The following Management's Discussion and Analysis of Financial Condition and
Results of Operations ("MD&A") relates to HealthSouth Corporation and its
subsidiaries and should be read in conjunction with our condensed consolidated
financial statements included under Part I, Item 1, Financial Statements
(Unaudited), of this report and our audited consolidated financial statements
for the year ended December 31, 2011 and Management's Discussion and Analysis of
Financial Condition and Results of Operations which are included in our Annual
Report on Form 10-K for the year ended December 31, 2011 (the "2011 Form 10-K").
As used in this report, the terms "HealthSouth," "we," "our," "us," and the
"Company" refer to HealthSouth Corporation and its subsidiaries, unless
otherwise stated or indicated by context.
This MD&A is designed to provide the reader with information that will assist in
understanding our condensed consolidated financial statements, the changes in
certain key items in those financial statements from period to period, and the
primary factors that accounted for those changes, as well as how certain
accounting principles affect our condensed consolidated financial statements.
See "Cautionary Statements Regarding Forward-Looking Statements" on page ii of
this report for a description of important factors that could cause actual
results to differ from expected results. See also Item 1A, Risk Factors, to the
2011 Form 10-K.
Executive Overview
Our Business
We operate inpatient rehabilitation hospitals and provide specialized
rehabilitative treatment on both an inpatient and outpatient basis. As of
June 30, 2012, we operated 99 inpatient rehabilitation hospitals (including 3
hospitals that operate as joint ventures which we account for using the equity
method of accounting), 26 outpatient rehabilitation satellite clinics (operated
by our hospitals, including one joint venture satellite), and 25 licensed,
hospital-based home health agencies. In addition to HealthSouth hospitals, we
manage three inpatient rehabilitation units through management contracts. While
our national network of inpatient hospitals stretches across 27 states and
Puerto Rico, our inpatient hospitals are concentrated in the eastern half of the
United States and Texas.
Our core business is providing inpatient rehabilitative services. We are the
nation's largest owner and operator of inpatient rehabilitation hospitals in
terms of revenues, number of hospitals, and patients treated and discharged. Our
inpatient rehabilitation hospitals offer specialized rehabilitative care across
a wide array of diagnoses and deliver comprehensive, high-quality,
cost-effective patient care services. The majority of patients we serve
experience significant physical and cognitive disabilities due to medical
conditions, such as strokes, neurological disorders, hip fractures, head
injuries, and spinal cord injuries, that are generally non-discretionary in
nature and which require rehabilitative healthcare services in an inpatient
setting. Our team of highly skilled nurses and physical, occupational, and
speech therapists working with our physician partners utilize proven technology
and clinical protocols with the objective of returning patients to home and
work. Patient care is provided by nursing and therapy staff as directed by
physician orders while case managers monitor each patient's progress and provide
documentation and oversight of patient status, achievement of goals, discharge
planning, and functional outcomes. Our hospitals provide a comprehensive
interdisciplinary clinical approach to treatment that leads to a higher level of
care and superior outcomes.
For 2012, our focus will be on providing high-quality, cost-effective care while
seeking to invest our strong cash flows from operations in compelling growth
opportunities in our core business. We will also consider opportunistic
repurchases of our preferred and common stock, common stock dividends, and, if
warranted, further reductions to our long-term debt (subject to changes in our
operating environment). In the first half of 2012, we:
• continued development of the following four, publicly announced de novo
hospitals;
Location # of Beds Construction Start Date Expected Operational Date
Marion County, Florida
(Ocala) 40 Q4 2011 Q4 2012
Littleton, Colorado (South
Denver) 40 Q2 2012 Q2 2013
Stuart, Florida (a joint
venture with Martin Health
Systems) 34 Q2 2012 Q2 2013
Southwest Phoenix, Arizona 40 Expected Q4 2012 Q3 2013
29--------------------------------------------------------------------------------
• received certificate of need approval to build a 50-bed inpatient
rehabilitation hospital in the greater Orlando, FL market;
• acquired 12 inpatient rehabilitation beds in Andalusia, Alabama from a
subsidiary of LifePoint Hospitals in order to add beds at our existing
hospital in Dothan, Alabama;
• signed a letter of intent to acquire the 34-bed inpatient
rehabilitation unit of CHRISTUS Santa Rosa Hospital - Medical Center.
This transaction closed in July 2012, and the operations of this unit
have been relocated to and consolidated with our existing hospital in
San Antonio, Texas;
• added 77 beds to existing hospitals;
• purchased, in conjunction with our joint venture partner, the land and
building previously subject to an operating lease associated with our
joint venture hospital in Fayetteville, Arkansas; and
• repurchased 46,645 shares of our convertible perpetual preferred stock.
In the three months ended June 30, 2012, discharge growth of 3.0% coupled with a
3.2% increase in net patient revenue per discharge generated 6.4% growth in net
patient revenue from our hospitals compared to the same period of 2011. Our
discharge growth included a 1.9% increase in same-store discharges in the second
quarter of 2012 compared to the second quarter of 2011. This revenue growth
resulted in a $1.8 million, or 2.0%, increase in operating earnings (as defined
in Note 23, Quarterly Data (Unaudited), to the consolidated financial statements
accompanying the 2011 Form 10-K) in the second quarter of 2012 compared to the
same quarter of 2011. In the six months ended June 30, 2012, discharge growth of
4.5% coupled with a 2.7% increase in net patient revenue per discharge generated
7.3% growth in net patient revenue from our hospitals compared to the same
period of 2011. Our discharge growth included a 3.4% increase in same-store
discharges during the first six months of 2012 compared to the same period of
2011. This revenue growth resulted in a $8.6 million, or 4.8%, increase in
operating earnings in the first six months of 2012 compared to the same period
of 2011. Operating earnings during the three and six months ended June 30, 2011
included a $10.6 million gain as part of Government, class action, and related
settlements, as discussed below. Net cash provided by operating activities was
$195.0 million for the six months ended June 30, 2012 compared to $158.1 million
for the same period of 2011. Net cash provided by operating activities increased
during the first half of 2012 compared to the same period of 2011 due primarily
to increased Net operating revenues, improved operating leverage, and a decrease
in interest expense. See the "Results of Operations" and "Liquidity and Capital
Resources-Sources and Uses of Cash" sections of this Item.
