EHC

Business Context and Reporting Period

Company: HealthSouth Corporation (Note: Request metadata listed "Encompass Health Corp," but the filing text identifies the registrant as HealthSouth Corporation).

Reporting Period: Fiscal year ended December 31, 2009.

Business Overview: HealthSouth is the nation's largest provider of inpatient rehabilitative healthcare services. As of December 31, 2009, the company operated 93 inpatient rehabilitation hospitals (including 3 joint ventures), 6 freestanding long-term acute care hospitals (LTCHs), 40 outpatient rehabilitation satellites, and 25 hospital-based home health agencies across 26 states and Puerto Rico. The company focuses on non-discretionary care for patients with conditions such as strokes, hip fractures, and neurological disorders.

Key Financial Metrics (2009)

Material Changes vs. Prior Period

• Revenue Growth: Net operating revenues increased 4.5% year-over-year, driven primarily by a 5.4% increase in inpatient discharges (112,975 discharges in 2009 vs. 107,184 in 2008). Same-store discharges grew 4.8%.
• Profitability Decline: Net income attributable to HealthSouth common shareholders dropped significantly from $226.4 million in 2008 to $68.8 million in 2009. This decline was largely due to the absence of a $121.3 million gain on the UBS Settlement recorded in 2008 and increased settlement expenses in 2009.
• Debt Reduction: The company reduced total debt outstanding by approximately $151 million in 2009. This was achieved through a refinancing transaction in December 2009 where $290 million of 8.125% Senior Notes due 2020 were issued to redeem $329.6 million of Floating Rate Senior Notes due 2014.
• Cash Flow Improvement: Operating cash flow increased 78.7% to $406.1 million, bolstered by $73.8 million in net cash proceeds from the UBS Settlement and $63.7 million in income tax refunds.
• Expense Management: Salaries and benefits as a percentage of revenue decreased to 49.6% in 2009 from 50.7% in 2008, attributed to improved retention rates and reduced contract labor costs.

Guidance, Outlook, and Risks

Outlook and Strategy: Management expects to continue deleveraging the balance sheet in 2010 while pursuing organic growth through increased market share and capacity expansions. The company anticipates strong cash flows to fund opportunistic expansion and debt reduction. No specific numerical guidance for 2010 revenue or earnings was provided in the text.

Key Risks and Contingencies:

• Regulatory and Reimbursement: The company faces significant risk from potential reductions in Medicare "market basket" updates and the potential implementation of "bundled" payment systems under healthcare reform legislation. A Medicare pricing "roll-back" was in effect from April 2008 through September 2009, though a 2.5% market basket update was implemented for fiscal year 2010.
• Legal Proceedings: The company remains a defendant in various lawsuits, including the Tucker derivative litigation against former CEO Richard M. Scrushy (where a $2.9 billion judgment was awarded but is under appeal and collection is uncertain) and arbitration with former auditor Ernst & Young.
• Staffing: Shortages of nurses and therapists in certain markets may require the use of more expensive temporary personnel, increasing labor costs.
• Debt Covenants: The company must maintain specific leverage and interest coverage ratios under its credit agreement. While compliant as of December 31, 2009, a severe downturn in earnings could impair compliance.

Investor Verification Checklist

• Debt Profile: Verify the specific terms of the new 8.125% Senior Notes due 2020 and the remaining maturity schedule of the term loan facility ($452 million due 2013, $299 million due 2015).
• Medicare Reimbursement: Monitor the final passage of healthcare reform legislation for potential reductions in market basket updates or changes to the Inpatient Rehabilitation Facility Prospective Payment System (IRF-PPS).
• Legal Settlements: Track the status of the $2.9 billion judgment against Richard M. Scrushy and the arbitration with Ernst & Young, as collection of these amounts is uncertain and could materially impact future cash flows.
• Discontinued Operations: Review the final disposition of assets held for sale, specifically the hospital in Baton Rouge, Louisiana, which was sold in January 2010.
• Staffing Costs: Monitor labor cost trends and turnover rates, as the company relies heavily on skilled clinical staff which is in short supply in many markets.