Business context and reporting period
HealthSouth Corporation (the registrant named in this filing; the request identifies the company as Encompass Health Corp) filed this unaudited Form 10-Q for the quarter ended March 31, 2011. It operated inpatient rehabilitation and long-term acute care hospitals, alongside outpatient and home health services. The comparison is with the three months ended March 31, 2010; dollar amounts are in millions unless otherwise stated.
Financial performance and position
| Metric | Q1 2011 | Q1 2010 or comparison |
|---|---|---|
| Net operating revenues | $538.1 | $491.0; up 9.6% |
| Operating expenses | $434.6 | $403.1 |
| Operating income, calculated as revenue less operating expenses | $103.5; 19.2% margin | $87.9; 17.9% margin |
| Income from continuing operations | $77.1 | $53.6 |
| Net income attributable to HealthSouth common shareholders | $73.3; basic EPS $0.79, diluted EPS $0.73 | $34.2; basic and diluted EPS $0.37 |
| Adjusted EBITDA, a company-defined non-GAAP measure | $123.4 | $106.4 |
| Cash from operating activities | $89.1 | $84.8 |
| Capital expenditures | $15.3 | $14.0 |
Hospital net patient revenue rose 9.2%, driven by 7.1% more discharges and a 1.9% increase in revenue per discharge. Same-store discharges grew 4.5%. Medicare accounted for 71.2% of revenue, versus 70.4% a year earlier. Outpatient visits declined to 239,902 from 255,445.
At March 31, cash and cash equivalents were $141.0, compared with $48.4 at year-end 2010. Current assets were $521.4 and current liabilities $337.9 (current ratio approximately 1.54). These figures exclude $26.5 of restricted cash and $45.4 of restricted marketable securities. Total debt was $1,564.2, versus $1,511.3 at year-end; long-term debt net of current portion was $1,550.8. Shareholders’ equity was $72.3, compared with a $2.2 deficit at year-end; convertible perpetual preferred stock was $387.4.
Material changes and unusual items
- Net income included $14.4 of income from discontinued operations, compared with a $3.1 loss in Q1 2010. The quarter included a $25.3 pretax gain from a Delaware unclaimed-property settlement; $24.8 was recorded in discontinued operations and the balance in operating revenue. The settlement agreement was signed April 4, 2011, after quarter-end, but the gain was recorded in Q1.
- The income tax provision was a $5.6 benefit, versus $2.5 of expense a year earlier. The 2011 benefit included approximately $24 from settling federal tax claims for 2007–08 and approximately $5 from other tax items. Management reported $702.7 of net deferred tax assets and stated their realization depends on future taxable income.
- Interest expense increased 15.1% to $35.1; the reported average interest rate rose to 8.9% from 7.0%. The company completed a $120.0 senior-note offering in March, used about $45.0 of proceeds to repay revolver borrowings, and held the remaining proceeds for an intended note redemption. Its interest-rate swaps expired in March, leaving no outstanding derivative positions.
Liquidity, outlook and risks
The company reported approximately $440 of availability under its $500 revolving credit facility and compliance with its financial covenants at quarter-end. It expected to redeem $285 of its 10.75% senior notes due 2016 in June 2011, using cash and revolver availability. Management estimated 2011 capital expenditures of approximately $100, excluding acquisitions, and expected cash income taxes of $7–$10 for the year.
Management maintained its full-year discharge-growth assumption of 2.5%–3.5%, excluding acquisitions. It cited organic growth, disciplined expansion, cost control and debt reduction as priorities, and said it expected strong operating cash flow to support these aims. A proposed FY2012 Medicare inpatient rehabilitation rule was preliminarily expected to have a net positive revenue impact; proposed changes to outpatient therapy reimbursement were estimated to reduce annual revenue by about $1.4. Medicare payment updates, healthcare reform and implementation of accountable-care arrangements remained uncertain.
Key risks include Medicare and other reimbursement changes, regulatory compliance, staffing availability and labor costs, weaker patient volumes, and integration or performance of acquired and newly opened hospitals. Litigation and contingencies include a $2.9 billion judgment against former CEO Richard Scrushy, upheld by Alabama’s Supreme Court; the company said collection timing and amount could not be predicted. It also reported 38 guarantees on leases of divested businesses, with a maximum potential payment of approximately $32.2, for which it had recorded no liability because performance was not considered probable. A $12.3 million patient-care verdict was under appeal, with a $7.7 million insurance-related receivable recorded. Management said there were no material changes to the 2010 Form 10-K risk factors, and that disclosure controls were effective.
Investor verification points
- Separate recurring operating performance from the Delaware settlement gain, discontinued operations and the favorable tax items when assessing earnings and EPS.
- Verify the outcome, timing and funding of the planned $285 million redemption, as well as debt balances, interest costs and revolver availability after the transaction.
- Track discharge growth, Medicare revenue per discharge, same-store trends and outpatient volumes against management’s 2.5%–3.5% full-year discharge outlook.
- Review the effects of final Medicare and outpatient reimbursement rules, and the recoverability of deferred tax assets and outstanding Medicare-denied receivables.
- Monitor collection prospects for the Scrushy judgment, the appeal of the patient-care verdict, and exposure under guarantees and other legal or divestiture-related contingencies.