We believe the demand for inpatient rehabilitative healthcare services will
continue to increase as the U.S. population ages, and we believe this
demographic factor aligns with our strengths in, and focus on, inpatient
rehabilitative care. Unlike many of our competitors that may offer inpatient
rehabilitation as one of many secondary services, inpatient rehabilitation is
our core business. We also believe we can address the demand for inpatient
rehabilitative services in markets where we currently do not have a presence by
constructing or acquiring new hospitals. For additional discussion of our
strategy and business outlook, see the "Business Outlook" section below.
Reclassifications
As of January 1, 2012, we reclassified our Provision for doubtful accounts from
operating expenses to a component of Net operating revenues for all periods
presented. See Note 1, Basis of Presentation, to the condensed consolidated
financial statements included in Part I, Item 1, Financial Statements
(Unaudited), of this report.
Litigation By and Against Former Independent Auditor
As discussed in Note 8, Contingencies, to the condensed consolidated financial
statements included in Part I, Item 1, Financial Statements (Unaudited), of this
report, the arbitration process continues in the pursuit of our claims against
Ernst & Young LLP and the defense of their claims against us. The rules of the
American Arbitration Association require that all aspects of the arbitration
remain confidential. Since the beginning of the arbitration in July 2010 and
through June 30, 2012, there have been approximately 100 days of hearings,
generally in four-day blocks of time. Going forward, the arbitrators have
scheduled approximately seven additional weeks through May 2013. We can provide
no assurances as to the timing of the conclusion of the arbitration, including
whether all the additional weeks will be necessary or sufficient to conclude the
arbitration. However, we remain confident in our claims and are committed to
aggressively and diligently pursuing them to conclusion.
30
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Stock Repurchase Authorization
In October 2011, our board of directors authorized the repurchase of up to $125
million of our common stock. The repurchase authorization does not require the
repurchase of a specific number of shares, has an indefinite term, and is
subject to termination at any time by our board of directors. Subject to certain
terms and conditions, including a maximum price per share and compliance with
federal and state securities and other laws, the repurchases may be made from
time to time in open market transactions, privately negotiated transactions, or
other transactions, including trades under a plan established in accordance with
Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. Repurchases
under this authorization, if any, are expected to be funded using cash on hand
and availability under our revolving credit facility. There has been no activity
under the Company's common stock repurchase authorization since its inception.
Our board of directors also granted discretion to management to
opportunistically repurchase from time to time, subject to similar conditions,
warrants issued pursuant to the warrant agreement, dated as of January 16, 2004,
with Wells Fargo Bank Northwest, N.A., as warrant agent, and up to $125 million
of our convertible perpetual preferred stock. Likewise, this authority does not
require the purchase of a specific number of warrants or shares, has an
indefinite term, and is subject to termination at any time by our board of
directors. See Note 20, Earnings per Common Share, to the consolidated financial
statements accompanying the 2011 Form 10-K for additional information regarding
these warrants. As discussed in Note 3, Convertible Perpetual Preferred Stock,
to the condensed consolidated financial statements included in Part I, Item 1,
Financial Statements (Unaudited), of this report, we repurchased 46,645 shares
of our preferred stock for $46.5 million during the first six months of 2012.
Key Challenges
As we continue to execute our business plan, the following are some of the
challenges we face:
• Reduced Medicare Reimbursement. On August 2, 2011, President Obama
signed into law the Budget Control Act of 2011, provisions of which
will result in an automatic 2% reduction of Medicare program payments
for all healthcare providers effective upon executive order of the
President in January 2013. We currently estimate this automatic
reduction, known as "sequestration," will result in a net decrease in
our Net operating revenues of approximately $32 million annually in
2013. Additionally, concerns held by federal policymakers about the
federal deficit and national debt levels could result in enactment of
further federal spending reductions, further entitlement reform
legislation affecting the Medicare program, or both. We cannot predict
what alternative or additional deficit reduction initiatives or
Medicare payment reductions, if any, will ultimately be enacted into
law, or the timing or effect any such initiatives or reductions will have on us. If enacted, such initiatives or reductions would likely be
challenging for all providers, would likely have the effect of limiting
Medicare beneficiaries' access to healthcare services, and could have
an adverse impact on our financial position, results of operations, and
cash flows. However, we believe the steps we have taken to reduce our
debt and corresponding debt service obligations coupled with our
efficient cost structure should allow us to adjust to or mitigate any
potential initiative or payment reductions more easily than many other
inpatient rehabilitation providers.
• Changes to Our Operating Environment Resulting from Healthcare Reform.
On March 23, 2010, President Obama signed the Patient Protection and
Affordable Care Act (the "PPACA") into law. On March 30, 2010,
President Obama signed into law the Health Care and Education
Reconciliation Act of 2010, which amended the PPACA (together, the
"2010 Healthcare Reform Laws"). On June 28, 2012, the Supreme Court ofthe United States upheld the constitutionality of the 2010 Healthcare
Reform Laws, with the exception of the provisions for the mandatory
expansion of Medicaid coverage by the states. The 2010 Healthcare
Reform Laws remain subject to continuing legislative scrutiny. We
cannot predict the outcome of any future legislation related to the
2010 Healthcare Reform Laws, but we have been, and will continue to be,
actively engaged in the legislative and regulatory process to attempt
to ensure any healthcare laws or regulations adopted or amended promote
our goal of high-quality, cost-effective care.
