HealthSouth Corporation (now Encompass Health Corp.) — FY 2010 Form 10-K
Reporting period: Fiscal year ended December 31, 2010; filed February 24, 2011. This is an annual report, not a standalone Q4 filing. The registrant named in the filing is HealthSouth Corporation.
Business context
HealthSouth was the largest U.S. provider of inpatient rehabilitation services, operating 97 inpatient rehabilitation hospitals, six freestanding long-term acute care hospitals, outpatient clinics and hospital-based home health agencies. Inpatient services generated approximately 92% of 2010 revenue. Medicare accounted for 70.5% of revenue, up from 67.9% in 2009.
Financial and operating performance
| Metric | FY 2010 | FY 2009 | Change or context |
|---|---|---|---|
| Net operating revenue | $1,999.3 million | $1,911.1 million | Up 4.6% |
| Net income attributable to HealthSouth | $899.0 million | $94.8 million | Includes a major noncash tax benefit |
| Net income attributable to common shareholders | $873.0 million | $68.8 million | Basic EPS $9.41; diluted EPS $8.28 |
| Operating earnings (company-defined) | $310.0 million | $244.6 million | Up 26.7% |
| Adjusted EBITDA (credit-agreement definition) | $427.4 million | $383.0 million | Up 11.6%; non-GAAP measure |
| Cash from operating activities | $331.0 million | $406.1 million | Down; 2009 included UBS settlement proceeds and larger tax refunds |
| Cash and cash equivalents | $48.4 million | $80.9 million | Excludes restricted cash and investments |
| Working capital | $46.9 million | $34.8 million | Positive at year-end |
| Long-term debt, including current portion | $1,511.3 million | $1,662.5 million | Includes $89.1 million of capital leases in 2010 |
| Discharges | 116,153 | 112,975 | Up 2.8%; same-store discharges up 1.2% |
The reported $736.6 million income tax benefit primarily reflected an $825.4 million reduction in the deferred-tax valuation allowance. Consequently, headline net income and EPS substantially overstate the change in underlying operating performance. Revenue growth reflected increased discharges and higher revenue per discharge; outpatient visits declined to 1.03 million from 1.12 million.
Material changes and capital structure
- Debt was reduced by approximately $151 million during 2010. In October, the company issued $275 million of 7.25% senior notes due 2018 and $250 million of 7.75% notes due 2022, and refinanced its credit agreement with a $500 million revolving facility maturing in 2015.
- At year-end, $78 million was drawn on the revolver and approximately $376 million remained available. The company reported compliance with its covenants, with leverage and interest coverage ratios both at 3.5x.
- Debt refinancing extended maturities and lowered floating-rate exposure, but replaced lower-rate term loans with higher-coupon notes and incurred refinancing costs. The company identified its 10.75% notes due 2016 as a potential repayment or refinancing priority beginning in June 2011.
- 2010 development activity included acquisitions and openings of rehabilitation facilities. Capital expenditures were $70.9 million; management expected approximately $100 million in 2011, excluding acquisitions.
Outlook, risks and unusual items
- For 2011, management targeted annual discharge growth of 2.5%–3.5%, excluding acquisitions, and planned to prioritize operating performance, debt reduction and disciplined growth. This was a management expectation, not formal revenue or earnings guidance.
- Management estimated the 2011 outpatient reimbursement and pricing changes would reduce annual revenue by approximately $1.4 million. It also estimated the first productivity adjustment to Medicare inpatient rehabilitation updates, effective October 2011, at about a 1% reduction.
- Medicare dependence and healthcare reform create reimbursement, documentation and compliance risks. Future market-basket reductions, productivity adjustments, quality-reporting penalties, audits and changes to payment models could pressure revenue or increase costs.
- Staffing shortages, rising labor costs, competition, claim denials and self-insurance estimates are significant operating risks. Self-insured liability reserves were $152.9 million at year-end, up from $137.5 million.
- A $2.9 billion judgment against former CEO Richard Scrushy was affirmed by the Alabama Supreme Court on January 28, 2011, after the fiscal year-end. The company had not recorded a receivable because collection was uncertain; recovery would be reduced by contractual sharing obligations and expenses.
- The company settled UnitedHealthcare-related arbitration for $4.3 million, payable in January 2011, within amounts previously accrued. It also recorded a $12.3 million jury verdict liability in a separate case, with an estimated $7.7 million insurance receivable; the verdict was under appeal.
- Net income was materially affected by the valuation-allowance release. Other notable items included $12.3 million of debt-extinguishment losses, $13.3 million of swap losses and a $4.6 million charge related to the jury verdict. The filing reports an unqualified audit opinion and effective internal control over financial reporting.
Important facts for investors to verify
- Underlying earnings and cash generation excluding the $736.6 million tax benefit, nonrecurring items and working-capital timing.
- Whether deferred tax assets can be realized as forecast, including the remaining $112.7 million valuation allowance and potential Section 382 limitations.
- Post-refinancing interest expense, debt maturities, covenant headroom and the plan for the 10.75% notes due 2016.
- Actual discharge growth and reimbursement effects from Medicare updates, outpatient fee changes and evolving healthcare regulations.
- Collection prospects and net proceeds, if any, from the Scrushy judgment, and outcomes of the remaining litigation and insurance claims.