HealthSouth Corporation (now Encompass Health) — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013; unaudited. HealthSouth operated inpatient rehabilitation hospitals and related outpatient services. At June 30, it operated 103 inpatient rehabilitation hospitals, including two equity-method joint ventures. Dollar amounts below are in millions unless stated otherwise.
Financial results
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net operating revenue | $564.5 | $533.4 | $1,137.1 | $1,072.0 |
| Income from continuing operations before tax | $92.4 | $83.3 | $192.2 | $169.6 |
| Income tax benefit (expense) | $86.5 | ($26.9) | $53.0 | ($56.0) |
| Net income attributable to HealthSouth | $165.2 | $46.7 | $216.5 | $90.9 |
| Basic / diluted EPS | $1.85 / $1.66 | $0.43 / $0.43 | $2.28 / $2.09 | $0.82 / $0.82 |
| Adjusted EBITDA (non-GAAP) | $134.5 | $125.1 | $273.8 | $252.1 |
- Revenue grew 5.8% in Q2 and 6.1% in the first half. Inpatient hospital revenue increased 6.5% and 6.9%, respectively, reflecting discharge growth of 6.3% and 5.2%; outpatient and other revenue declined.
- Q2 operating expenses were $445.9, versus $424.1; first-half expenses were $890.7, versus $851.0. Calculated operating margin after doubtful-account provision was about 20.0% in Q2 versus 19.5% a year earlier, and 20.7% for the first half versus 19.7%.
- Reported earnings were materially lifted by the IRS settlement: the company recorded an approximately $115 million net income tax benefit in Q2, primarily from an increase to its federal NOL. The reported tax benefit was $86.5 million for Q2 and $53.0 million for the first half. Thus, net income and EPS growth do not represent operating growth alone.
- First-half operating cash flow was $226.8, up from $195.0. Investing cash use was $101.4; financing cash use was $189.5, principally reflecting the $234.1 common-stock tender offer. Cash declined by $64.1 to $68.7.
- At June 30, cash was $68.7; current assets were $591.5 and current liabilities $311.6. Long-term debt, net of current portion, was $1,319.7; total debt including current maturities was approximately $1,330.7. Revolver availability was $491.1. The company reported compliance with credit covenants and no significant debt maturities before 2018.
Changes, outlook and notable developments
- Discharge growth and higher patient acuity supported revenue; Medicare represented 74.6% of revenue. Management estimated sequestration reduced Adjusted EBITDA by about $8 million in Q2 and $9 million in the first half, and estimated a roughly $28 million net revenue impact for 2013.
- Management described the outlook as reasonably positive, citing demographic demand and its market position, while emphasizing reimbursement, regulation and staffing challenges. There is no specific earnings forecast in the provided filing text. Estimated 2013 capital expenditures were reduced to $165–$195 million, excluding acquisitions and leased-property purchases.
- Growth activity included the April acquisition of a 58-bed Augusta, Georgia hospital for $28.9 million, opening new hospitals in Colorado and Florida, and ongoing development projects. The acquired hospital contributed $2.7 million of revenue and a $1.2 million loss attributable to HealthSouth through June 30.
- The first-quarter tender offer repurchased approximately 9.1 million shares for $234.1 million. On July 25, the board approved a quarterly common dividend of $0.18 per share, with the first payment scheduled for October 2013. The board also authorized, but did not necessarily exercise, optional redemption of 10% of two senior-note issues.
- Key risks include Medicare reimbursement cuts and potential payment reforms, including proposals concerning the 60% rule and site-neutral payments; dependence on Medicare; labor availability and costs; and compliance and litigation exposure. HHS-OIG investigations concern Medicare/Medicaid claims at a closed facility and four hospitals; outcomes and timing were unknown. Several legacy lawsuits remain pending, and the company said potential loss estimates were not possible in certain matters.
- Other unusual items: a $2.0 million settlement recovery reduced operating expenses. The Sulton case was settled for a nonmaterial amount. The company expected approximately $10–$12 million from a property-sale arrangement in Q3 2013, with the gain to be deferred and amortized over five years.
Investor verification priorities
- Separate recurring operating performance from the large IRS-related tax benefit when assessing earnings and EPS.
- Track Medicare sequestration and proposed reimbursement rules, including the reported 60% rule and site-neutral payment proposals.
- Review cash usage and leverage after the tender offer, new dividend, planned property purchases and any senior-note redemption; the filing does not provide a specific leverage-ratio value.
- Monitor HHS-OIG investigations and material litigation developments, including potential financial exposure that the company said could not be estimated.
- Confirm execution, costs and returns from new hospitals, acquisitions, and the revised capital expenditure plan.