Many provisions within the 2010 Healthcare Reform Laws have impacted or could in
the future impact our business, including: (1) reducing annual market basket
updates to providers, including annual productivity adjustment reductions;
(2) implementing pilot studies to assess the potential benefits of combining, or
"bundling," reimbursement for a Medicare beneficiary's episode of care;
(3) implementing a voluntary program for accountable care organizations;
(4) creating an Independent Payment Advisory Board; and (5) modifying
employer-sponsored healthcare insurance plans. Based on our patient mix, we do
not believe the Supreme Court's upholding of the individual mandate or
invalidation of the mandatory Medicaid coverage expansion will have a material
effect on us.
31
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Most notably for us are the reductions in our annual market basket updates. In
accordance with Medicare laws and statutes, the United States Centers for
Medicare and Medicaid Services ("CMS") makes annual adjustments to Medicare
reimbursement rates by what is commonly known as a market basket update. The
reductions in our annual market basket updates began on April 1, 2010 and
continue through 2019. The reduction in effect from October 1, 2011 through
September 30, 2012 and again from October 1, 2012 through September 30, 2013 is
0.1%.
In addition, beginning on October 1, 2011, the 2010 Healthcare Reform Laws
require the market basket update to be reduced further by a productivity
adjustment on an annual basis. The productivity adjustments equal the trailing
10-year average of changes in annual economy-wide private nonfarm business
multi-factor productivity. The productivity adjustment effective from October 1,
2011 to September 30, 2012 is a decrease to the market basket update of 1.0%,
while the productivity adjustment effective from October 1, 2012 to September
30, 2013 is a decrease to the market basket update of 0.7%.
On July 29, 2011, CMS released its notice of final rulemaking for fiscal year
2012 (the "2012 Rule") for inpatient rehabilitation facilities under the
prospective payment system ("IRF-PPS"). The 2012 Rule is effective for Medicare
discharges between October 1, 2011 and September 30, 2012. The pricing changes
in this rule include a 2.9% market basket update that has been reduced by 0.1%
to 2.8% under the requirements of the 2010 Healthcare Reform Laws discussed
above, as well as other pricing changes that impact our hospital-by-hospital
base rate for Medicare reimbursement. Based on our analysis which utilizes,
among other things, the acuity of our patients over the 12-month period prior to
the rule's release, incorporates other adjustments included in this rule, and
the productivity adjustment discussed above, we believe the 2012 Rule will
result in a net increase to our Medicare payment rates of approximately 1.6%
effective October 1, 2011.
On July 25, 2012, CMS released its IRF-PPS final notice rule for fiscal year
2013 (the "2013 Rule"). The 2013 Rule will be effective for Medicare discharges
between October 1, 2012 and September 30, 2013. The pricing changes in this rule
include a 2.7% market basket update that will be reduced by 0.1% under the
requirements of the 2010 Healthcare Reform Laws discussed above, as well as
other pricing changes that impact our hospital-by-hospital base rate for
Medicare reimbursement. Based on our analysis which utilizes, among other
things, the acuity of our patients over the 12-month period prior to the rule's
release, incorporates other adjustments included in this rule, and the
productivity adjustment discussed above, we believe the 2013 Rule will result in
a net increase to our Medicare payment rates of approximately 2.1% effective
October 1, 2012, before applying the effect of sequestration.
The 2010 Healthcare Reform Laws and their impact or potential future impact to
us are discussed in more detail in Item 1, Business, "Healthcare Reform," and
Item 7, Management's Discussion and Analysis of Financial Condition and Results
of Operations, "Executive Overview," to the 2011 Form 10-K.
Given the complexity and the number of changes in these laws, as well as the
implementation timetable for many of them, we cannot predict their ultimate
impact. However, we believe the above provisions are the issues with the
greatest potential impact on us. We will continue to evaluate and review these
laws, and, based on our track record, we believe we can adapt to these
regulatory changes.
• Maintaining Strong Volume Growth. As discussed above, the majority of
patients we serve experience significant physical and cognitive
disabilities due to medical conditions, such as strokes, neurological
disorders, hip fractures, head injuries, and spinal cord injuries, that
are generally non-discretionary in nature and which require
rehabilitative healthcare services in an inpatient setting. In
addition, because most of our patients are persons 65 and older, our patients generally have insurance coverage through Medicare. However,
we do treat some patients with medical conditions that are
discretionary in nature. During periods of economic uncertainty,
patients may choose to forgo discretionary procedures. We believe this
is one of the factors creating weakness in the number of patients
admitted to and discharged from acute care hospitals. Because
approximately 94% of our patients are referred to us by acute care
hospitals, if these patients continue to forgo procedures and acute
care providers report soft volumes, it may be more challenging for us
to maintain our recent volume growth rates.
32--------------------------------------------------------------------------------
• Recruiting and Retaining High-Quality Personnel. Our operations are
dependent on the efforts, abilities, and experience of our medical
personnel, such as physical therapists, occupational therapists, speech
pathologists, nurses, other healthcare professionals, and our
management. In some markets, the lack of availability of medical
personnel is an operating issue facing all healthcare providers, although the weak economy has mitigated this issue to some degree. We
have maintained a comprehensive compensation and benefits package to
remain competitive in this challenging staffing environment while also being consistent with our goal of being a high-quality, cost-effective
provider of inpatient rehabilitative services.
Unlike certain other post-acute settings, patients treated in inpatient
rehabilitation hospitals require and receive significantly more intensive
services because of their acute medical conditions. This includes 24-hour per
day, seven days per week supervision by registered nurses. As part of our
efforts to continue to provide high-quality inpatient rehabilitative services,
our hospitals are utilizing more certified rehabilitation registered nurses
("CRRNs"). We encourage our nursing professionals to seek CRRN certifications
via salary incentives and tuition reimbursement programs. While these incentive
programs increase our costs, we believe the benefits of increasing the number of
CRRNs far out-weigh such costs and further differentiate us, in particular our
quality of care, from other post-acute providers.
