Business context and reporting period
HealthSouth Corporation’s Form 10-K covers the fiscal year ended December 31, 2014; it also reports fourth-quarter results. The company operated 107 inpatient rehabilitation hospitals and acquired Encompass Home Health and Hospice on December 31, 2014. Because the acquisition closed on the final day of the year, Encompass’s 2014 revenue and operating results are not included in HealthSouth’s consolidated results.
Financial and operating performance
| Metric | 2014 | 2013 | Change |
|---|---|---|---|
| Net operating revenue | $2,405.9 million | $2,273.2 million | +5.8% |
| Income from continuing operations | $276.2 million | $382.5 million | -27.8% |
| Net income attributable to HealthSouth | $222.0 million | $323.6 million | -31.4% |
| Diluted earnings per share | $2.29 | $2.58 | Down |
| Operating earnings (company-defined) | $418.4 million | $435.7 million | Down |
| Adjusted EBITDA (non-GAAP) | $577.6 million | $551.6 million | Up |
| Cash provided by operations | $444.9 million | $470.3 million | Down |
Fourth-quarter 2014 net operating revenue was $613.4 million, operating earnings were $96.5 million, and net income attributable to HealthSouth was $42.1 million. The filing reports fourth-quarter 2013 figures of $572.1 million, $106.9 million, and $48.9 million, respectively.
- Hospital discharges rose 3.5%; same-store discharges increased 1.3%. Inpatient net patient revenue per discharge rose 3.1%. Outpatient visits fell 8.4%.
- Operating expenses were 79.3% of net operating revenue, compared with 77.6% in 2013. Salaries and benefits remained the largest expense category.
- The 2014 income-tax provision was $110.7 million, versus $12.7 million in 2013. The prior year included an approximately $115 million benefit from an IRS settlement; 2014 tax expense also included substantial deferred tax expense. Cash income taxes, net of refunds, were approximately $16 million.
- At year-end, cash was $66.7 million, working capital was $322.3 million, and total assets were $3.409 billion. Long-term debt including current maturities was $2.132 billion, including $86.7 million of capital lease obligations. Approximately $243 million was available under the revolving credit facility.
- Capital expenditures were approximately $188 million. Management expected 2015 capital expenditures of $190 million to $240 million, including $30 million to $40 million for home health and hospice agencies.
Material changes versus prior period
Revenue growth reflected higher discharges, increased revenue per discharge, new hospital capacity, and consolidation of Fairlawn. Reported earnings fell despite revenue and Adjusted EBITDA growth, principally because 2013 benefited from the IRS tax settlement. The 2014 comparison also reflected higher interest and depreciation, lower favorable self-insurance reserve adjustments, $9.3 million of Encompass transaction costs, and a $13.2 million debt-extinguishment loss. A $27.2 million gain from consolidating Fairlawn partly offset these items.
Encompass added a new growth platform but increased leverage: the acquisition’s stated cash consideration was $695.5 million, funded with revolving and term-loan borrowings; management sellers rolled approximately $64.5 million of equity into the subsidiary. The preliminary purchase-price allocation included $592.5 million of goodwill and was subject to measurement-period adjustments.
Outlook, risks and unusual items
- Management described its outlook as positive, citing aging demographics, demand for post-acute care, and opportunities to expand through hospital development and home health and hospice acquisitions. No specific consolidated earnings guidance was provided in the filing.
- For 2015, management estimated Medicare payment rates would rise about 2.3% for inpatient rehabilitation before sequestration, while Encompass home health rates were expected to decline about 1.3% before sequestration. Medicare sequestration continued to reduce payments by 2%.
- Management estimated a potential outpatient revenue reduction of approximately $2.9 million annually if a scheduled physician-fee reduction took effect in April 2015 without congressional relief.
- Key risks include heavy Medicare dependence, reimbursement cuts and changing post-acute payment models, medical-necessity audits and delayed appeals, labor shortages and wage inflation, and integration and performance risks from Encompass. Medicare accounted for 74.1% of 2014 revenue before Encompass results.
- The DOJ was investigating alleged improper or fraudulent claims involving pre- and post-admission practices at HealthSouth hospitals. The company had received subpoenas relating to 11 hospitals and agreed to provide additional patient records; it said the investigation’s timing and outcome could not be predicted.
- Other litigation included the General Medicine action, scheduled for retrial in March 2015; the company said an adverse outcome was not probable and the loss could not be estimated. The filing also describes possible undisclosed qui tam claims.
- Cash from operations declined as receivables grew amid Medicare claim denials and administrative appeal delays. Patient accounts receivable subject to MAC prepayment medical-necessity review were $62.2 million at year-end, versus $22.5 million a year earlier.
- The company reported compliance with its credit-agreement financial covenants at year-end and no significant debt maturities before 2019. Its 2014 financial statements received an unqualified audit opinion, and management reported effective internal control; Encompass, acquired on year-end, was excluded from the control assessment.
Important facts for investors to verify
- Whether Encompass integration, operating performance, and purchase accounting support the expected growth and returns, and how the new home health and hospice segment performs in 2015.
- How Medicare denials, appeals, and collections affect receivables and operating cash flow, and whether reserve assumptions remain appropriate.
- Debt, revolver availability, covenant headroom, and the effect of acquisition financing and subsequent refinancing on interest expense and leverage.
- Developments in the DOJ investigation, Medicare audit exposure, and the General Medicine litigation, including any changes in estimated contingencies.
- Actual reimbursement changes, sequestration, and any outpatient payment reductions compared with management’s stated estimates.