Business Combinations

Inpatient Rehabilitation

In September 2018, we acquired approximately 62% of a 29-bed inpatient rehabilitation unit, including a 60-bed certificate of need, in Murrells Inlet, South Carolina through a joint venture with Tidelands Health. The acquisition was funded through contributions of funds to be utilized by the consolidated joint venture to build a 46-bed de novo inpatient rehabilitation satellite location. This transaction was not material to our financial position, results of operations, or cash flows. The acquisition was made to enhance our position and ability to provide inpatient rehabilitative services to patients in Murrells Inlet and its surrounding areas.

We accounted for this transaction under the acquisition method of accounting and reported the results of operations of

the acquired hospital 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 asset; an income approach utilizing the relief-from-royalty method for the trade name intangible asset; and an income approach utilizing the excess earnings method for the certificate of need 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 this transaction is deductible for federal income tax purposes.

The fair values recorded were based upon a preliminary valuation. Estimates and assumptions used in such valuation are subject to change, which could be significant, within the measurement period (up to one year from the acquisition date). The primary areas of the preliminary valuation that are not yet finalized relate to the fair values of amounts for intangible assets and the final amount of residual goodwill. We expect to continue to obtain information to assist us in determining the fair values of the net assets acquired at the acquisition date during the measurement period.

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



Identifiable intangible assets:
Noncompete agreement (useful life of 3 years)	$	0.6
Trade name (useful life of 20 years)	1.4
Certificate of need (useful life of 20 years)	7.7
Goodwill	6.4
Total assets acquired	$	16.1

Information regarding the net cash paid for the inpatient rehabilitation acquisitions during each period presented is as follows (in millions):



	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Fair value of assets acquired	$	9.7		$	5.4		$	9.7		$	11.0
Goodwill	6.4			9.0			6.4			24.0
Fair value of noncontrolling interest owned by joint venture partner	(16.1		)	(14.4		)	(16.1		)	(24.1		)
Net cash paid for acquisitions	$	—		$	—		$	—		$	10.9

Home Health and Hospice

Camellia Acquisition

On May 1, 2018, we completed the previously announced acquisition of privately owned Camellia Healthcare and affiliated entities (“Camellia”). The Camellia portfolio consists of hospice, home health and private duty locations in Mississippi, Alabama, Louisiana and Tennessee. The acquisition leverages our home health and hospice operating platform across key certificate of need states and strengthens our geographic presence in the Southeastern United States. We funded the cash purchase price of the acquisition with cash on hand and borrowings under our revolving credit facility.

We accounted for this transaction under the acquisition method of accounting and reported the results of operations of Camellia from its date of acquisition. Assets acquired and liabilities assumed were recorded at their estimated fair values as of the acquisition date. Estimated fair values were based on various valuation methodologies including: replacement cost and continued use methods for property and equipment; an income approach using primarily discounted cash flow techniques for the noncompete and certain license intangible assets; an income approach utilizing the relief-from-royalty method for the trade name intangible asset; and an income approach utilizing the excess earnings method for the certificate of need and certain license intangible assets. 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. For all other assets and liabilities, the fair value was assumed to represent carrying value due to their short maturities. The excess of the fair value of the consideration conveyed over the fair value of the net assets acquired was recorded as goodwill. All goodwill recorded as a result from this transaction is deductible for federal income tax purposes. The goodwill reflects our expectations of favorable growth opportunities in the home health and hospice markets based on positive demographic trends.

The fair values recorded were based upon a preliminary valuation. Estimates and assumptions used in such valuation are subject to change, which could be significant, within the measurement period (up to one year from the acquisition date). The primary areas of the preliminary valuation that are not yet finalized relate to the fair values of amounts for income taxes and the final amount of residual goodwill. We expect to continue to obtain information to assist us in determining the fair values of the net assets acquired at the acquisition date during the measurement period.

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



Cash and cash equivalents	$	1.3
Prepaid expenses and other current assets	0.3
Property and equipment, net	0.6
Identifiable intangible assets:
Noncompete agreements (useful lives of 5 years)	0.5
Trade name (useful life of 1 year)	1.4
Certificates of need (useful lives of 10 years)	16.6
Licenses (useful lives of 10 years)	21.6
Goodwill	97.0
Total assets acquired	139.3
Liabilities assumed:
Accounts payable	4.3
Accrued payroll	4.0
Total liabilities assumed	8.3
Net assets acquired	$	131.0

Information regarding the net cash paid for Camellia is as follows (in millions):



Fair value of assets acquired, net of $1.3 million of cash acquired	$	41.0
Goodwill	97.0
Fair value of liabilities assumed	(8.3		)
Net cash paid for acquisition	$	129.7

Other Home Health and Hospice Acquisitions

During the nine months ended September 30, 2018, we completed the following home health and hospice 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 post-acute healthcare services to patients in the applicable geographic areas. Each acquisition was funded using cash on hand.


•	In January 2018, we acquired the assets of one hospice location from Golden Age Hospice, Inc. in Oklahoma City, Oklahoma.


•	In June 2018, we acquired the assets of one hospice location from Medical Services of America in Las Vegas, Nevada.

We accounted for these transactions under the acquisition method of accounting and reported the results of operations of the acquired locations from their respective dates of acquisition. Assets acquired were recorded at their estimated fair values as of the respective acquisition dates. The fair values of identifiable intangible assets were based on valuations using an income approach. The income approach is based on 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 net assets acquired was recorded as goodwill. The goodwill reflects our expectations of our ability to utilize the acquired locations’ mobile workforce and established relationships within each community and the benefits of being able to leverage operational efficiencies with favorable growth opportunities based on positive demographic trends in these markets. All goodwill recorded as a result of 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):



Identifiable intangible assets:
Noncompete agreements (useful lives of 5 years)	$	0.2
Licenses (useful lives of 10 years)	0.8
Goodwill	5.1
Total assets acquired	$	6.1

Information regarding the net cash paid for the other home health and hospice acquisitions during each period presented is as follows (in millions):



	Three Months Ended September 30,					Nine Months Ended September 30,
	2018		2017			2018		2017
Fair value of assets acquired	$	—	$	2.7		$	1.0	$	5.4
Goodwill	—		13.1			5.1		20.5
Fair value of liabilities assumed	—		(0.1		)	—		(0.2		)
Net cash paid for acquisitions	$	—	$	15.7		$	6.1	$	25.7

Pro Forma Results of Operations

The following table summarizes the results of operations of the above mentioned acquisitions from their respective dates of acquisition included in our consolidated results of operations and the unaudited pro forma results of operations of the combined entity had the date of the acquisitions been January 1, 2017 (in millions):



	Net Operating Revenues		Net Income Attributable to Encompass Health
Acquired entities only: Actual from acquisition date to September 30, 2018
Inpatient Rehabilitation	$	—	$	(0.9	)
Camellia	31.5		(0.5		)
All Other Home Health and Hospice	1.8		(0.1		)
Combined entity: Supplemental pro forma from 06/01/2018-09/30/2018	1,070.9		89.2
Combined entity: Supplemental pro forma from 06/01/2017-09/30/2017	1,007.5		70.1
Combined entity: Supplemental pro forma from 01/01/2018-09/30/2018	3,221.9		270.7
Combined entity: Supplemental pro forma from 01/01/2017-09/30/2017	2,979.7		207.6

The information presented above is for illustrative purposes only and is not necessarily indicative of results that would

have been achieved if the acquisitions had occurred as of the beginning of our 2017 reporting period.

See Note 2, Business Combinations, to the consolidated financial statements accompanying the 2017 Form 10-K for information regarding acquisitions completed in 2017.