Recruiting and retaining qualified personnel for our hospitals will remain a
high priority for us. See also Item 1A, Risk Factors, to the 2011 Form 10-K.
• Operating in a Highly Regulated Industry. We are required to comply
with extensive and complex laws and regulations at the federal, state, and local government levels. These rules and regulations have affected,
or could in the future affect, our business activities by having an
impact on the reimbursement we receive for services provided or the costs of compliance, mandating new documentation standards, requiring
licensure or certification of our hospitals, regulating our
relationships with physicians and other referral sources, regulating
the use of our properties, and limiting our ability to enter new
markets or add new beds to existing hospitals. Ensuring continuous
compliance with these laws and regulations is an operating requirement
for all healthcare providers.
Reimbursement for our inpatient rehabilitation services is discussed above and
in Item 1, Business, "Sources of Revenues," to the 2011 Form 10-K.
Our outpatient services are primarily reimbursed under Medicare's physician fee
schedule. By statute, the physician fee schedule is subject to annual automatic
adjustment by a sustainable growth rate formula that has resulted in reductions
in reimbursement rates every year since 2002. However, in each instance,
Congress has acted to suspend or postpone the effectiveness of these automatic
reimbursement reductions. For example, under the CMS notice of final rulemaking
for the physician fee schedule for calendar year 2012, released on November 1,
2011, a statutory reduction of 27.4% would have been implemented. However,
Congress passed on December 23, 2011, and President Obama signed into law, an
extension of the current Medicare physician fee schedule payment rates from
January 1, 2012 through February 29, 2012, and again in February 2012, they
acted to extend the current Medicare physician reimbursement rates through
December 31, 2012, further postponing the statutory reduction. On July 6, 2012,
CMS again released a notice of proposed rulemaking for calendar year 2013 that
would reduce outpatient service payments by the sustainable growth rate formula.
If Congress does not again extend relief as it has done since 2002 or
permanently modify the sustainable growth rate formula by January 1, 2013,
payment levels for outpatient services under the physician fee schedule will be
reduced at that point by more than 26%. We currently estimate that a 26%
reduction, before taking into account our efforts to mitigate these changes,
would result in a net decrease in our Net operating revenues of approximately $8
million annually and may lead to our closure of additional outpatient satellite
clinics. However, we cannot predict what action, if any, Congress will take on
the physician fee schedule and other reimbursement matters affecting our
outpatient services or what future rule changes CMS will implement.
Effective October 1, 2012, all inpatient rehabilitation facilities will be
required to submit data for the IRF Quality Reporting Program to CMS. Beginning
in fiscal year 2014, and each subsequent fiscal year thereafter, failure to
submit the required quality data will result in a two percentage point reduction
to the applicable facility's annual market basket increase factor for payments
made for discharges occurring during that fiscal year. We are preparing our
hospitals for these reporting requirements and will begin submitting the
required data to CMS in October.
We have invested, and will continue to invest, substantial time, effort, and
expense in implementing and maintaining internal controls and procedures
designed to ensure regulatory compliance, and we are committed to continued
adherence to these guidelines. More specifically, because Medicare comprises a
significant portion of
33
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our Net operating revenues, it is important for us to remain compliant with the
laws and regulations governing the Medicare program and related matters
including anti-kickback and anti-fraud requirements. If we were unable to remain
compliant with these regulations, our financial position, results of operations,
and cash flows could be materially, adversely impacted.
See also Item 1, Business, "Sources of Revenue" and "Regulation," and Item 1A,
Risk Factors, to the 2011 Form 10-K.
Business Outlook
Healthcare has always been a highly regulated industry, and the inpatient
rehabilitation sector is no exception. Successful healthcare providers are those
who can provide high-quality, cost-effective care and have the capabilities to
adapt to changes in the regulatory environment. Given the range of possible
outcomes from the deficit reduction initiatives being discussed in Washington
and the legislative challenges to the 2010 Healthcare Reform Laws, we believe
this is true now more than ever. We also believe HealthSouth has the necessary
attributes - dedicated, skilled employees, balance sheet strength,
infrastructure, scale, and management - to adapt and succeed in a highly
regulated industry, and we have a proven track record of being able to do so.
While we do not anticipate any significant change to the long-term demand for
inpatient rehabilitative care or our ability to provide this care on a
high-quality, cost-effective basis, we do expect continued uncertainty
surrounding the potential for future changes to the Medicare program. Despite
this uncertainty, we will continue to maintain our focus on providing
high-quality care while seeking incremental efficiencies in our cost structure.
Our growth strategy in 2012 will again focus on organic growth and development
activities, and we believe continued growth in our Adjusted EBITDA and our
strong cash flows from operations will allow us to invest in these growth
opportunities. We will also consider opportunistic repurchases of our preferred
and common stock, common stock dividends, and, if warranted, further reductions
to our long-term debt (subject to changes in our operating environment).
We also will remain committed to our goal of being a high-quality,
cost-effective provider of inpatient rehabilitative services. In addition to our
efforts to increase the number of CRRNs in our hospitals, as discussed earlier,
we also encourage our hospitals to participate in The Joint Commission's
Disease-Specific Care Certification Program. Under this program, Joint
Commission accredited organizations, like our hospitals, may seek certification
for chronic diseases or conditions such as brain injury or stroke rehabilitation
by demonstrating compliance with national standards, demonstrating the effective
use of evidence-based clinical practice guidelines to manage and optimize
patient care, and demonstrating an organized approach to performance measurement
and evaluation of clinical outcomes. Obtaining such certifications demonstrates
our commitment to excellence in providing disease-specific care. Currently, 71
of our hospitals hold one or more disease-specific certifications.
