HealthSouth Corporation (now Encompass Health) — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. The filing issuer was HealthSouth Corporation, which described itself as the largest U.S. owner and operator of inpatient rehabilitation hospitals. It operated 103 inpatient rehabilitation hospitals, 16 outpatient clinics and 25 hospital-based home health agencies.
Financial performance and liquidity
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net operating revenue | $596.9 million | $564.0 million | $1,792.5 million | $1,701.1 million |
| Net income attributable to HealthSouth | $50.1 million | $58.2 million | $179.9 million | $274.7 million |
| Net income attributable to common shareholders | $48.5 million | $52.5 million | $175.2 million | $257.5 million |
| Diluted EPS | $0.52 | $0.58 | $1.85 | $2.68 |
| Adjusted EBITDA | $140.0 million | $135.5 million | $436.8 million | $409.3 million |
| Operating cash flow | Not separately reported for quarter | Not separately reported for quarter | $374.7 million | $369.4 million |
- Q3 revenue increased 5.8%; nine-month revenue increased 5.4%. Inpatient hospital revenue rose 6.6% and 6.2%, respectively, reflecting higher discharges and revenue per discharge. Medicare generated 73.5% of Q3 revenue.
- Q3 net income attributable to HealthSouth fell 13.9%; nine-month net income fell 34.5%. The prior-year periods benefited from a $21.3 million settlement-related operating gain in Q3 and a $23.3 million gain year to date, while 2013 year-to-date results also included a substantial IRS-related tax benefit. In 2014, nine-month other income included a $27.2 million Fairlawn remeasurement gain.
- Adjusted EBITDA increased 3.3% in Q3 and 6.7% year to date. The filing’s figures imply approximate EBITDA margins of 23.5% and 24.3% of revenue, respectively, versus 24.0% and 24.1% in 2013. Operating expenses grew faster than revenue in both 2014 periods.
- Nine-month capital spending was approximately $147 million for property, equipment and capitalized software. Cash increased to $272.3 million from $64.5 million at year-end, including approximately $182 million of September bond-offering proceeds; the proceeds were subsequently used in part for debt redemption.
- At September 30, total debt was $1.65 billion, including $208.5 million classified as current. Current assets were $783.0 million and current liabilities $514.7 million. The company reported approximately $718 million available under its credit agreement and compliance with its leverage and interest-coverage covenants.
Material changes and operating developments
- Q3 discharges rose 3.8%, including 1.9% same-store growth; revenue per discharge increased 2.7%. Nine-month discharges rose 3.1%, including 1.0% same-store growth, while revenue per discharge increased 3.0%. Winter storms reduced nine-month same-store discharge growth by an estimated 60 basis points.
- In June, HealthSouth increased its ownership of Fairlawn Rehabilitation Hospital from 50% to 80%, began consolidating it, and recognized the $27.2 million gain. Fairlawn contributed $15.4 million revenue and $2.6 million net income attributable to HealthSouth from acquisition through September.
- September financing included $175 million of additional 5.75% senior notes due 2024 and an amended credit agreement with a $150 million term-loan facility and maturity extended to September 2019. In October, the company redeemed approximately $271 million of 7.25% notes due 2018 and planned a December redemption of approximately $25 million of 7.75% notes due 2022. It expected an approximately $13 million fourth-quarter loss on early debt extinguishment.
- The company repurchased 1.3 million shares for $43.1 million during the first nine months and increased its quarterly common dividend from $0.18 to $0.21 per share. Approximately $207 million remained under the $250 million repurchase authorization at September 30.
Outlook, risks and contingencies
- Management described the outlook as positive, citing aging-related demand, its market position and plans for organic growth, new hospitals, acquisitions and capacity additions. It expected 2014 capital expenditures of $180 million to $225 million, excluding acquisitions, and estimated cash income taxes of $12 million to $17 million, net of refunds.
- Management estimated the fiscal 2015 Medicare inpatient rehabilitation payment rule would raise its Medicare rates approximately 2.3% from October 1, 2014, before sequestration. It expected the provision for doubtful accounts to remain approximately 1.5% of revenue for 2014.
- Key risks include reimbursement and healthcare-policy changes, regulatory scrutiny, staffing availability and costs, competition, and execution of development projects. Medicare represented about three-quarters of revenue, creating material exposure to changes in Medicare payment and eligibility rules.
- The DOJ investigation into alleged improper Medicare and Medicaid claims expanded to subpoenas involving 11 hospitals, including supplemental requests for two previously subpoenaed hospitals. The company said it was cooperating and could not predict the timing or outcome. The General Medicine fraudulent-transfer case was reset for trial in March 2015; management said an adverse outcome was not probable but could not estimate a loss range. The filing also describes other litigation and the possibility of undisclosed qui tam claims.
- Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter. It reported no material changes to the risk factors in its 2013 Form 10-K.
Important facts for investors to verify
- Whether revenue and discharge growth can continue while labor, other operating costs and Medicare exposure affect margins.
- The recurring earnings and cash-flow impact after excluding the Fairlawn gain, prior-year settlement gains and tax-related items.
- Debt and liquidity after the October and planned December redemptions, including financing costs and the expected extinguishment loss.
- Developments in the DOJ investigation, General Medicine trial, Medicare audits and related potential contingencies.
- Whether management’s Medicare-rate, bad-debt, tax and capital-expenditure expectations are borne out; future dividends and repurchases remain subject to board discretion and financing restrictions.