		7.2
Fair value adjustments to redeemable noncontrolling interests	—	—		(18.2)		—		—		—		(18.2)
Consolidation of Yuma Rehabilitation Hospital	—	—		—		—		—		25.0		25.0
Repurchases of common stock in open market	(0.1)	—		—		—		(2.1)		—		(2.1)
Other	0.1	—		0.4		—		(0.4)		0.1		0.1
Balance at end of period	98.6	$	1.1	$	2,417.8	$	(594.1)	$	(491.7)	$	338.2	$	1,671.3

The accompanying notes to condensed consolidated financial statements are an integral part of these condensed statements.

3

Encompass Health Corporation and Subsidiaries

Condensed Consolidated Statements of Shareholders’ Equity (Continued)

(Unaudited)

	Nine Months Ended September 30, 2020
	(In Millions)
	Encompass Health Common Shareholders
	Number of Common Shares Outstanding	Common Stock		Capital in Excess of Par Value		Accumulated Deficit		Treasury Stock		Noncontrolling Interests		Total
Balance at beginning of period	98.6	$	1.1	$	2,369.9	$	(526.5)	$	(492.3)	$	340.9	$	1,693.1
Net income	—	—		—		198.2		—		53.2		251.4
Receipt of treasury stock	(0.2)	—		—		—		(15.7)		—		(15.7)
Dividends declared ($0.84 per share)	—	—		(83.9)		—		—		—		(83.9)
Exchange of Holdings shares	0.6	—		27.1		—		19.2		—		46.3
Stock-based compensation	—	—		25.3		—		—		—		25.3
Distributions declared	—	—		—		—		—		(50.9)		(50.9)
Capital contributions from consolidated affiliates	—	—		—		—		—		32.5		32.5
Repurchases of common stock in open market	(0.1)	—		—		—		(4.9)		—		(4.9)
Other	0.5	—		4.7		—		(1.4)		(0.8)		2.5
Balance at end of period	99.4	$	1.1	$	2,343.1	$	(328.3)	$	(495.1)	$	374.9	$	1,895.7

	Nine Months Ended September 30, 2019
	(In Millions)
	Encompass Health Common Shareholders
	Number of Common Shares Outstanding	Common Stock		Capital in Excess of Par Value		Accumulated Deficit		Treasury Stock		Noncontrolling Interests		Total
Balance at beginning of period	98.9	$	1.1	$	2,588.7	$	(885.2)	$	(427.9)	$	280.3	$	1,557.0
Net income	—	—		—		291.1		—		54.4		345.5
Receipt of treasury stock	(0.3)	—		—		—		(16.2)		—		(16.2)
Dividends declared ($0.82 per share)	—	—		(81.5)		—		—		—		(81.5)
Stock-based compensation	—	—		24.1		—		—		—		24.1
Distributions declared	—	—		—		—		—		(52.8)		(52.8)
Capital contributions from consolidated affiliates	—	—		—		—		—		20.0		20.0
Fair value adjustments to redeemable noncontrolling interests	—	—		(118.9)		—		—		—		(118.9)
Consolidation of Yuma Rehabilitation Hospital	—	—		—		—		—		25.0		25.0
Repurchases of common stock through the open market	(0.8)	—		—		—		(45.9)		—		(45.9)
Other	0.8	—		5.4		—		(1.7)		11.3		15.0
Balance at end of period	98.6	$	1.1	$	2,417.8	$	(594.1)	$	(491.7)	$	338.2	$	1,671.3

The accompanying notes to condensed consolidated financial statements are an integral part of these condensed statements.