While we acknowledge there is a high degree of uncertainty in the healthcare
industry, the fundamentals of our business remain strong. As the nation's
largest owner and operator of inpatient rehabilitation hospitals, we believe we
differentiate ourselves from our competitors based on our broad platform of
clinical expertise, the quality of our clinical outcomes, the application of
rehabilitative technology, and the sustainability of best practices. We are in a
healthcare sector with favorable demographics. Most of the patients we treat are
over the age of 65 and have conditions such as strokes, hip fractures, and a
variety of debilitating neurological conditions that are generally
non-discretionary in nature. As the baby boomers age, this segment of the
population will grow. In our markets, we have estimated the demand for inpatient
rehabilitative care is growing at an average of 2.0% to 2.6% per year. Not only
are we in a growing sector of healthcare, we are the industry leader in that
sector. We have invested considerable resources into clinical and management
systems and protocols that have allowed us to consistently gain market share,
realize better outcomes than our competitors, and achieve these results at
significantly lower costs. This investment has continued in 2012 as we began the
company-wide roll-out of our new electronic clinical information system.
34
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As previously noted, healthcare has always been a highly regulated industry, and
we have cautioned our stockholders that future Medicare payments could be at
risk. However, we also have adopted strategies to prepare us to absorb these
risks. Further, we believe the regulatory and reimbursement risks discussed
above may present us with opportunities to grow by acquiring or consolidating
existing operations in our highly fragmented industry. We have been disciplined
in creating a capital structure that is flexible with no significant debt
maturities prior to 2016. We have redeemed our most expensive debt and reduced
our interest expense. We have not acquired companies outside our core business.
Rather, we have invested in our core business and created an infrastructure that
enables us to provide high-quality care on a cost-effective basis. Most
importantly, our balance sheet is strong. Our leverage ratio is within our
target range, we have ample liquidity, we continue to generate strong cash flows
from operations, and we have flexibility with how we choose to invest our cash.
In the second quarter of 2012, both Moody's and S&P upgraded our corporate
credit rating. For these and other reasons, we believe we will be able to adapt
to any changes in reimbursement and be in a position to take action should a
properly sized and priced acquisition or consolidation opportunity arise.
Results of Operations
During the three and six months ended June 30, 2012 and 2011, we derived
consolidated Net operating revenues from the following payor sources:
Three Months Ended June 30, Six Months Ended June 30,
2012 2011 2012 2011
Medicare 72.9 % 72.0 % 73.3 % 71.7 %
Medicaid 1.3 % 1.8 % 1.2 % 1.7 %
Workers' compensation 1.5 % 1.7 % 1.5 % 1.7 %
Managed care and other discount plans 19.6 % 19.8 % 19.5 % 19.8 %
Other third-party payors 1.8 % 2.0 % 1.7 % 2.1 %
Patients 1.3 % 1.1 % 1.3 % 1.1 %
Other income 1.6 % 1.6 % 1.5 % 1.9 %
Total 100.0 % 100.0 % 100.0 % 100.0 %
Our payor mix is weighted heavily towards Medicare. Our hospitals receive
Medicare reimbursements under IRF-PPS. Under IRF-PPS, our hospitals receive
fixed payment amounts per discharge based on certain rehabilitation impairment
categories established by the United States Department of Health and Human
Services. Under IRF-PPS, our hospitals retain the difference, if any, between
the fixed payment from Medicare and their operating costs. Thus, our hospitals
benefit from being high-quality, low-cost providers. For additional information
regarding Medicare reimbursement, see the "Sources of Revenues" section of
Item 1, Business, of the 2011 Form 10-K.
Under IRF-PPS, hospitals are reimbursed on a "per discharge" basis. Thus, the
number of patient discharges is a key metric utilized by management to monitor
and evaluate our performance. The number of outpatient visits is also tracked in
order to measure the volume of outpatient activity each period.
35
--------------------------------------------------------------------------------For the three and six months ended June 30, 2012 and 2011, our consolidated
results of operations were as follows:
Percentage
Three Months Ended June 30, Percentage Change Six Months Ended June 30, Change
2012 2011 2012 vs. 2011 2012 2011 2012 vs. 2011
(In Millions, Except Percentage Change)
Net operating revenues $ 533.4 $ 505.1 5.6 % $ 1,072.0$ 1,011.1 6.0 %
Less: Provision for
doubtful accounts
(6.5 ) (5.0 ) 30.0 % (12.8 ) (9.8 ) 30.6 %
Net operating revenues
less provision for
doubtful accounts 526.9 500.1 5.4 % 1,059.2 1,001.3 5.8 %
Operating expenses:
Salaries and benefits 257.4 241.6 6.5 % 518.4 485.6 6.8 %
Other operating expenses 74.4 75.4 (1.3 )% 147.4 146.3 0.8 %
General and administrative
expenses 28.0 27.4 2.2 % 58.0 54.3 6.8 %
Supplies 25.9 26.2 (1.1 )% 52.4 52.0 0.8 %
Depreciation and
amortization 20.0 19.6 2.0 % 39.5 39.1 1.0 %
Occupancy costs 12.3 12.1 1.7 % 24.8 23.7 4.6 %
Loss on disposal of assets 0.6 1.0 (40.0 )% 1.4 1.1 27.3 %
Government, class action,
and related settlements - (10.6 ) (100.0 )% - (10.6 ) (100.0 )%
Professional
fees-accounting, tax, and
legal 5.5 8.4 (34.5 )% 9.1 12.2 (25.4 )%
Total operating expenses 424.1 401.1 5.7 % 851.0 803.7 5.9 %
Loss on early
