Business context and reporting period
HealthSouth Corporation’s unaudited Form 10-Q covers the quarter and nine months ended September 30, 2016. The company provided post-acute care through inpatient rehabilitation hospitals and home health and hospice services in 34 states and Puerto Rico. Results include the acquisitions of Reliant (October 2015) and CareSouth (November 2015); the filing attributes much of the year-over-year growth to these additions.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net operating revenues | $926.8 million | $778.6 million | $2,757.3 million | $2,283.6 million |
| Income from continuing operations | $78.2 million | $67.5 million | $236.3 million | $188.6 million |
| Net income attributable to HealthSouth | $61.7 million | $50.7 million | $182.3 million | $136.1 million |
| Diluted EPS | $0.64 | $0.52 | $1.90 | $1.41 |
| Adjusted EBITDA | $198.4 million | $165.4 million | $594.8 million | $491.0 million |
- Revenue increased 19.0% in Q3 and 20.7% year to date. Q3 revenue growth reflected 12.6% more inpatient rehabilitation discharges and 2.9% higher net revenue per discharge; home health and hospice revenue rose 37.9%, including 50.7% more home health admissions, partly offset by a 2.9% decline in revenue per episode.
- Q3 segment Adjusted EBITDA was $198.6 million for inpatient rehabilitation, up 19.5%, and $25.8 million for home health and hospice, up 24.6%. Consolidated Adjusted EBITDA is a non-GAAP measure.
- For the nine months, net cash from operating activities was $489.5 million versus $368.2 million; investing cash outflow was $156.3 million versus $179.4 million; financing cash outflow was $318.4 million versus $546.1 million. Cash rose by $14.8 million to $76.4 million.
- At September 30, 2016, total debt carrying value was $3,010.8 million, including $150.0 million drawn on the revolving facility; long-term debt net of current portion was $2,974.0 million. Cash was $76.4 million, and reported revolver availability was approximately $417 million. Restricted cash and marketable securities were not freely available for general purposes.
- Current assets were $666.0 million and current liabilities $476.0 million. The filing reported compliance with credit-agreement leverage and interest-coverage covenants. No significant debt maturities were expected before 2020.
- Cash dividends were $0.24 per share in Q3, increased from $0.23; the board declared another $0.24 dividend for January 2017. The company repurchased approximately $22 million of shares in the first half of 2016.
Material changes versus the prior comparable period
- Net income attributable to HealthSouth rose 21.7% in Q3 and 33.9% for the nine months. Growth was chiefly acquisition- and volume-driven; operating costs also increased, including salaries, depreciation and occupancy.
- Provision for doubtful accounts increased to $14.8 million in Q3 from $10.7 million and to $46.7 million year to date from $33.2 million. Management linked the increase to aging-based reserves amid administrative payment delays at its largest Medicare Administrative Contractor.
- Interest expense increased 19.4% in Q3 and 32.8% year to date, largely due to higher average borrowings associated with the Reliant and CareSouth acquisitions.
- The company redeemed the remaining $176 million principal of its 7.75% notes due 2022 in 2016, recording $7.4 million of early-extinguishment losses year to date. Debt declined from $3,171.5 million at December 31, 2015 to $3,010.8 million.
Outlook, commentary, risks and unusual items
- Management described its outlook as positive, citing aging demographics, demand for post-acute care, operational scale and growth opportunities. It planned to pursue organic growth, hospital development and acquisitions, while using some free cash flow for debt reduction over time. No specific full-year revenue or earnings guidance is stated in the provided filing text.
- Management estimated 2016 capital expenditures of $185 million to $225 million, of which $95 million to $105 million were considered nondiscretionary. It estimated that the 2017 IRF payment rule would increase its Medicare rates approximately 1.9%, before sequestration. Based on a proposed home-health rule, it expected a 3%–4% decrease in Encompass Medicare payment rates in 2017; the rule was not final.
- Key exposures include Medicare and other reimbursement changes, payment audits and delays, staffing costs and availability, regulatory compliance, competition, integration and execution risks, and changes to coordinated-care and bundled-payment models. Medicare represented 75.0% of nine-month revenue.
- CMS delayed the start of home-health pre-claim review demonstrations in Florida, Texas and Massachusetts; management expected added administrative expense and possible temporary receivable and cash-flow pressure. The filing also discusses DOJ subpoenas and an ongoing investigation into alleged improper Medicare and Medicaid claims, whose timing and outcome management could not predict.
- In the Honts matter, a jury awarded $20.0 million; the company appealed and posted a bond. At quarter-end it recorded a $21.0 million liability and a $15.0 million insurance-related receivable, with an additional $5.7 million net charge for the nine months. The Nichols case dismissal was appealed; management said an adverse outcome was not probable and loss was not estimable.
- The company filed a non-automatic tax accounting method change awaiting IRS acceptance; if accepted as filed, it anticipated approximately $50 million of additional tax benefits through September 30, 2016. This was contingent, not recorded as a stated realized benefit.
- Other notable items include a $7.4 million year-to-date debt-extinguishment loss and a $5.7 million net Honts litigation charge. Management cited a 2.75% merit increase for nonmanagement hospital employees effective October 1, 2016.
Most important facts for investors to verify
- How much of reported revenue and EBITDA growth reflects acquisitions versus same-store performance, and whether integration costs or new-site ramp-up affect future margins.
- Whether Medicare claim delays and denials ease, and how doubtful-account provisions, receivables and operating cash flow respond.
- Final 2017 home-health reimbursement and pre-claim review requirements, alongside the realized impact of the IRF rate update.
- Progress on debt reduction, covenant headroom, revolver availability, capital spending and the sustainability of dividends and buybacks.
- Developments in the Honts appeal, DOJ investigation and pending IRS tax-method request, including any changes to recorded liabilities or expected benefits.