Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 2008, for HealthSouth Corporation (noting the metadata reference to Encompass Health Corp, the filing text identifies the registrant as HealthSouth Corporation). The Company is the largest provider of inpatient rehabilitation services in the United States, operating 93 inpatient rehabilitation hospitals, 6 long-term acute care hospitals, and various outpatient facilities. The reporting period includes the impact of a Medicare pricing "roll-back" effective April 1, 2008, and the Company's continued focus on deleveraging its balance sheet.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2008 | Nine Months Ended Sep 30, 2008 | Nine Months Ended Sep 30, 2007 |
|---|---|---|---|
| Net Operating Revenues | $456.2 million | $1,378.6 million | $1,302.9 million |
| Net Income | $6.6 million | $70.5 million | $699.2 million |
| Net Income Available to Common Shareholders | $0.1 million | $51.0 million | $679.7 million |
| Operating Expenses | $416.0 million | $1,173.4 million | $1,159.7 million |
| Interest Expense | $40.4 million | $131.3 million | $177.9 million |
| Cash from Operating Activities | N/A | $149.3 million | ($139.1 million) |
| Total Debt (Long-term + Current) | $1,876.8 million | $1,876.8 million | $2,042.7 million |
| Cash and Cash Equivalents | $24.9 million | $24.9 million | $19.8 million |
Note: Net Income for the nine months ended Sep 30, 2007, was significantly inflated by gains from discontinued operations ($473.7 million) related to the divestiture of surgery centers, outpatient, and diagnostic divisions.
Material Changes vs. Prior Period
- Revenue Growth: Net operating revenues increased 6.5% quarter-over-quarter and 5.8% year-over-year (nine months), driven by an 8.1% increase in same-store patient discharges and the "TeamWorks" operational initiative.
- Profitability Decline: Net income dropped 97.7% quarter-over-quarter and 89.9% year-over-year. This decline is primarily due to the absence of significant one-time gains from discontinued operations recorded in 2007, rather than a deterioration in core operating performance.
- Debt Reduction: The Company reduced total debt by approximately $208 million since December 31, 2007. This was achieved through the sale of the corporate campus, a $150 million equity offering in June 2008, and the use of a $46 million federal income tax refund received in October 2008.
- Expense Management: Interest expense decreased 32.9% quarter-over-quarter due to lower average borrowings and interest rates. Professional fees decreased 56.5% quarter-over-quarter.
- Discontinued Operations: The Company reclassified one hospital and one gamma knife center as discontinued operations in Q3 2008. Results from discontinued operations showed a loss of $2.8 million for the quarter, compared to income of $37.5 million in the prior year quarter.
Guidance, Outlook, and Risks
- Strategic Focus: Management's primary objective remains debt reduction and deleveraging. The Company plans to use proceeds from a pending settlement with UBS (estimated at $100 million) to further reduce long-term debt.
- Operational Outlook: The Company expects minimal impact from the global economic downturn on its core inpatient business, as the majority of patients have non-discretionary medical needs. However, outpatient services (less than 10% of revenue) may face some pressure.
- Regulatory Environment: The Company is navigating a Medicare pricing "roll-back" effective April 1, 2008, through September 30, 2009. While this reduces revenue per discharge, the stabilization of the "75% Rule" at a 60% compliance threshold is expected to support volume growth.
- Liquidity and Covenants: As of September 30, 2008, the Company was in compliance with its Credit Agreement covenants (leverage and interest coverage ratios). The Company maintains approximately $309 million in availability under its revolving credit facility.
- Legal Contingencies: Significant ongoing litigation includes the securities class action settlement (liability adjusted quarterly based on stock price), derivative litigation against former auditor Ernst & Young and investment bank UBS, and a dispute with General Medicine regarding a prior subsidiary. The Company has recorded a $131.2 million liability for the securities litigation settlement as of September 30, 2008.
Investor Verification Checklist
- Debt Covenants: Verify continued compliance with the leverage and interest coverage ratios in the Credit Agreement, especially given the high debt load ($1.88 billion) and potential interest rate volatility.
- Discontinued Operations: Confirm the finalization of the divestiture of the remaining surgery center facility in Illinois and the associated deferred proceeds ($26.5 million).
- Legal Settlements: Monitor the status of the UBS settlement (agreement in principle reached Oct 2008) and the securities litigation settlement distribution, as these impact cash flow and liability valuations.
- Medicare Reimbursement: Track the impact of the 2007 Medicare Act pricing roll-back on net patient revenue per discharge versus volume growth.
- Staffing Costs: Review trends in "Salaries and benefits" as a percentage of revenue, given the industry-wide shortage of physical therapists and the Company's recent benefit enhancements.