extinguishment of debt - 26.1 (100.0 )% - 26.1 (100.0 )%
Interest expense and
amortization of debt
discounts and fees 23.0 34.9 (34.1 )% 46.3 70.0 (33.9 )%
Other income (0.4 ) (0.7 ) (42.9 )% (1.3 ) (1.3 ) - %
Equity in net income of
nonconsolidated affiliates (3.1 ) (3.2 ) (3.1 )% (6.4 ) (5.7 ) 12.3 %
Income from continuing
operations before income
tax expense 83.3 41.9 98.8 % 169.6 108.5 56.3 %
Provision for income tax
expense 26.9 11.2 140.2 % 56.0 3.8 1,373.7 %
Income from continuing
operations 56.4 30.7 83.7 % 113.6 104.7 8.5 %
Income from discontinued
operations, net of tax 3.5 1.6 118.8 % 3.1 19.1 (83.8 )%
Net income 59.9 32.3 85.4 % 116.7 123.8 (5.7 )%
Less: Net income
attributable to
noncontrolling interests (13.2 ) (10.4 ) 26.9 % (25.8 ) (22.1 ) 16.7 %
Net income attributable to
HealthSouth $ 46.7 $ 21.9 113.2 % $ 90.9 $ 101.7 (10.6 )%
36--------------------------------------------------------------------------------
Provision for Doubtful Accounts and Operating Expenses as a % of Net Operating
Revenues
Three Months Ended June 30, Six Months Ended June 30,
2012 2011 2012 2011
Provision for doubtful accounts 1.2 % 1.0 % 1.2 % 1.0 %
Operating expenses:
Salaries and benefits 48.3 % 47.8 % 48.4 % 48.0 %
Other operating expenses 13.9 % 14.9 % 13.8 % 14.5 %
General and administrative expenses 5.2 % 5.4 % 5.4 % 5.4 %
Supplies 4.9 % 5.2 % 4.9 % 5.1 %
Depreciation and amortization 3.7 % 3.9 % 3.7 % 3.9 %
Occupancy costs 2.3 % 2.4 % 2.3 % 2.3 %
Loss on disposal of assets 0.1 % 0.2 % 0.1 % 0.1 %
Government, class action, and related
settlements - % (2.1 )% - % (1.0 )%
Professional fees-accounting, tax, and
legal 1.0 % 1.7 % 0.8 % 1.2 %
Total operating expenses 79.5 % 79.4 % 79.4 % 79.5 %
Additional information regarding our operating results for the three and six
months ended June 30, 2012 and 2011 is as follows:
Three Months Ended June 30, Percentage Change Six Months Ended June 30, Percentage Change
2012 2011 2012 vs. 2011 2012 2011 2012 vs. 2011
(In Millions, Except Percentage Change)
Net patient
revenue-inpatient $ 495.0 $ 465.4 6.4 % $ 995.6 $ 927.5 7.3 %
Net patient
revenue-outpatient
and other revenues 38.4 39.7 (3.3 )% 76.4 83.6 (8.6 )%
Net operating
revenues $ 533.4 $ 505.1 5.6 % $ 1,072.0 $ 1,011.1 6.0 %
(Actual Amounts)
Discharges 30,719 29,811 3.0 % 61,590 58,938 4.5 %
Net patient revenue
per discharge $16,114 $15,612 3.2 % $16,165 $15,737 2.7 %
Outpatient visits 229,152 244,647 (6.3 )% 460,395 481,408 (4.4 )%
Average length of
stay (days) 13.4 13.4 - % 13.5 13.6 (0.7 )%
Occupancy % 69.2 % 69.0 % 0.3 % 69.7 % 69.6 % 0.1 %
# of licensed beds 6,538 6,356 2.9 % 6,538 6,356 2.9 %
Full-time
equivalents* 15,378 15,150 1.5 % 15,325 15,097 1.5 %
Employees per
occupied bed 3.41 3.47 (1.7 )% 3.38 3.43 (1.5 )%
* Excludes 393 and 396 full-time equivalents for the three months ended
June 30, 2012 and 2011, respectively, and 394 and 397 full-time
equivalents for the six months ended June 30, 2012 and 2011,
respectively, who are considered part of corporate overhead with their
salaries and benefits included in General and administrative expenses in
our condensed consolidated statements of operations. Full-time
equivalents included in the above table represent those who participate
in or support the operations of our hospitals and exclude an estimate of
full-time equivalents related to contract labor.
We actively manage the productive portion of our Salaries and benefits utilizing
certain metrics, including employees per occupied bed, or "EPOB." This metric is
determined by dividing the number of full-time equivalents, including an
estimate of full-time equivalents from the utilization of contract labor, by the
number of occupied beds during each period. The number of occupied beds is
determined by multiplying the number of licensed beds by our occupancy
percentage.
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In the discussion that follows, we use "same-store" comparisons to explain the
changes in certain performance metrics and line items within our financial
statements. We calculate same-store comparisons based on hospitals open
throughout both the full current periods and prior periods presented. These
comparisons include the financial results of market consolidation transactions
in existing markets, as it is difficult to determine, with precision, the
incremental impact of these transactions on our results of operations.
Net Operating Revenues
Our consolidated Net operating revenues consist primarily of revenues derived
from patient care services. Net operating revenues also include other revenues
generated from management and administrative fees and other non-patient care
services. These other revenues approximated 1.6% of consolidated Net operating
revenues for the three months ended June 30, 2012 and 2011 and 1.5% and 1.9% of
consolidated Net operating revenues for the six months ended June 30, 2012 and
2011, respectively. See below for discussion of state provider taxes included in
other revenues during the six months ended June 30, 2011.
Net patient revenue from our hospitals was 6.4% higher for the three months
ended June 30, 2012 than the three months ended June 30, 2011. This increase was
attributable to a 3.0% increase in patient discharges and a 3.2% increase in net
patient revenue per discharge. Discharge growth included a 1.9% increase in
same-store discharges. Net patient revenue per discharge increased primarily due
to pricing adjustments from Medicare and managed care payors and higher average
acuity for the patients we served. As discussed above, we received a Medicare
market basket update of 2.9% under the 2012 Rule effective October 1, 2011.