4

Encompass Health Corporation and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited)

	Nine Months Ended September 30,
	2020		2019
	(In Millions)
Cash flows from operating activities:
Net income	$	257.1	$	355.6
Loss from discontinued operations, net of tax	—		0.6
Adjustments to reconcile net income to net cash provided by operating activities—
Depreciation and amortization	180.7		160.3
Loss on early extinguishment of debt	—		2.3
Stock-based compensation	25.3		87.0
Deferred tax (benefit) expense	(5.7)		20.8
Gain on consolidation of Yuma Rehabilitation Hospital	—		(19.2)
Other, net	15.5		2.3
Change in assets and liabilities, net of acquisitions—
Accounts receivable	(71.8)		(37.8)
Other assets	17.3		(11.1)
Accounts payable	10.3		(4.2)
Accrued payroll	86.7		(21.0)
Accrued interest payable	(0.2)		7.4
Other liabilities	(90.0)		(118.7)
Net cash used in operating activities of discontinued operations	(0.2)		(4.6)
Total adjustments	167.9		63.5
Net cash provided by operating activities	425.0		419.7
Cash flows from investing activities:
Acquisitions of businesses, net of cash acquired	(1.1)		(231.2)
Purchases of property and equipment	(256.2)		(259.9)
Additions to capitalized software costs	(5.7)		(9.2)
Other, net	(1.8)		(11.4)
Net cash used in investing activities	(264.8)		(511.7)

(Continued)

5

Encompass Health Corporation and Subsidiaries

Condensed Consolidated Statements of Cash Flows (Continued)

(Unaudited)

	Nine Months Ended September 30,
	2020		2019
	(In Millions)
Cash flows from financing activities:
Proceeds from bond issuance	592.5		1,000.0
Principal payments on debt, including pre-payments	(14.7)		(115.8)
Borrowings on revolving credit facility	330.0		525.0
Payments on revolving credit facility	(375.0)		(555.0)
Principal payments under finance lease obligations	(16.7)		(14.2)
Debt issuance costs	(13.5)		(15.2)
Taxes paid on behalf of employees for shares withheld	(15.7)		(16.2)
Dividends paid on common stock	(84.3)		(81.3)
Distributions paid to noncontrolling interests of consolidated affiliates	(52.9)		(57.6)
Repurchases of common stock, including fees and expenses	(4.9)		(45.9)
Purchase of equity interests in consolidated affiliates	(162.3)		(162.9)
Other, net	25.8		11.4
Net cash provided by financing activities	208.3		472.3
Increase in cash, cash equivalents, and restricted cash	368.5		380.3
Cash, cash equivalents, and restricted cash at beginning of period	159.6		133.5
Cash, cash equivalents, and restricted cash at end of period	$	528.1	$	513.8
Reconciliation of Cash, Cash Equivalents, and Restricted Cash
Cash and cash equivalents at beginning of period	$	94.8	$	69.2
Restricted cash at beginning of period	57.4		59.0
Restricted cash included in other long-term assets at beginning of period	7.4		5.3
Cash, cash equivalents, and restricted cash at beginning of period	$	159.6	$	133.5
Cash and cash equivalents at end of period	$	450.0	$	422.0
Restricted cash at end of period	57.2		66.8
Restricted cash included in other long-term assets at end of period	20.9		25.0
Cash, cash equivalents, and restricted cash at end of period	$	528.1	$	513.8
Supplemental schedule of noncash financing activity:
Adoption of ASC 842	$	—	$	349.4

The accompanying notes to condensed consolidated financial statements are an integral part of these condensed statements.

6

Encompass Health Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

1.Basis of Presentation

Encompass Health Corporation, incorporated in Delaware in 1984, including its subsidiaries, is one of the nation’s largest providers of post-acute healthcare services, offering both facility-based and home-based patient services in 39 states and Puerto Rico through its network of inpatient rehabilitation hospitals, home health agencies, and hospice agencies. We manage our operations and disclose financial information using two reportable segments: (1) inpatient rehabilitation and (2) home health and hospice. See also Note 11, Segment Reporting.

The accompanying unaudited condensed consolidated financial statements of Encompass Health Corporation and Subsidiaries should be read in conjunction with the consolidated financial statements and accompanying notes contained in Encompass Health’s Annual Report on Form 10-K filed with the United States Securities and Exchange Commission on February 27, 2020 (the “2019 Form 10‑K”). The unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the SEC applicable to interim financial information. Certain information and note disclosures included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been omitted in these interim statements, as allowed by such SEC rules and regulations. The condensed consolidated balance sheet as of December 31, 2019 has been derived from audited financial statements, but it does not include all disclosures required by GAAP. However, we believe the disclosures are adequate to make the information presented not misleading.

