HealthSouth Corporation (now identified in the request as Encompass Health Corp.) — 2013 Form 10-K
Reporting period: Fiscal year ended December 31, 2013. This is an annual filing; it includes fourth-quarter results but is not a standalone quarterly report. The filing identifies the registrant as HealthSouth Corporation.
Business context
HealthSouth operated the largest U.S. inpatient rehabilitation hospital network, with 103 hospitals across 28 states and Puerto Rico, alongside outpatient clinics and hospital-based home health agencies. Inpatient rehabilitation was its core business; Medicare represented 74.5% of 2013 revenue. The company reported 129,988 discharges, up 5.0%, including 2.5% same-store discharge growth.
Key financial results
| Metric | 2013 | 2012 | Change or context |
|---|---|---|---|
| Net operating revenues | $2,273.2 million | $2,161.9 million | Up 5.1% |
| Operating earnings (company-defined) | $435.7 million | $378.7 million | Up 15.1% |
| Net income | $381.4 million | $235.9 million | Up 61.7% |
| Net income attributable to HealthSouth | $323.6 million | $185.0 million | Up 74.9% |
| EPS attributable to common shareholders | $2.58 | $1.67 | 2013 includes the preferred-stock exchange charge described below |
| Net cash from operating activities | $470.3 million | $411.5 million | Up $58.8 million |
| Adjusted EBITDA (non-GAAP) | $551.6 million | $505.9 million | Up 9.0% |
Total operating expenses were 77.6% of revenue, compared with 79.5% in 2012. Inpatient net patient revenue rose 5.9%, reflecting higher discharges and a 0.9% increase in revenue per discharge. Outpatient and other revenue declined 4.6%; outpatient visits fell 8.4%.
At December 31, 2013, cash and cash equivalents were $64.5 million, working capital was $268.8 million, and approximately $519 million was available under the $600 million revolving facility. Current assets were $580.4 million and current liabilities $311.6 million. Total debt reported on the balance sheet was $1,517.5 million, including $88.9 million of capital lease obligations; $45 million was drawn on the revolver. The company reported compliance with its debt covenants and no significant debt maturities before 2018.
Capital expenditures and capitalized software costs totaled $216.5 million in 2013. The company paid $234.1 million, including fees, to repurchase common stock in a tender offer and paid $15.7 million in common dividends. Cash declined by $68.3 million during the year.
Material changes and unusual items
- Revenue increased 5.1%, while operating expenses grew 2.7%; operating expenses as a share of revenue improved by 1.9 percentage points.
- The IRS settlement generated an approximately $115 million income tax benefit in 2013, contributing to a 3.2% effective tax rate versus 31.9% in 2012. This materially boosted reported earnings; cash income taxes paid, net of refunds, were approximately $8 million.
- In November 2013, HealthSouth exchanged $320 million principal amount of 2.00% convertible subordinated notes due 2043 for 257,110 preferred shares. The transaction reduced outstanding preferred shares but added debt; the notes’ effective interest rate was 6.0%.
- A $6.7 million reduction in self-insurance reserves followed a change in the statistical confidence level used. Management said favorable claims trends supported the change. Adjusted EBITDA also included this benefit.
- Medicare post-payment audits reduced 2013 revenue by approximately $8 million. The company said the claims under review represented less than 1% of Medicare discharges from 2010–2013 and intended to appeal substantially all denials.
- Fourth-quarter revenue was $572.1 million and operating earnings were $106.9 million. Net income was $64.2 million, but common-share EPS was a loss of $0.31, reflecting the accounting charge associated with the preferred-stock exchange.
Outlook, risks and contingencies
Management characterized the outlook as reasonably positive, citing aging demographics, expected growth in Medicare-eligible patients of about 3% annually, and opportunities for organic growth, new hospitals, and acquisitions. For 2014, it expected capital expenditures of $185 million to $230 million, excluding acquisitions, and cash income taxes of approximately $10 million to $15 million. It forecast an approximately $8 million year-over-year revenue reduction from Medicare sequestration in 2014. It also estimated that an unmitigated reduction of more than 20.1% in outpatient physician-fee-schedule payments could reduce annual revenue by about $5 million; congressional action remained uncertain.
Major risks include Medicare reimbursement changes and audit outcomes; the DOJ/HHS-OIG investigation following subpoenas to four hospitals concerning alleged improper or fraudulent claims; staffing shortages and rising labor costs; competition for referrals; and execution risks in development and acquisitions. The filing also describes litigation, including the General Medicine action, which was scheduled for trial in September 2014; management said an adverse judgment was not probable but could not estimate a loss range. HealthSouth reported that disclosure controls and internal control over financial reporting were effective as of year-end, and its auditor issued an unqualified opinion.
Important facts for investors to verify
- Whether the approximately $115 million IRS tax benefit and unusually low 2013 tax rate are nonrecurring, and how much of the reported earnings increase reflects operating performance.
- Subsequent developments, denials, appeals, and potential financial exposure from RAC audits and the DOJ/HHS-OIG investigation.
- Actual 2014 Medicare and outpatient reimbursement changes, including sequestration and the physician fee schedule, versus management’s estimates.
- Debt and liquidity after the preferred-stock exchange, capital spending, dividends, and repurchases; confirm covenant headroom and the timing of maturities.
- Whether discharge growth, cost efficiencies, and new-hospital ramp-ups support management’s outlook, and whether the self-insurance reserve assumptions remain appropriate.
- The filing discusses a planned increase in the buyback authorization from $200 million to $250 million approved in February 2014; verify implementation and subsequent filings.