However, this market basket update was reduced by 1.1% to 1.8% under the
requirements of the 2010 Healthcare Reform Laws.
Net patient revenue from our hospitals was 7.3% higher for the six months ended
June 30, 2012 than the six months ended June 30, 2011 due to the same reasons
discussed above for the quarter-over-quarter increase. Net patient revenue per
discharge also increased during the first half of 2012 compared to the first
half of 2011 as a result of a higher percentage of Medicare patients (as shown
in the above payor mix table). Patient discharges increased 4.5% during the six
months ended June 30, 2012 compared to the same period of 2011. Discharge growth
was enhanced during the six months ended June 30, 2012 compared to the same
period of 2011 by the additional day in February due to leap year. Same-store
discharges were 3.4% higher period over period for the six months.
Outpatient and other revenues decreased during the second quarter of 2012
compared to the second quarter of 2011 due to the decrease in outpatient
volumes, the closure of outpatient satellite clinics in prior periods, and a
reduction in home health pricing related to the 2012 Medicare home health rule.
The decrease in outpatient volumes was slightly offset by an increase in the
number of home health visits included in these volume metrics.
Outpatient and other revenues include the receipt of state provider taxes. A
number of states in which we operate hospitals assess a provider tax to certain
healthcare providers. Those tax revenues at the state level are generally
matched by federal funds. In order to induce healthcare providers to serve low
income patients, many states redistribute a substantial portion of these funds
back to the various providers. These redistributions are based on different
metrics than those used to assess the tax, and are thus in different amounts and
proportions than the initial tax assessment. As a result, some providers receive
a net benefit while others experience a net expense. See the discussion of Other
operating expenses below for information on state provider tax expenses.
While state provider taxes are a regular component of our operating results,
during 2011, a new provider tax was implemented in Pennsylvania where we operate
nine inpatient hospitals. As a result of the implementation of this new provider
tax in Pennsylvania, in the first quarter of 2011, we recorded approximately
$3.4 million related to the period from July 1, 2010 through December 31, 2010
when we were notified by Pennsylvania of the specific provider tax refund to be
issued to us after Pennsylvania had received approval from CMS on its amended
state plan relative to these taxes.
Excluding the state provider tax refunds discussed above, outpatient and other
revenues decreased during the six months ended June 30, 2012 compared to the
same period of 2011 due to the same reasons discussed above for the
quarter-over-quarter decrease.
Provision for Doubtful Accounts
As disclosed previously, we have experienced denials of certain diagnosis codes
by Medicare contractors based on medical necessity. We dispute, or "appeal,"
most of these denials, and we have historically collected approximately 58% of
all amounts denied. The resolution of these disputes can take in excess of one
year, and we cannot provide assurance as to the ongoing and future success of
these disputes. As such, we make provisions against these receivables in
accordance with our
38
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accounting policy that necessarily considers the age and historical collection
trends of the receivables in this review process as part of our Provision for
doubtful accounts. Therefore, as we experience increases or decreases in these
denials, or if our actual collections of these denials differs from our
estimated collections, we may experience volatility in our Provision for
doubtful accounts. See also Item 1, Business, "Sources of Revenues-Medicare
Reimbursement," to the 2011 Form 10-K.
The change in the Provision for doubtful accounts as a percent of Net operating
revenues in the three and six months ended June 30, 2012 compared to the same
periods of 2011 was primarily the result of an increase in Medicare claim
denials.
Salaries and Benefits
Salaries and benefits are the most significant cost to us and represent an
investment in our most important asset: our employees. Salaries and benefits
include all amounts paid to full- and part-time employees who directly
participate in or support the operations of our hospitals, including all related
costs of benefits provided to employees. It also includes amounts paid for
contract labor.
Salaries and benefits increased in the three and six months ended June 30, 2012
compared to the same periods of 2011 primarily due to increased patient volumes,
including an increase in the number of full-time equivalents as a result of our
2011 development activities, an approximate 2% merit increase provided to
employees on October 1, 2011, and a change in the skills mix of employees at our
hospitals. As part of the standardization of our labor practices across all of
our hospitals and as part of our efforts to continue to provide high-quality
inpatient rehabilitative services, our hospitals are utilizing more registered
nurses and CRRNs, which increases our average cost per full-time equivalent, and
fewer licensed practical nurses.
Salaries and benefits as a percent of Net operating revenues increased in both
2012 periods presented compared to the same periods of 2011 due primarily to the
higher skills mix of our employees in the first half of 2012 compared to the
same periods of 2011, an increase in workers' compensation costs, and the ramp
up of operations at two new hospitals that opened in the fourth quarter of 2011.
These items were offset by improved labor productivity, as shown in our EPOB
metric above.
Other Operating Expenses
Other operating expenses include costs associated with managing and maintaining
our hospitals. These expenses include such items as contract services,
utilities, non-income related taxes, insurance, professional fees, and repairs
and maintenance.
As a percent of Net operating revenues, Other operating expenses decreased
during the three and six months ended June 30, 2012 compared to the same periods
of 2011 due primarily to our increasing revenue base as well as a decrease in
self-insurance costs in 2012. As disclosed previously, we update our actuarial
estimates surrounding our self-insurance reserves in June and December of each
year. Self-insurance costs associated with professional and general liability
risks in the second quarter of 2011 were higher than the second quarter of 2012
due to the need to increase reserves in 2011 based upon the actuarial study
completed at that time.
