HealthSouth Corporation (2011 Q3 Form 10-Q)
Filing identity: The filing is under HealthSouth Corporation, for the quarter ended September 30, 2011. It describes the company as a major U.S. inpatient rehabilitation hospital operator.
Business context and reporting period
At quarter-end, HealthSouth operated 97 inpatient rehabilitation hospitals, 28 outpatient satellite clinics and 25 hospital-based home health agencies, and managed three inpatient rehabilitation units. The filing presents unaudited results for the three and nine months ended September 30, 2011, compared with 2010. Results for the 2010 periods were reclassified to show the long-term acute care hospitals (LTCHs) as discontinued operations.
Financial and operating metrics
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net operating revenues | $497.7m | $460.8m | $1,508.8m | $1,386.7m |
| Income from continuing operations | $33.6m | $38.7m | $138.3m | $142.1m |
| Net income attributable to HealthSouth | $57.0m | $31.8m | $158.7m | $119.8m |
| Adjusted EBITDA | $110.5m | $95.9m | $343.3m | $297.5m |
| Net cash provided by operating activities | Not provided for quarter | Not provided for quarter | $210.8m | $263.9m |
- Quarterly revenue rose 8.0%; nine-month revenue rose 8.8%. Hospital net patient revenue increased 8.6% and 9.1%, respectively, reflecting higher discharges and revenue per discharge.
- Q3 income from continuing operations fell 13.2%, while net income attributable to HealthSouth rose 79.2%. The latter included a $65.8m pretax gain on the sale of five LTCHs, reported in discontinued operations. Nine-month discontinued-operations income also included a $24.8m Delaware settlement gain.
- Q3 diluted EPS was $0.54, including $0.37 from discontinued operations; continuing-operations EPS was $0.17. Nine-month diluted EPS was $1.49, including $0.59 from discontinued operations; continuing-operations EPS was $0.90.
- Operating expenses were $410.3m in Q3 and $1,223.8m for nine months. The filing reports total operating expenses at 82.4% and 81.1% of revenue, respectively, versus 83.7% and 82.9% in 2010.
- Q3 operating margin, calculated as revenue less reported operating expenses divided by revenue, was about 17.6%, compared with 16.3% in Q3 2010. This calculation excludes interest, taxes and other items below operating expenses.
- Discharges increased 5.1% in Q3 and 6.3% year to date; same-store discharges grew 4.0% in both periods. Occupancy improved to 67.2% in Q3 from 66.0%. Outpatient visits declined to 236,969 from 253,837.
- Nine-month operating cash flow declined to $210.8m from $263.9m. Capital expenditures were $61.9m, compared with $48.8m. Cash and cash equivalents were $47.7m at September 30.
- Long-term debt, net of current portion, was $1,308.7m, down from $1,496.8m at year-end 2010. Total debt in the debt note, including current debt and capital leases, was $1,327.7m. Convertible perpetual preferred stock was $387.4m.
- Current assets were $410.4m and current liabilities $288.1m, for working capital of $122.3m and a current ratio of about 1.42. The company also reported $276m available under its revolving credit facility; restricted cash and marketable securities are not included in reported cash.
Material changes versus prior comparable periods
- Growth in patient volume and revenue, alongside expense discipline, lifted Adjusted EBITDA 15.2% in Q3 and 15.4% for the first nine months. Management reported operating earnings growth of 17.9% for Q3 and 20.9% year to date.
- Q3 continuing-operations income was lower despite higher pretax income, primarily reflecting a substantially higher income tax provision and debt-redemption charges. Nine-month interest expense increased 5.4%, while Q3 interest expense fell 14.6%.
- HealthSouth completed the sale of five LTCHs on August 1 for an amended aggregate purchase price of $117.5m; it closed the Houston LTCH in August and expected to sell its real estate. The sale generated $107.9m in cash proceeds and a $65.8m pretax gain.
- The company redeemed all $500.6m principal of its 10.75% Senior Notes due 2016 through June and September transactions. It recorded $38.8m of nine-month loss on early extinguishment of debt. Debt reduction and refinancing actions improved the stated maturity profile, with no significant maturities before 2016, according to management.
- Shareholders’ equity moved from a deficit of $2.2m at year-end 2010 to positive equity of $151.8m at September 30, 2011.
Outlook, management commentary, risks and unusual items
- Management cited continued demand for inpatient rehabilitation, demographic support and strong operating performance, but gave no specific full-year revenue, earnings or cash-flow guidance in the provided filing text. It expected approximately $90m of 2011 capital expenditures, excluding acquisitions; about $40m was described as discretionary.
- Management’s preliminary assessment of the FY2012 Medicare inpatient rehabilitation payment rule was a net increase of approximately 1.6% in its Medicare payment rates from October 1, 2011. It separately described a 2.9% market-basket update reduced by a 1.1% productivity adjustment under healthcare reform.
- Key reimbursement uncertainties included deficit-reduction proposals, possible Medicare payment cuts and a proposed increase in the IRF compliance threshold from 60% to 75%. The filing also flagged the possibility of a 27.4% cut to outpatient physician-fee-schedule payments from January 1, 2012 if Congress did not act on the sustainable growth rate formula.
- Medicare represented 72.0% of Q3 revenue and 71.8% of nine-month revenue. Management reported increased denials of certain Medicare diagnosis codes during the first half of 2011 and expected doubtful-account provisions as a percentage of revenue to rise in subsequent quarters as denied claims aged.
- An HHS-OIG subpoena received in June sought records concerning Houston LTCH admissions, lengths of stay and discharges in a possible Medicare and Medicaid claims investigation. The company said it was cooperating and could not predict the investigation’s timing or outcome.
- Other material contingencies included ongoing litigation and a $12.3m jury verdict under appeal, for which the company recorded a liability, partly offset by a $7.7m insurance receivable. HealthSouth also disclosed up to $26.2m of maximum exposure under 29 guarantees of sold-facility leases, for which it had not recorded a liability because it did not consider performance probable.
- In October 2011, after quarter-end, the board authorized up to $125m of common-stock repurchases. Any repurchases were discretionary and could be funded from cash and revolving-credit availability. Management said it might redirect planned growth spending toward debt repayment or buybacks amid reimbursement uncertainty.
- Deferred tax assets were $622.5m on the balance sheet, including $649.6m of net deferred tax assets described in the tax note when current amounts are included; the company maintained a valuation allowance of about $105m. Realization depends on future taxable income and other estimates.
Most important facts for investors to verify
- Separate recurring performance from discontinued operations: the LTCH sale gain and Delaware settlement materially boosted reported net income and EPS.
- Track Medicare denial trends, receivable aging and collection outcomes, since management expected doubtful-account provisions to increase.
- Assess exposure to Medicare and outpatient reimbursement changes, including deficit-reduction measures, compliance thresholds and congressional action on physician-fee payments.
- Review cash conversion and liquidity: nine-month operating cash flow fell year over year, and reported cash excludes substantial restricted balances.
- Monitor debt covenants, refinancing and capital allocation, including any use of the $276m revolver availability for repurchases or expansion.
- Follow the HHS-OIG inquiry, litigation, guarantees and the recoverability of deferred tax assets; outcomes or estimates may change.