The unaudited results of operations for the interim periods shown in these financial statements are not necessarily indicative of operating results for the entire year. In our opinion, the accompanying condensed consolidated financial statements recognize all adjustments of a normal recurring nature considered necessary to fairly state the financial position, results of operations, and cash flows for each interim period presented.

Consolidation—

As a result of an amendment to the joint venture agreement related to Yuma Rehabilitation Hospital, the accounting for this hospital changed from the equity method of accounting to a consolidated entity effective July 1, 2019. The amendment revised certain participatory rights held by our joint venture partner resulting in Encompass Health gaining control of this entity from an accounting perspective. We accounted for this change in control as a business combination and consolidated this entity using the acquisition method. The consolidation of Yuma Rehabilitation Hospital did not have a material impact on our financial position, results of operations, or cash flows. As a result of our consolidation of this hospital and the remeasurement of our previously held equity interest at fair value, Goodwill increased by $24.9 million and we recorded a $19.2 million gain as part of Other income during the three and nine months ended September 30, 2019.

Net Operating Revenues—

Our Net operating revenues disaggregated by payor source and segment are as follows (in millions):

	Inpatient Rehabilitation				Home Health and Hospice				Consolidated
	Three Months Ended September 30,				Three Months Ended September 30,				Three Months Ended September 30,
	2020		2019		2020		2019		2020		2019
Medicare	$	592.4	$	624.5	$	228.6	$	248.4	$	821.0	$	872.9
Medicare Advantage	141.1		94.7		29.6		25.2		170.7		119.9
Managed care	95.9		87.3		12.4		10.4		108.3		97.7
Medicaid	38.4		28.0		3.3		4.8		41.7		32.8
Other third-party payors	10.8		12.1		—		—		10.8		12.1
Workers’ compensation	4.6		6.9		0.3		0.3		4.9		7.2
Patients	5.1		6.1		0.2		—		5.3		6.1
Other income	11.1		12.7		0.1		0.2		11.2		12.9
Total	$	899.4	$	872.3	$	274.5	$	289.3	$	1,173.9	$	1,161.6

7

Encompass Health Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

	Inpatient Rehabilitation				Home Health and Hospice				Consolidated
	Nine Months Ended September 30,				Nine Months Ended September 30,				Nine Months Ended September 30,
	2020		2019		2020		2019		2020		2019
Medicare	$	1,738.1	$	1,892.8	$	658.8	$	684.4	$	2,396.9	$	2,577.2
Medicare Advantage	418.2		276.2		88.3		77.4		506.5		353.6
Managed care	274.3		257.5		35.9		26.7		310.2		284.2
Medicaid	103.7		81.4		11.7		13.8		115.4		95.2
Other third-party payors	31.1		32.6		—		—		31.1		32.6
Workers’ compensation	15.7		21.6		0.8		0.7		16.5		22.3
Patients	14.8		17.8		0.9		0.5		15.7		18.3
Other income	37.2		36.4		0.5		0.8		37.7		37.2
Total	$	2,633.1	$	2,616.3	$	796.9	$	804.3	$	3,430.0	$	3,420.6

Medicare Administrative Contractors, under programs known as “widespread probes”, have conducted pre-payment claim reviews of our Medicare billings and in some cases denied payment for certain diagnosis codes. We dispute or “appeal” most of these denials, and for claims we choose to take to administrative law judge (“ALJ”) hearings, we have historically experienced a success rate of 70%. This historical success rate is a component of our estimate of transaction price utilized in determining Net operating revenues. The Medicare appeals adjudication process is administered by the Office of Medicare Hearings and Appeals (“OMHA”) and has been subject to significant delay resulting in a backlog of claims awaiting adjudication. Beginning in March 2020, OMHA increased the frequency of hearings and the number of claims set at each hearing, which we believe adds to the substantive and procedural deficiencies in the appeals process. If current OHMA practices continue, an increased number of unfavorable ALJ decisions could have a negative effect on our long-term ALJ success rate. We are exploring various remedies to counter such negative effects. We believe it is too early to determine what impact, if any, these recent changes in the appeals process will have on our historical success rate or Net operating revenues.

