HealthSouth Corporation (identified in request as Encompass Health Corp.) — Q3 2013 Form 10-Q
Entity note: The filing is for HealthSouth Corporation, for the quarter ended September 30, 2013. The company describes itself as the largest U.S. owner and operator of inpatient rehabilitation hospitals. Unless stated otherwise, amounts below are in millions of dollars.
Business context and reporting period
HealthSouth operated 103 inpatient rehabilitation hospitals, 21 outpatient rehabilitation clinics and 25 hospital-based home health agencies across 28 states and Puerto Rico. The filing covers the three and nine months ended September 30, 2013, compared with the same periods in 2012.
Financial and operating performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net operating revenues | $564.0 | $537.0 | $1,701.1 | $1,609.0 |
| Income from continuing operations | $73.2 | $60.4 | $318.4 | $174.0 |
| Net income attributable to HealthSouth | $58.2 | $47.1 | $274.7 | $138.0 |
| Basic EPS | $0.60 | $0.43 | $2.86 | $1.24 |
| Adjusted EBITDA | $135.5 | $125.2 | $409.3 | $377.3 |
| Cash provided by operating activities | — | $369.4 | $302.2 |
Q3 revenue increased 5.0%; hospital inpatient revenue grew 6.0%, reflecting 5.7% more discharges and a 0.3% increase in revenue per discharge. Nine-month revenue increased 5.7%, with inpatient revenue up 6.6%. Same-store discharges rose 3.2% in Q3 and 2.9% year to date. Outpatient visits declined 8.6% in Q3 and 10.0% year to date.
Operating expenses were 75.3% of net operating revenue in Q3 versus 79.3% a year earlier; the ratio benefited materially from settlement-related gains. Salaries and benefits were 47.8% of revenue versus 48.8%. Adjusted EBITDA increased 8.2% in Q3 and 8.5% year to date. The filing says 2013 EBITDA benefited from approximately $8 million of self-insurance reserve adjustments; sequestration reduced EBITDA by approximately $8 million in Q3 and $17 million year to date.
At September 30, cash and equivalents were $65.0, current assets $575.1 and current liabilities $311.8. Long-term debt, net of current portion, was $1,306.2; total debt carrying amount including current maturities was $1,319.9. Convertible perpetual preferred stock was $342.2. The company reported approximately $529 million available under its revolver and compliance with its leverage and interest-coverage covenants. Restricted cash and restricted marketable securities totaled $99.8 and were not available for general use.
Capital expenditures for property, equipment and capitalized software were approximately $182 million for the first nine months. Cash declined $67.8 to $65.0, principally reflecting the $234.1 common-stock tender offer and higher investment spending.
Material changes versus prior comparable period
- Q3 net income attributable to HealthSouth rose 23.6%; nine-month net income nearly doubled. The year-to-date comparison is heavily affected by a one-time IRS settlement tax benefit of approximately $115 million recorded in Q2 2013.
- Q3 operating results included $21.3 million of gains in government, class action and related settlements, versus $3.5 million in Q3 2012; the nine-month gains were $23.3 million versus $3.5 million. These included a noncash liability reduction and recoveries from former officers.
- Medicare represented 74.1% of Q3 revenue, up from 73.1%; for the first nine months it was 74.5%, also up from 73.1%. Sequestration and ramp-up costs at new hospitals offset some revenue growth.
- The company repurchased approximately 9.1 million shares for $234.1 million in Q1 and initiated a $0.18 quarterly common dividend, first paid in October. Shares outstanding were 87.4 million at September 30, down from 95.7 million at year-end 2012.
- Investing cash use rose to $197.2 million from $124.3 million, reflecting higher capital expenditures and the $28.9 million Walton Rehabilitation Hospital acquisition. Financing cash use rose to $240.0 million from $44.8 million, primarily due to the share repurchase.
Outlook, risks and unusual items
Management described its outlook as reasonably positive, citing aging demographics, industry position and continued demand for inpatient rehabilitation. It highlighted organic growth, new hospitals, acquisitions and shareholder returns as priorities. No full-year revenue or earnings guidance is provided. Management estimated 2013 sequestration would reduce net operating revenue by approximately $28 million and said sequestration would continue to reduce otherwise payable Medicare reimbursement by 2% absent legislative change. The company estimated a net Medicare rate increase of approximately 1.95% under the FY2014 final rule, effective October 1, 2013.
Management revised 2013 capital expenditure expectations to $155–$195 million, excluding acquisitions and purchases of leased properties; approximately $80–$90 million was described as nondiscretionary. On October 29, 2013, the company gave notice of an intended redemption of $58.1 million principal of senior notes for approximately $60 million, funded with cash and revolver availability; it expected an approximately $2 million extinguishment loss in Q4.
Key risks include Medicare and other reimbursement changes, healthcare regulation, staffing costs and shortages, competition, and the ability to develop or acquire hospitals. The filing discusses HHS-OIG investigations into Medicare and Medicaid claims at a closed hospital and four operating hospitals; the company said it was cooperating and could not predict the outcome. Medicare audit requests covered payments representing less than 1% of average annual discharges over the prior three years, but scope and outcomes remained uncertain. The company stated it did not believe adverse judgments or settlements were probable in certain disclosed lawsuits, while noting that potential losses could not be estimated in some matters. Management reported disclosure controls were effective and no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Separate recurring operating performance from the $115 million IRS tax benefit and settlement gains when assessing earnings and year-over-year growth.
- Review the extent and potential financial effects of HHS-OIG investigations, Medicare audits, and other legal proceedings; outcomes were not predictable in the filing.
- Monitor the effect of sequestration and future Medicare payment rules on reimbursement, patient volumes and margins.
- Assess liquidity after the share repurchase, dividend payments, property purchases and planned note redemption; distinguish unrestricted cash from restricted assets.
- Check whether planned capital spending and hospital development proceed on schedule and within the stated range, and whether new facilities achieve expected utilization.