HealthSouth Corporation (now Encompass Health) — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014; unaudited. The filing is by HealthSouth Corporation, the company’s name at the time. It operated inpatient rehabilitation hospitals and related outpatient and home-health services, with 103 inpatient rehabilitation hospitals at quarter-end.
Financial performance and liquidity
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net operating revenues | $604.4 million | $564.5 million | $1,195.6 million | $1,137.1 million |
| Income from continuing operations | $94.1 million | $178.9 million | $155.7 million | $245.2 million |
| Net income attributable to HealthSouth | $83.1 million | $165.2 million | $129.8 million | $216.5 million |
| Adjusted EBITDA | $152.7 million | $134.5 million | $296.8 million | $273.8 million |
| Diluted EPS | $0.85 | $1.66 | $1.33 | $2.09 |
Revenue increased 7.1% in Q2 and 5.1% in the first half. Q2 inpatient discharges rose 3.0% and revenue per discharge rose 4.9%; first-half increases were 2.7% and 3.2%, respectively. The filing reports operating expenses at 77.3% of net operating revenues in Q2, versus 79.0% a year earlier. Approximate operating income before interest and other items—revenues after doubtful-account provision less operating expenses—was $127.6 million, or 21.1% of revenue, versus $111.6 million, or 19.8%, in Q2 2013.
Lower reported earnings year over year principally reflect an unusually favorable 2013 tax comparison: a prior-year IRS settlement generated a substantial tax benefit. Q2 2014 also included a $27.2 million gain on remeasurement of the prior Fairlawn interest following consolidation. A $6.7 million derivative-option gain was included in discontinued operations. These items affect comparability; the 2014 Fairlawn gain was excluded from Adjusted EBITDA.
For the six months, operating cash flow was $235.1 million (up from $226.8 million); investing cash use was $107.0 million and financing cash use was $126.8 million. Cash increased $1.3 million to $65.8 million. At June 30, long-term debt, net of current portion, was $1,475.1 million; shareholders’ equity was $555.4 million. The company reported approximately $548 million available on its revolving facility and compliance with its debt covenants. Restricted cash and securities, totaling approximately $95.8 million, were not included in unrestricted cash. No significant debt maturities were expected before 2018.
Medicare represented 74.1% of Q2 revenue and 74.7% for the first half. The company paid common dividends of $0.18 per share in each of the first two quarters and repurchased 1.3 million shares for $43.1 million in the first half.
Material changes and management outlook
- Fairlawn Rehabilitation Hospital: HealthSouth increased ownership from 50% to 80% in June and began consolidating results. The transaction generated the $27.2 million reported gain and added approximately 60 basis points to Q2 discharge growth.
- Operating trends: Same-store discharges increased 1.4% in Q2 and 0.9% in the first half. First-half same-store volume was affected by winter storms; management estimated a 50-basis-point adverse effect on first-half discharge growth. Sequestration reduced first-quarter revenue per discharge by approximately $9 million.
- Outpatient visits fell 10.3% in Q2 and 9.7% in the first half, attributed to clinic closures and competition from physician offices. Occupancy was 70.5% in Q2, compared with 69.9% a year earlier.
- Management described the outlook as reasonably positive, citing aging-population demand, its market position, and expected continued cash generation. It gave no full-year revenue or earnings guidance in the provided filing text.
- Management estimated 2014 capital expenditures of $185–$230 million, excluding acquisitions, and cash income taxes of approximately $12–$17 million, net of refunds. The 2014 doubtful-account provision outlook was approximately 1.5% of revenue.
- CMS’s proposed FY2015 inpatient rehabilitation payment rule implied an estimated net payment-rate increase of approximately 2.2% for the company, effective October 1, 2014; this was a company estimate of a proposed rule, not a final outcome. Management identified reimbursement reform, audits, staffing, competition, and the uncertain transition to coordinated-care payment models as ongoing challenges. The board announced a quarterly dividend increase to $0.21 per share in July, subject to future board decisions.
Risks, contingencies, and controls
HealthSouth disclosed ongoing litigation, including General Medicine’s claims, and HHS-OIG/DOJ subpoenas involving alleged improper Medicare and Medicaid claims at multiple hospitals. The company said it was cooperating with the investigation and could not predict its timing or outcome. Management stated adverse outcomes were not considered probable in certain described lawsuits, but potential loss amounts were not estimable. The filing also notes RAC claim reviews and possible repayment exposure. No material risk-factor changes from the 2013 Form 10-K were reported. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Investor facts to verify
- Separate underlying operating growth from the Fairlawn gain and the $6.7 million option-related discontinued-operations gain.
- Normalize year-over-year earnings for the 2013 IRS tax benefit before assessing the earnings decline.
- Track Medicare reimbursement rules, RAC reviews, and the DOJ investigation, including any additional subpoenas or financial exposure.
- Monitor discharge and revenue-per-discharge trends alongside declining outpatient visits and the 1.5% doubtful-account provision outlook.
- Confirm ongoing covenant headroom, debt maturities, planned capital spending, and the sustainability of dividends and repurchases.