Business context and reporting period
This is HealthSouth Corporation’s unaudited Form 10-Q for the quarter and nine months ended September 30, 2012. The filing identifies the registrant as HealthSouth Corporation. It operated 99 inpatient rehabilitation hospitals, 26 outpatient rehabilitation satellite clinics, and 25 hospital-based home health agencies. Medicare represented 73.1% of revenue in both the quarter and nine-month period.
Financial performance and liquidity
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net operating revenues | $537.0 million | $497.7 million | $1,609.0 million | $1,508.8 million |
| Revenue after doubtful-account provision | $530.0 million | $492.6 million | $1,589.2 million | $1,493.9 million |
| Income from continuing operations | $60.4 million | $33.6 million | $174.0 million | $138.3 million |
| Net income attributable to HealthSouth | $47.1 million | $57.0 million | $138.0 million | $158.7 million |
| Net income attributable to common shareholders | $41.4 million | $50.5 million | $119.1 million | $139.2 million |
| Basic and diluted EPS | $0.44 | $0.54 | $1.26 | $1.49 |
| Adjusted EBITDA | $125.2 million | $110.5 million | $377.3 million | $343.3 million |
- Q3 inpatient revenue increased 8.7%, with discharges up 4.2% and net patient revenue per discharge up 4.4%. Nine-month inpatient revenue rose 7.8%; discharges increased 4.4% and revenue per discharge 3.3%.
- Operating cash flow was $302.2 million for the first nine months, versus $213.2 million a year earlier. Investing activities used $124.3 million; capital expenditures and capitalized software totaled $128.2 million. Cash increased to $163.2 million from $30.1 million at year-end 2011.
- Debt totaled approximately $1.322 billion, including current maturities. The balance sheet reported $1.242 billion of long-term debt, net of current portion. Current assets were $548.8 million and current liabilities $377.8 million.
- At September 30, the company reported approximately $559 million available under its $600 million revolving facility and was in compliance with its financial covenants. The filing does not provide a clear actual leverage ratio; it states the maximum permitted ratio was 4.75x and that leverage was within management’s target range.
Material changes versus the prior comparable period
- Q3 revenue rose 7.9% and continuing-operations income increased, while net income attributable to HealthSouth fell 17.4%. The prior-year quarter included $34.7 million of discontinued-operations income, chiefly related to divestitures; Q3 2012 had a $0.5 million discontinued-operations loss.
- For the first nine months, revenue rose 6.6% and continuing-operations income rose 25.8%, but attributable net income declined 13.0%. The 2011 period included substantial discontinued-operations gains, including the sale of five long-term acute care hospitals. The 2012 tax provision was $84.1 million versus $21.9 million in 2011; the prior-year figure benefited from federal tax settlements and other tax benefits.
- Operating cash flow increased, while investing cash flow shifted from a $32.7 million source in 2011 to a $124.3 million use in 2012, reflecting higher capital spending and the absence of the prior-year hospital-sale proceeds. Financing cash use declined to $44.8 million from $246.6 million.
- In August the company amended its credit agreement, increasing revolver capacity from $500 million to $600 million, reducing the applicable rate spread by 50 basis points, and extending maturity to August 2017. In September it issued $275 million of 5.75% senior notes due 2024. In October, after quarter-end, it used proceeds to redeem $64.5 million principal of older notes and expected to record an approximately $2.7 million early-extinguishment loss in Q4.
Outlook, management commentary, risks and unusual items
- Management described demand and the business outlook as positive, estimating inpatient rehabilitation demand in its markets was growing 2.0%–2.6% annually. It emphasized organic development, acquisitions in its core business, productivity, and investment in clinical systems. The filing did not provide a specific earnings or revenue forecast.
- Management estimated the Medicare sequestration reductions expected in January 2013 would reduce annual net operating revenue by approximately $34 million. The 2013 inpatient rehabilitation payment rule was expected to increase Medicare rates approximately 2.1% from October 1, 2012, before sequestration.
- A potential reduction of more than 26% in outpatient physician-fee-schedule payments, absent further congressional action, was estimated to reduce annual revenue by approximately $8 million before mitigation and could prompt additional clinic closures. The company also cited reimbursement uncertainty, regulatory compliance, referral volumes, staffing and labor costs, and collection risk.
- Q3 and nine-month results included a $4.9 million gain from consolidating St. Vincent Rehabilitation Hospital and remeasuring the previously held interest, and a $3.5 million gain from recovery of assets related to Richard Scrushy. The St. Vincent consolidation increased goodwill by $15.6 million and was not considered material to the company’s overall financial position or results.
- Medicare claim denials and longer adjudication times increased the doubtful-account provision to 1.3% of revenue in Q3 from 1.0% a year earlier. The company said it historically collected approximately 58% of appealed denied amounts, but resolution could take over a year.
- Gross unrecognized tax benefits were $79.0 million at September 30, 2012, largely connected with efforts to maximize federal net operating loss benefits. IRS pre-filing review could produce a material favorable tax impact, but the company said the amount and range could not be estimated.
- Material contingencies include the General Medicine litigation, a federal investigation concerning claims at a closed hospital, and a $12.3 million verdict under appeal in South Carolina; the company recorded a $12.3 million liability and a $7.7 million insurance-related receivable for the latter matter. The company also disclosed $11.1 million of maximum potential exposure under lease guarantees, for which it had recorded no liability because performance was not considered probable.
Important facts for investors to verify
- Whether Medicare sequestration and subsequent reimbursement rule changes occurred as anticipated, and their realized effect on revenue, margins, and cash flow.
- Whether discharge growth, revenue per discharge, labor productivity, and outpatient activity trends continued after Q3; outpatient visits were down 6.5% in the quarter.
- Debt balances, cash availability, covenant headroom, and the post-quarter redemption and related refinancing costs.
- The resolution and financial impact of the IRS tax-benefit process, litigation, Medicare claim denials, and the HHS-OIG investigation.
- Whether planned 2012 capital expenditures of $155 million–$190 million, excluding acquisitions, and ongoing hospital development were funded from cash generation without weakening liquidity.