Business context and reporting period
HealthSouth Corporation’s unaudited Form 10-Q covers the quarter and nine months ended September 30, 2015. The company provided inpatient rehabilitation, home health, and hospice services in 33 states and Puerto Rico. Following its December 2014 acquisition of Encompass, it reported two segments: inpatient rehabilitation and home health and hospice. (The filing issuer is HealthSouth Corporation.)
Financial performance and liquidity
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net operating revenues | $778.6 million | $596.9 million | $2,283.6 million | $1,792.5 million |
| Income from continuing operations | $67.5 million | $65.7 million | $188.6 million | $221.4 million |
| Net income attributable to HealthSouth | $50.7 million | $50.1 million | $136.1 million | $179.9 million |
| Diluted EPS | $0.52 | $0.52 | $1.41 | $1.85 |
| Adjusted EBITDA | $165.4 million | $140.0 million | $491.0 million | $436.8 million |
| Operating cash flow | Not presented quarterly | Not presented quarterly | $368.2 million | $374.7 million |
- Revenue rose 30.4% for the quarter and 27.4% year to date, mainly reflecting Encompass, acquired at the end of 2014. Inpatient rehabilitation revenue increased 10.5% and 8.8%, respectively. Q3 inpatient discharges grew 9.6%, including 3.9% same-store growth; revenue per discharge rose 1.2%.
- Despite higher revenue, nine-month income attributable to HealthSouth declined 24.3%. Prior-year results included a $27.2 million gain from consolidating Fairlawn; 2015 included $20.0 million of debt-extinguishment losses and an $8.0 million settlement provision. Q3 diluted EPS was unchanged year over year.
- Operating expenses were 81.2% of revenue in Q3 versus 79.6% a year earlier, and 81.3% year to date versus 78.7%. Management cited labor and medical-claim costs, bad debt, and investment in operating systems and compliance.
- Cash and equivalents were $801.6 million at September 30, compared with $66.7 million at year-end 2014. The increase included debt proceeds earmarked for the Reliant acquisition. Operating cash flow was slightly lower year over year; investing used $179.4 million and financing provided $546.1 million over nine months.
- Debt was $2,824.3 million gross ($2,800.7 million net of current portion), up from $2,131.6 million gross at year-end. The company reported $541 million available under its revolver and compliance with its credit covenants. Current assets were $1,463.0 million and current liabilities $403.6 million.
- Common dividends were increased to $0.23 per share quarterly from $0.21. The preferred stock was converted into common shares in April 2015.
Material changes, outlook, and risks
- Acquisitions and financing: HealthSouth completed the Reliant acquisition in October 2015 for approximately $730 million in cash, adding 11 rehabilitation hospitals and 902 beds; management said it expected the transaction to be immediately accretive to EPS, excluding transaction costs. The company had raised debt proceeds before quarter-end to fund the purchase. CareSouth, a 45-location home health business, was expected to close November 1, 2015 for approximately $170 million, subject to customary conditions and approvals.
- Management outlook: Management cited aging demographics, its clinical platform, and growth opportunities as supportive of long-term demand. It expected leverage to rise following acquisitions, with a longer-term goal of reducing leverage through EBITDA growth and debt repayment. No consolidated revenue or EPS forecast is provided in the filing.
- Reimbursement: Management estimated the FY2016 inpatient rehabilitation rule would increase Medicare payment rates about 1.6%, before sequestration. It estimated the proposed 2016 home-health rule could reduce Encompass payment rates about 2.0%, before sequestration. These estimates and the proposed home-health rule are subject to change.
- Investment plans: The company estimated 2015 capital expenditures of $1.055 billion to $1.115 billion, inclusive of the Reliant and CareSouth acquisitions; approximately $85 million to $95 million was characterized as nondiscretionary. Timing of projects and acquisitions could affect actual spending.
- Principal risks: Approximately 75% of revenue came from Medicare. The filing highlights reimbursement cuts and rule changes, Medicare claims audits and delayed appeals, labor and medical-cost inflation, acquisition integration and performance, competition, and uncertainty from coordinated-care and bundled-payment models. DOJ investigations into alleged improper Medicare and Medicaid claims remained open; the company said it was cooperating and could not predict their outcome. A long-running shareholder lawsuit also remained unresolved; management said loss was not probable and could not estimate a loss range.
- Other notable items: A General Medicine lawsuit was settled in March 2015 for an amount the company said was not material. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Investor verification priorities
- Confirm the post-quarter Reliant closing costs, assumed lease obligations, integration progress, and actual contribution to earnings and cash flow.
- Track CareSouth closing, financing, integration, and realized benefits against management’s expectations.
- Monitor Medicare claim denials, receivable growth, appeal recoveries, and outcomes of the DOJ investigations.
- Reconcile the unusually high quarter-end cash balance with acquisition funding and assess leverage, covenant headroom, and debt-service capacity after the acquisitions.
- Verify final reimbursement changes, capital spending, and whether home-health and rehabilitation growth offsets labor, medical-claim, and other cost pressures.