Business Context and Reporting Period
Company: HealthSouth Corporation (Note: Filing text identifies registrant as HealthSouth Corporation; metadata reference to Encompass Health Corp reflects a later name change).
Reporting Period: Quarterly period ended March 31, 2010.
Business Overview: The Company is the largest provider of inpatient rehabilitative healthcare services in the United States, operating 93 inpatient rehabilitation hospitals, 6 long-term acute care hospitals, and various outpatient clinics and home health agencies across 26 states and Puerto Rico. Revenue is heavily weighted toward Medicare (70.4% in Q1 2010).
Key Financial Metrics
| Metric (in millions) | Q1 2010 | Q1 2009 |
|---|---|---|
| Net Operating Revenues | $491.0 | $472.9 |
| Net Income | $50.5 | $53.5 |
| Net Income Attributable to HealthSouth | $40.7 | $44.9 |
| Diluted EPS (Common Shareholders) | $0.37 | $0.44 |
| Adjusted Consolidated EBITDA | $106.4 | $98.4 |
| Net Cash Provided by Operating Activities | $84.8 | $183.1 |
| Total Debt (Current + Long-term) | $1,657.3 | $1,662.5 |
| Cash and Cash Equivalents | $116.8 | $90.7 |
Margins: Operating expenses as a percentage of net operating revenues increased to 82.1% in Q1 2010 from 80.4% in Q1 2009. Salaries and benefits remained flat at 49.3% of revenues.
Material Changes vs. Prior Period
- Revenue Growth: Net operating revenues increased 3.8% year-over-year, driven by a 4.8% increase in net patient revenue per discharge and a 1.1% increase in patient discharges. This was offset by a decline in outpatient volumes due to clinic closures and severe winter storms.
- Profitability Decline: Net income attributable to HealthSouth decreased 9.4% to $40.7 million. This decline is primarily attributable to the absence of a $15.9 million net gain from government and class action settlements recorded in Q1 2009.
- Cash Flow Volatility: Operating cash flow decreased significantly to $84.8 million from $183.1 million. The prior year included $73.8 million in net proceeds from the UBS Settlement and approximately $49 million in tax refunds, which were not present in the current period.
- Interest Expense: Interest expense decreased 11.3% to $30.5 million due to a lower average interest rate (7.0% vs. 7.5%) and reduced average borrowings.
Guidance, Outlook, and Risks
Outlook and Strategy: Management focuses on deleveraging the balance sheet, organic growth, and disciplined acquisitions. Due to low LIBOR rates and senior notes trading above call prices, immediate debt reduction is not viewed as attractive; the focus has shifted to growing Adjusted Consolidated EBITDA. The Company expects to spend approximately $110 million on capital expenditures in 2010.
Regulatory Risks: The passage of the Patient Protection and Affordable Care Act (PPACA) in March 2010 reduced the annual Medicare market basket update from 2.5% to 2.25% effective April 1, 2010, with further reductions expected through 2019. The Company faces potential future "bundling" of acute and post-acute care reimbursement.
Legal Contingencies:
- Scrushy Litigation: A $2.9 billion judgment against former CEO Richard Scrushy remains on appeal; collectability is uncertain, and no amounts are recorded.
- United HealthCare: Arbitration disputes regarding therapy claims from 1997-2003 are ongoing, with United alleging damages of $13.0 million.
- General Medicine: Litigation regarding fraudulent transfers involving a former subsidiary is stayed pending an appeal.
Unusual Items: Q1 2009 results included a $15.9 million gain from settlements and $100 million in UBS settlement proceeds, making year-over-year comparisons of operating income and cash flow difficult.
Investor Verification Checklist
- Debt Covenants: Verify continued compliance with leverage and interest coverage ratios under the credit agreement, as Adjusted Consolidated EBITDA is a critical covenant metric.
- Medicare Reimbursement: Monitor the impact of the reduced market basket update (2.25%) and potential future bundling initiatives on revenue per discharge.
- Legal Recoveries: Assess the likelihood and timing of collecting the $2.9 billion judgment against Richard Scrushy, noting the 35% fee obligation to derivative plaintiffs and 25% to federal plaintiffs.
- Outpatient Volume: Confirm the stabilization of outpatient volumes following the closure of satellite clinics and the impact of staffing shortages.
- Capital Expenditures: Track the $110 million capital budget, specifically the opening of new hospitals in Loudoun County and Bristol, Virginia, and the associated ramp-up costs.