    See Note 1, Summary of Significant Accounting Policies, to the consolidated financial statements accompanying the

2019 Form 10-K for our policy related to Net operating revenues.

Risks and Uncertainties—

The novel coronavirus disease 2019 (“COVID-19”) pandemic has caused a disruption to our nation’s healthcare system. Such disruption includes reductions in the availability of personal protective equipment (“PPE”) to prevent spread of the disease during patient treatment and increases in the cost of PPE. Elective procedures were postponed by physicians and acute-care hospitals and limited by governmental order to preserve capacity for the expected volume of COVID-19 patients and reduce the risk of the spread of COVID-19. Initially, these postponements and limitations were widespread. Now, they are more market or state specific and driven by the extent of the pandemic in those areas. Beginning in mid-March and continuing into the second and third quarters, we experienced decreased volumes in both segments which we believe 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, lock downs of assisted living facilities that prevent our home care and hospice clinicians and other care providers 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. In the home health and hospice segment, we also experienced decreases in visits per episode and institutional referrals because of the COVID-19 pandemic, both of which negatively impacted pricing for home health.

In March and April 2020, the federal government began to undertake numerous legislative and regulatory initiatives designed to provide relief to the healthcare industry during the COVID-19 pandemic. A specific initiative impacting us is the Coronavirus Aid, Relief, and Economic Security Act of 2020 (the “CARES Act”) which temporarily suspends the automatic 2% reduction of Medicare program payments known as “sequestration” for the period of May 1 through December 31, 2020 and authorizes the cash distribution of relief funds from the United States Department of Health and Human Services (“HHS”) to healthcare providers in response to the COVID-19 pandemic. On April 10, 2020, HHS began distributing CARES Act relief funds, for which we did not apply, to various of our bank accounts. We refused the CARES Act relief funds, and our banks returned all the funds to HHS. We intend to refuse any additional CARES Act relief funds distributed in the future.

8

Encompass Health Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

Additionally, the CARES Act and a series of waivers and guidance issued by the Centers for Medicare and Medicaid Services (“CMS”) suspend various Medicare patient coverage criteria and documentation and care requirements in an effort to provide regulatory relief until the public health emergency for the COVID-19 pandemic has ended. For inpatient rehabilitation, the regulatory relief includes the temporary suspension of the requirement that patients must be able to tolerate a minimum of three hours of therapy per day for five days per week, waiver of certain of the requirements that at least 60% of a facility’s patients must have a diagnosis from at least 1 of 13 specified medical conditions, and waiver of the requirement for a physician to conduct and document a post-admission evaluation (as part of the Notice of Final Rulemaking for Fiscal Year 2021 for inpatient rehabilitation facilities under the inpatient rehabilitation facility prospective payment system, CMS removed the post-admission evaluation requirement from the inpatient rehabilitation coverage criteria effective October 1, 2020). In addition, the requirement of physician face-to-face visits at least three days a week may be fulfilled using telehealth. For home health, the relief includes the allowance of nurse practitioners and physician assistants under certain conditions to certify, establish and periodically review the plan of care, as well as supervise the provision of items and services for beneficiaries under the Medicare home health benefit and expands the use of telehealth. Additionally, CMS expanded the definition of “homebound” to include patients needing skilled services who are homebound due solely to their COVID-19 diagnosis or patients susceptible to contract COVID-19. For hospice, the relief includes the temporary waiver of the requirement to use volunteers and to conduct a nurse visit every two weeks to evaluate aides, as well as the expanded use of telehealth for routine services and patient recertification.

As discussed in Note 4, Long-term Debt, in April 2020, we amended our credit agreement primarily to provide covenant relief due to business disruptions from the COVID-19 pandemic. The amendment included, among other things, the carve-out of the COVID-19 pandemic from the definition of material adverse effect for 364 days and modifications to the interest coverage and leverage ratios under the agreement.

The foregoing and other disruptions to our business as a result of the COVID-19 pandemic have had and are likely to continue to have an adverse effect on our business and could have a material adverse effect on our business, results of operations, financial condition and cash flows.

