HealthSouth Corporation (now Encompass Health) — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015. The filing reports HealthSouth Corporation and its consolidated subsidiaries, a post-acute care provider operating inpatient rehabilitation and home health and hospice businesses.
Financial performance
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Net operating revenues | $740.6 million | $591.2 million | +25.3% |
| Revenue after doubtful-account provision | $729.0 million | $583.7 million | +24.9% |
| Income from continuing operations | $59.3 million | $61.6 million | -3.7% |
| Net income attributable to HealthSouth common shareholders | $40.9 million | $45.1 million | -9.3% |
| Diluted EPS | $0.44 | $0.48 | -8.3% |
| Adjusted EBITDA | $156.1 million | $144.1 million | +8.3% |
| Cash provided by operating activities | $102.0 million | $107.1 million | -4.8% |
- Growth in revenue and Adjusted EBITDA primarily reflected the December 2014 acquisition of Encompass Home Health and Hospice. The acquired business contributed approximately $103 million of the revenue increase.
- Inpatient rehabilitation revenue rose 7.8% to $630.3 million; discharges increased 6.8%, including 2.9% same-store growth, and revenue per discharge increased 1.8%. Segment Adjusted EBITDA declined 1.5% to $164.4 million.
- Home health and hospice revenue was $110.3 million and Segment Adjusted EBITDA was $16.9 million. The comparison with 2014 is not meaningful because the prior period included only legacy agencies, not Encompass.
- Total operating expenses rose 30.2% to $608.5 million, faster than revenue. Salaries and benefits increased to 52.0% of revenue from 48.4%; the filing cites the acquisition, new-hospital start-up costs, quality-reporting staffing and other investments.
- Cash and cash equivalents were $208.3 million at quarter-end, versus $66.7 million at December 31, 2014; the March balance included about $135 million of proceeds from the 2023 notes offering. The company also had approximately $555 million available under its revolving credit facility. Restricted cash and marketable securities were excluded from cash and equivalents.
- Debt carrying value was $2.272 billion, including $149.8 million classified as current. Current liabilities were $497.6 million. The company reported compliance with its credit agreement covenants.
Changes versus the prior comparable period
- Net income attributable to HealthSouth declined despite higher revenue, as cost growth, increased doubtful-account provisions, higher interest expense and $8.0 million of government, class-action and related settlement expense weighed on results. Pre-tax income from continuing operations fell 5.1% to $89.6 million.
- Operating cash flow fell by $5.1 million. Management attributed the decrease mainly to acquisition-related costs and assumed liabilities, working-capital needs—including increased receivables—and higher cash interest expense.
- Investing cash outflow narrowed to $45.7 million from $67.8 million, primarily due to the timing of capital spending. Financing provided $85.3 million, compared with $50.7 million used in the prior-year quarter, reflecting bond issuance and debt repayments.
- The company began reporting two segments— inpatient rehabilitation and home health and hospice—after acquiring Encompass and changing its management reporting. Prior-period segment information was recast.
Outlook, risks and notable items
- Management described its outlook as positive, citing aging-related demand, its market position, care quality and opportunities for organic growth and acquisitions. It emphasized uncertainty around healthcare delivery and payment reforms; the filing provides no consolidated full-year revenue or earnings guidance.
- Management expected 2015 capital expenditures of $190 million to $240 million, including $30 million to $40 million for new home health and hospice agencies. Estimated 2015 cash income tax expense, net of refunds, was $15 million to $20 million.
- CMS’s proposed FY2016 inpatient rehabilitation rule was estimated by management to produce an approximately 2.0% increase in Medicare payment rates from October 1, 2015, before sequestration. This was a proposed rule, not a final payment outcome.
- In April 2015, the company redeemed $290 million principal of 8.125% notes due 2020 for approximately $302 million. It expected to record an approximately $19 million early-extinguishment loss in Q2 2015. The 2023 notes offering and April redemption are subsequent events, not Q1 cash transactions in full.
- All outstanding convertible perpetual preferred stock was forcibly converted into 3,271,415 common shares on April 23, 2015. Management estimated an annual positive cash impact of $3.5 million at the current common dividend rate.
- The company settled the General Medicine lawsuit in March 2015; the settlement terms were confidential and the cash payment was described as not material. The filing separately reports $8.0 million of government, class-action and related settlement expense; it does not clearly reconcile that expense to the stated immaterial payment.
- DOJ investigations concerning alleged improper Medicare and Medicaid claims remained ongoing; the company said it was cooperating and could not predict the investigations’ timing or outcome. Other litigation and exposure to Medicare audits, claim denials and delayed appeals remain risks. Management said there were no material changes to the risk factors in the 2014 Form 10-K.
- Other stated risks include changes to Medicare reimbursement and healthcare regulations, staffing availability and costs, competitive pressures, acquisition integration, and legal or regulatory proceedings.
Most important facts for investors to verify
- How much of reported growth and future performance is attributable to Encompass, and whether acquired operations achieve expected integration benefits.
- Whether inpatient discharge growth and reimbursement per discharge persist, and whether bad-debt expense and Medicare claim denials ease.
- Cash generation and liquidity after the April 2020-note redemption, including actual revolver availability and covenant headroom.
- The eventual cost, timing and outcome of DOJ inquiries, Medicare audits and other legal matters, and the nature of the reported $8.0 million settlement expense.
- Final Medicare payment-rule changes, sequestration effects, and actual capital expenditures against the $190 million–$240 million estimate.