HealthSouth Corporation (now Encompass Health) — Q2 2010 Form 10-Q
Reporting period: Three and six months ended June 30, 2010. The filing is in the name of HealthSouth Corporation. Unless stated otherwise, financial amounts are in millions of dollars.
Business context and reporting period
HealthSouth operated inpatient rehabilitation hospitals and long-term acute care hospitals, with outpatient clinics and hospital-based home health agencies. At June 30, it reported 95 inpatient rehabilitation hospitals, six freestanding long-term acute care hospitals, 38 outpatient satellite clinics, and 25 licensed hospital-based home health agencies. Medicare represented 69.6% of Q2 revenue and 70.0% for the first half.
The company acquired a 50-bed Las Vegas rehabilitation hospital on June 1 and opened a new 40-bed Virginia hospital to patients on June 14.
Financial results and liquidity
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Net operating revenue | $496.9 | $481.6 | $987.9 | $954.5 |
| Income from continuing operations | $57.4 | $2.3 | $111.0 | $58.5 |
| Net income attributable to HealthSouth common shareholders | $40.8 | $(12.0) | $75.0 | $26.4 |
| Basic and diluted EPS | $0.44 | $(0.14) | $0.81 | $0.30 |
| Adjusted Consolidated EBITDA | $103.7 | $94.0 | $210.1 | $192.4 |
Revenue increased 3.2% in Q2 and 3.5% year to date. Management cited higher inpatient revenue per discharge and increased discharges: Q2 discharges rose 2.2% to 29,016; first-half discharges rose 1.7% to 57,014. Inpatient revenue grew 4.3% in Q2 and 4.6% for the first half. Outpatient visits fell 9.0% in Q2 and 9.5% year to date.
Q2 operating expenses were $415.8, or 83.7% of revenue, versus $444.3, or 92.3%, a year earlier; the comparison benefited from the absence of prior-year settlement charges. Management-reported operating earnings were $73.5 for Q2 and $154.2 for the first half, versus $25.7 and $112.6, respectively, in 2009. Adjusted Consolidated EBITDA is a non-GAAP measure defined under the credit agreement.
First-half operating cash flow was $172.7, compared with $229.2 in 2009; investing cash outflow was $39.7 and financing cash outflow was $41.4. Cash increased $91.6 to $172.6. The prior-year operating cash flow included $73.8 of net UBS settlement proceeds and $54.0 of tax refunds; 2010 included $9.7 of prior-period state tax refunds.
At June 30, cash was $172.6, restricted cash $49.7, and current assets $503.9 versus current liabilities of $391.4. Total debt, including current maturities, was approximately $1,654.5, down from $1,662.5 at year-end 2009. Shareholders’ deficit was $817.3. The full $400 revolving credit facility was available, and the company reported compliance with its credit covenants. Scheduled debt principal payments were $10.8 for the remainder of 2010 and $21.2 for 2011.
Material changes versus prior comparable periods
- Common-shareholder earnings improved substantially, partly because 2009 included government, class-action, and related settlement charges of $48.7 in Q2 and $32.8 for the first half. These were not repeated in 2010.
- First-half adjusted EBITDA rose to $210.1 from $192.4, while operating cash flow declined, in part because of prior-year settlement proceeds and tax refunds.
- Other operating expenses increased 14.3% in Q2, including a $4.6 net charge tied to a malpractice verdict and a $2.9 increase in professional and general liability reserves. Salaries and benefits grew more slowly than revenue, and doubtful-account provisions declined.
- The Medicare share of revenue increased, while outpatient revenue and visits declined. Occupancy fell to 67.4% in Q2 from 69.4%, partly reflecting 230 newly licensed beds.
Outlook, risks, contingencies, and unusual items
- Outlook: No specific revenue or EPS forecast was provided. Management prioritized deleveraging, organic growth, cost-effective care, disciplined expansion, and adapting to regulation. It expected approximately $110 of 2010 capital expenditures, including about $60 considered discretionary, and said expenses could temporarily outpace revenue as new and acquired hospitals ramped up.
- Reimbursement and regulation: Healthcare reform reduced the 2010 Medicare market-basket update from 2.5% to 2.25%; similar reductions are scheduled through 2019, with a productivity adjustment beginning in 2011. Management’s preliminary assessment was that the FY2011 IRF payment rule would have a net positive revenue effect. A proposed outpatient therapy rule could reduce annual revenue by approximately $4; other proposed physician-fee changes could add an estimated $6 annual reduction if not offset by Congress.
- Legal and insurance matters: A July 30, 2010 jury verdict awarded $12.3 in a patient-care case. The company recorded a $12.3 liability and a $7.7 expected insurance recovery, for a $4.6 net charge, and said it would appeal. The company also disclosed $42.7 maximum exposure under 58 lease guarantees, for which it had not recorded a liability because performance was not considered probable.
- Significant litigation: A $2.9 billion judgment against former CEO Richard Scrushy was on appeal; no recovery was recorded and collectability was uncertain. United’s arbitration demands totaled $9.5 after certain claims were dismissed; the company had recorded an estimate of potential liability, but the filing does not state its amount. Other proceedings include a General Medicine appeal and confidential arbitration with former auditor Ernst & Young; potential exposure in these matters could not be estimated.
- Tax and accounting: A valuation allowance of approximately $888 covered deferred tax assets; gross unrecognized tax benefits were $45.4 at June 30. The filing disclosed a 2009 out-of-period adjustment that increased reported pretax income by approximately $4.9 for Q2 and $4.5 for the first half; management said it was not material and did not restate prior periods. The filing also noted a $0.6 impairment in discontinued operations.
- Other developments: The company completed its five-year Corporate Integrity Agreement with HHS-OIG in May 2010. Management reported disclosure controls were effective and no material quarterly change in internal controls.
Most important facts for investors to verify
- Whether inpatient discharge growth and higher revenue per discharge can offset continued outpatient volume declines and Medicare payment reductions.
- Cash-flow durability after adjusting for timing effects and prior-period settlement and tax receipts, and progress in reducing approximately $1.65 billion of debt.
- Actual financial effects of the 2011 IRF and physician-fee rules, including any Congressional action on proposed payment changes.
- Outcome and potential cash exposure from the patient-care verdict, United arbitration, General Medicine litigation, Scrushy appeal, and lease guarantees.
- Whether the tax valuation allowance, uncertain tax positions, and estimated insurance recoveries change materially.