Business context and reporting period
HealthSouth Corporation’s unaudited Form 10-Q covers the quarter and six months ended June 30, 2011. The registrant was named HealthSouth Corporation in the filing. It operated 97 inpatient rehabilitation hospitals, along with outpatient clinics and hospital-based home health agencies. Results for the 2010 comparison periods were reclassified to present long-term acute care hospitals (LTCHs) as discontinued operations.
Financial performance and liquidity
Amounts are in millions except per-share data and operating statistics.
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net operating revenues | $505.1 | $467.3 | $1,011.1 | $925.9 |
| Income from continuing operations | $30.7 | $54.2 | $104.7 | $103.4 |
| Net income attributable to HealthSouth | $21.9 | $47.3 | $101.7 | $88.0 |
| Net income attributable to common shareholders | $15.4 | $40.8 | $88.7 | $75.0 |
| Basic and diluted EPS | $0.17 | $0.44 | $0.95 | $0.81 |
| Adjusted EBITDA | $115.3 | $100.4 | $232.8 | $201.6 |
- Revenue increased 8.1% in Q2 and 9.2% for the first half. Hospital discharges rose 6.1% and 6.9%, respectively; revenue per discharge increased 2.6% and 2.3%.
- As-reported operating expenses were 80.4% of revenue in Q2 versus 83.1% a year earlier, and 80.5% versus 82.5% for the half year. Q2 operating earnings increased 27.8%, according to management; this measure includes a $10.6 million settlement-related gain.
- Q2 continuing income fell despite revenue growth, notably reflecting a $26.1 million loss on early debt extinguishment and higher interest expense. Six-month results also benefited from a $24.8 million Delaware settlement gain recorded in discontinued operations and tax benefits from IRS and other tax settlements.
- Operating cash flow was $156.9 million for the first half, versus $173.1 million in 2010; investing cash use was $49.2 million and financing cash use was $95.8 million. Cash increased $11.9 million to $60.3 million.
- At June 30, total debt was $1,458.5 million before current-portion presentation (long-term debt net of current portion was $1,440.1 million), versus $1,511.3 million at year-end 2010. Current assets were $428.5 million and current liabilities $319.1 million. The company reported $312 million available on its $500 million revolving facility and compliance with its leverage and interest-coverage covenants.
- Shareholders’ equity was $96.6 million, compared with a $2.2 million deficit at December 31, 2010. Restricted cash and marketable securities of $76.9 million were excluded from reported cash and were not described as freely available liquidity.
Material changes and outlook
- In June, HealthSouth redeemed $335 million principal of 10.75% Senior Notes due 2016 at a premium, using cash, a $150 million revolver draw, a $100 million term loan, and bond-offering proceeds. It recorded a $26.1 million extinguishment loss and expected another approximately $13 million loss upon redeeming the remaining notes in Q3.
- On August 1, 2011, after the quarter, the company completed the sale of five LTCHs and related locations for approximately $117.5 million. It expected a Q3 pretax gain of $63–$68 million. The Houston LTCH was removed from the sale agreement; the company expected to close it and sell its real estate in Q3, and noted possible impairment charges.
- Management maintained a second-half 2011 discharge-growth assumption of 2.5%–3.5%, excluding acquisitions, and targeted four to six new hospitals annually beginning in 2012. Expected 2011 capital expenditures were approximately $100 million, excluding acquisitions.
- Management estimated that the FY2012 inpatient rehabilitation payment rule would produce an approximately 1.6% net increase in Medicare payment rates beginning October 1, 2011. The company highlighted ongoing reimbursement uncertainty, including productivity adjustments and possible federal deficit-related Medicare cuts. It also warned that outpatient physician-fee payments could fall approximately 29.5% in 2012 absent Congressional action.
- Medicare represented 72.0% of Q2 revenue. Other stated challenges include staffing and labor costs, claim denials and collection delays, healthcare regulation, and the impact of healthcare reform. The company planned company-wide implementation of a Cerner clinical information system beginning in 2012.
Risks, contingencies and unusual items
- HealthSouth received an HHS-OIG document subpoena in June concerning possible improper Medicare and Medicaid claims at the Houston LTCH. It was cooperating and could not predict the outcome.
- The company reported a $12.3 million jury verdict in the Sulton professional-liability case, which it was appealing; it had recorded the liability and a $7.7 million insurance receivable.
- HealthSouth was pursuing collection of a $2.9 billion judgment against former CEO Richard Scrushy. It recorded a $10.6 million net gain from an initial distribution, but stated that the timing and extent of further collection were uncertain; a U.S. Supreme Court petition was pending.
- Potential maximum exposure on 35 guarantees of lease obligations associated primarily with divested businesses was approximately $29.2 million; no liability was recorded because performance was not considered probable. Other litigation, possible undisclosed qui tam claims, and indemnification obligations from past divestitures also remain risks.
- Cash taxes were $4.2 million for the first half; management estimated annual cash income taxes of approximately $5–$8 million, while noting dependence on tax attributes and future taxable income.
Key facts investors should verify
- Whether debt reduction and the remaining 10.75% note redemption proceeded as planned, including the cash cost and extinguishment charge.
- The final proceeds, working-capital treatment, and realized gain from the five-LTCH sale, plus the Houston facility’s closure, property sale, and any impairment.
- Trends in discharges, revenue per discharge, staffing expense, Medicare denials, and cash conversion relative to management’s growth assumptions.
- Any developments in Medicare reimbursement, federal deficit measures, outpatient fee reductions, and the Houston OIG investigation.
- Changes in liquidity, revolver availability, covenant headroom, and the realization of deferred tax assets and NOLs.
- Updates on the Scrushy judgment collection and material litigation, including the Sulton appeal and the potential exposure from guarantees and divestiture indemnities.