Encompass Health Corp. (filed as HealthSouth Corporation) — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012. The filing identifies the registrant as HealthSouth Corporation; the supplied company metadata uses Encompass Health Corp.
Business context
HealthSouth operated inpatient rehabilitation hospitals and provided inpatient and outpatient rehabilitation services. At June 30, 2012, it reported 99 inpatient rehabilitation hospitals, 26 outpatient satellite clinics, and 25 hospital-based home health agencies. Medicare accounted for 72.9% of Q2 revenue and 73.3% for the first half.
Financial performance and position
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Net operating revenue | $533.4 million | $505.1 million | $1,072.0 million | $1,011.1 million |
| Revenue after doubtful-account provision | $526.9 million | $500.1 million | $1,059.2 million | $1,001.3 million |
| Income from continuing operations | $56.4 million | $30.7 million | $113.6 million | $104.7 million |
| Net income attributable to HealthSouth | $46.7 million | $21.9 million | $90.9 million | $101.7 million |
| Net income attributable to common shareholders | $40.4 million | $15.4 million | $77.7 million | $88.7 million |
| Basic and diluted EPS | $0.43 | $0.17 | $0.82 | $0.95 |
| Adjusted EBITDA (non-GAAP) | $125.1 million | $115.3 million | $252.1 million | $232.8 million |
- Q2 discharges rose 3.0%, net patient revenue per discharge rose 3.2%, and inpatient net patient revenue increased 6.4%. For the first half, these measures rose 4.5%, 2.7%, and 7.3%, respectively. Outpatient visits declined 6.3% in Q2 and 4.4% for the first half.
- Operating expenses were 79.5% of net operating revenue in Q2 and 79.4% for the first half, compared with 79.4% and 79.5%, respectively, in 2011.
- Operating cash flow was $195.0 million for the first half, versus $158.1 million. Capital expenditures and capitalized software totaled $94.4 million; investing cash outflow was $88.3 million.
- Cash and equivalents were $41.1 million at June 30, excluding $30.7 million of restricted cash and $50.5 million of restricted marketable securities. The company reported approximately $357 million available under its revolver and compliance with its credit covenants.
- Long-term debt, net of current portion, was $1,219.4 million, down from $1,235.8 million at year-end 2011. Current assets were $424.5 million and current liabilities $324.6 million.
Changes, outlook, and management commentary
- Revenue growth reflected higher discharges and revenue per discharge, including pricing adjustments and higher patient acuity. Management cited improved operating leverage and labor productivity. Salary and benefit costs rose 6.5% in Q2 and 6.8% for the first half.
- Q2 income from continuing operations improved substantially year over year. For the first half, net income attributable to HealthSouth declined, largely against a prior-year comparison that included a $24.8 million discontinued-operations gain from a Delaware settlement; 2011 also included a $26.1 million debt-extinguishment loss and a $10.6 million settlement gain in operating expenses.
- Interest expense declined 34.1% in Q2 and 33.9% for the first half, reflecting lower average borrowings and interest rates. The company repurchased 46,645 preferred shares for $46.5 million in the first half; no common-stock repurchases were made under the announced program.
- Management raised its 2012 capital expenditure estimate to approximately $155–$190 million, excluding acquisitions, from $145–$180 million. It planned continued investment in hospital development, capacity, facility refreshes, and clinical information technology, while retaining the option to repurchase securities or reduce debt.
- Management estimated the Medicare sequestration reduction could lower annual revenue by approximately $32 million beginning in 2013. The FY2013 inpatient rehabilitation payment rule was expected to increase Medicare rates approximately 2.1% from October 1, 2012, before sequestration. A possible 26% outpatient physician-fee reduction could reduce annual revenue by approximately $8 million if Congress did not extend or change the formula.
- Key risks include Medicare and other reimbursement changes, regulation and compliance costs, staffing availability and labor costs, referral volumes, collection and Medicare claim-denial uncertainty, and litigation. Management cited favorable long-term demand demographics, strong operating cash flows, and no significant debt maturities before 2016.
Contingencies and unusual items
- The company recorded a $12.3 million liability for a South Carolina jury verdict, with a $7.7 million insurance receivable; the appeal was pending.
- General Medicine litigation resumed after an appellate court reinstated a $376 million consent judgment against former subsidiary Horizon/CMS. HealthSouth disputed liability and stated an adverse judgment or settlement was not probable; it could not estimate a potential loss.
- Fourteen lease guarantees had a maximum potential payment of approximately $20.5 million; no liability was recorded because performance was not considered probable.
- Gross unrecognized tax benefits rose to $79.5 million from $6.0 million at year-end, primarily in connection with efforts to establish additional federal tax benefits. The IRS approved the company’s request to use a pre-filing agreement process in July; the potential impact was not estimable and could be materially favorable.
- An HHS-OIG investigation involving a closed long-term acute care hospital remained ongoing; the company said it was cooperating and could not predict the outcome.
Important facts for investors to verify
- Confirm the registrant identity and any relationship between HealthSouth Corporation in this filing and the Encompass Health Corp. named in the request.
- Track actual Medicare reimbursement changes, sequestration implementation, outpatient payment policy, and their effect on revenue and margins.
- Monitor discharge growth, revenue per discharge, outpatient volumes, doubtful-account provisions, and labor costs against management’s commentary.
- Review the capital expenditure program, revolver availability, debt and covenant headroom, and preferred-stock repurchases.
- Follow the General Medicine and South Carolina cases, the HHS-OIG investigation, and developments in the IRS tax-benefit process; outcomes and potential financial effects remain uncertain.