Recently Adopted Accounting Pronouncements—

    In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326),” which provides guidance for accounting for credit losses on financial instruments. The new guidance introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments and modifies the impairment model for available-for-sale debt securities. The new guidance was effective for us beginning January 1, 2020. The adoption of this guidance resulted in an immaterial change to our condensed consolidated financial statements.

In August 2018, the FASB issued ASU 2018-15, “Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.” The update helps entities evaluate the accounting for fees paid by a customer in a cloud computing arrangement (hosting arrangement), by providing guidance in determining when the arrangement includes a software license. It requires entities to account for such costs consistent with the guidance on capitalizing costs associated with developing or obtaining internal-use software. The new guidance was effective for us beginning January 1, 2020. The adoption of this guidance did not have a material impact to our condensed consolidated financial statements.

In March 2020, the Securities and Exchange Commission adopted final rules that amend the financial disclosure requirements in Rule 3-10 of Regulation S-X for guarantors of registered debt securities and subsidiary issuers. The new rules are effective January 4, 2021, but early adoption is permitted. The new rules permit alternative disclosures of summarized financial information, rather than our previous footnote presentation of condensed consolidating financial statements. The new rules also permit the summarized financial information and related disclosures to be presented outside of the condensed consolidated financial statements and accompanying notes. We elected to early adopt the new rules effective July 1, 2020. The summarized financial information and related disclosures are presented in Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of this report.

Recent Accounting Pronouncements Not Yet Adopted—

    In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes.” The standard removes certain exceptions to the general principles of ASC 740 and simplifies other areas such as accounting for outside basis differences of equity method investments. Either prospective or retrospective transition of this standard is dependent upon the specific amendments. The new guidance is effective for us beginning January 1, 2021, including interim periods within that reporting period. Early adoption is permitted. We continue to review the requirements of this standard and any potential impact it may have on our condensed consolidated financial statements.

9

Encompass Health Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

We do not believe any other recently issued, but not yet effective, accounting standards will have a material effect on our condensed consolidated financial position, results of operations, or cash flows.

2.Business Combinations

Inpatient Rehabilitation

    During the nine months ended September 30, 2020, we completed the following inpatient rehabilitation acquisitions, none of which were individually material to our financial position, results of operations, or cash flows. Each acquisition was made to enhance our position and ability to provide inpatient rehabilitation services to patients in the applicable geographic areas.

•In January 2020, we acquired 68% of the operations of a 13-bed inpatient rehabilitation unit in Denver, Colorado through a joint venture with Portercare Adventist Health System. The acquisition was funded through a contribution of our existing 40-bed inpatient rehabilitation hospital in Littleton, Colorado and through contributions of funds which were utilized by the consolidated joint venture to build a 20-bed expansion to the Littleton hospital.

•In May 2020, we acquired 51% of the operations of a 45-bed inpatient rehabilitation unit in Dayton, Ohio through a joint venture with Premier Health Partners. The acquisition was funded through contributions of funds which were utilized by the consolidated joint venture to build a 60-bed de novo inpatient rehabilitation hospital.

    We accounted for these transactions under the acquisition method of accounting and reported the results of operations of the acquired hospitals from its respective date of acquisition. Assets acquired were recorded at their estimated fair values as of the acquisition date. Estimated fair values were based on various valuation methodologies including: an income approach using primarily discounted cash flow techniques for the noncompete intangible assets and an income approach utilizing the relief from royalty method for the trade name intangible asset. The aforementioned income methods utilize management’s estimates of future operating results and cash flows discounted using a weighted-average cost of capital that reflects market participant assumptions. The excess of the fair value of the consideration conveyed over the fair value of the assets acquired was recorded as goodwill. The goodwill reflects our expectations of our ability to gain access to and penetrate the acquired hospital’s historical patient base and the benefits of being able to leverage operational efficiencies with favorable growth opportunities based on positive demographic trends in this market. None of the goodwill recorded as a result from these transactions is deductible for federal income tax purposes.

The fair value of the assets acquired at the acquisition date were as follows (in millions):

Property and equipment, net	$	0.1
Identifiable intangible assets:
Noncompete agreements (useful lives of 2 to 3 years)	0.7
Trade name (useful life of 20 years)	0.9
Goodwill