Other operating expenses in the six months ended June 30, 2011 included $1.9
million of expenses associated with the implementation of the new Pennsylvania
state provider tax program, as discussed above. Other operating expenses
associated with the implementation of our electronic clinical information system
were $0.7 million and $1.4 million higher in the three and six months ended
June 30, 2012, respectively, compared to the same periods of 2011.
General and Administrative Expenses
General and administrative expenses primarily include administrative expenses
such as information technology services, corporate accounting, human resources,
internal audit and controls, and legal services that are managed from our
corporate headquarters in Birmingham, Alabama. These expenses also include all
stock-based compensation expenses.
The increase in General and administrative expenses during the three and six
months ended June 30, 2012 compared to the same periods of 2011 primarily
resulted from increased expenses associated with stock-based compensation. Our
restricted stock awards contain vesting requirements that include a service
condition, market condition, performance condition, or a combination thereof.
Due to the Company's recent operating performance, our non-cash expenses
associated with these awards increased in 2012.
39
--------------------------------------------------------------------------------Supplies
Supplies expense includes all costs associated with supplies used while
providing patient care. These costs include pharmaceuticals, food, needles,
bandages, and other similar items. Supplies expense decreased as a percent of
Net operating revenues in the three and six months ended June 30, 2012 compared
to the same periods of 2011 due to our increasing revenue base, our supply chain
efforts, and our continual focus on monitoring and actively managing
pharmaceutical costs.
Depreciation and Amortization
Depreciation and amortization was relatively flat during the three and six
months ended June 30, 2012 compared to the three and six months ended June 30,
2011. While our capital expenditures increased during the latter half of 2011
and the first half of 2012, the majority of these expenditures relate to land
and construction in progress for our de novo hospitals and capitalized software
costs associated with the implementation of an electronic clinical information
system at our hospitals. Depreciation on these assets, excluding land which is
non-depreciable, does not begin until the applicable assets are placed in
service. Therefore, while we expect depreciation and amortization to increase
going forward, we did not experience an increase in these charges during the
first half of 2012.
Occupancy Costs
Occupancy costs include amounts paid for rent associated with leased hospitals
and outpatient rehabilitation satellite clinics, including common area
maintenance and similar charges. These costs did not change significantly during
the periods presented.
Government, Class Action, and Related Settlements
The gain included in Government, class action, and related settlements for the
three and six months ended June 30, 2011 resulted from the recovery of assets
from Richard M. Scrushy, our former chairman and chief executive officer, as
discussed in Note 8, Contingencies, "Litigation By and Against Richard M.
Scrushy," to the condensed consolidated financial statements included in Part I,
Item 1, Financial Statements (Unaudited), of this report.
Professional Fees-Accounting, Tax, and Legal
Professional fees-accounting, tax, and legal for the three and six months ended
June 30, 2012 and 2011 related primarily to legal and consulting fees for
continued litigation and support matters arising from prior reporting and
restatement issues. These expenses for the three and six months ended June 30,
2012 also included legal and consulting fees for the pursuit of our remaining
income tax benefits. See Note 21, Settlements, and Note 22, Contingencies and
Other Commitments, to the consolidated financial statements accompanying the
2011 Form 10-K and Note 6, Income Taxes, and Note 8, Contingencies, to the
condensed consolidated financial statements included in Part I, Item 1,
Financial Statements (Unaudited), of this report.
Loss on Early Extinguishment of Debt
In June 2011, we completed a call of $335 million in principal of our 10.75%
Senior Notes due 2016. The Loss on early extinguishment of debt during the three
and six months ended June 30, 2011 resulted from this transaction.
Interest Expense and Amortization of Debt Discounts and Fees
The decrease in Interest expense and amortization of debt discounts and fees
during the three and six months ended June 30, 2012 compared to the same periods
of 2011 was due to a decrease in our average borrowings outstanding and a
decrease in our average cash interest rate. During 2011, we reduced total debt
by approximately $257 million, including the redemption of our 10.75% Senior
Notes due 2016. Our average cash interest rate was 7.1% during the three and six
months ended June 30, 2012 compared to 8.7% and 8.8% for the three and six
months ended June 30, 2011, respectively. Our average cash interest rate
decreased as a result of the redemption of the 10.75% Senior Notes due 2016
during 2011, which was our most expensive debt, as well as the amendment to our
credit agreement in May 2011 which reduced by 100 basis points each of the
various applicable interest rates for any outstanding balance on our revolving
credit facility. In addition, pricing on our term loan and revolving credit
facility declined an additional 25 basis points in the third quarter of 2011 in
conformity with our credit agreement's leverage grid.
For additional information regarding debt and related interest expense, see Note
8, Long-term Debt, to the consolidated financial statements accompanying the
2011 Form 10-K.
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Income from Continuing Operations Before Income Tax Expense
Excluding the Loss on early extinguishment of debt during the three and six
months ended June 30, 2011, the increase in our Income from continuing
operations before income tax expense during the three and six months ended
June 30, 2012 compared to the same periods of 2011 resulted from increased Net
operating revenues, improved operating leverage and labor productivity, and a
decrease in interest expense.
Provision for Income Tax Expense
Due to our federal and state net operating loss carryforwards ("NOLs"), we
currently estimate our cash income tax expense to be approximately $8 million to
$12 million per year due primarily to state income tax expense of subsidiaries
which have separate state filing requirements, alternative minimum taxes, and
federal income taxes for subsidiaries not included in our federal consolidated
income tax return. For the three and six months ended June 30, 2012, cash income
tax expense was $2.2 million and $4.3 million, respectively, and for the three
and six months ended June 30, 2011, cash income tax expense was $1.7 million and
$4.2 million, respectively.
Our Provision for income tax expense of $26.9 million and $56.0 million for the
three and six months ended June 30, 2012 primarily resulted from the application
of our estimated effective blended federal and state income tax rate of
approximately 39% to our pre-tax income from continuing operations attributable
to HealthSouth.
Our Provision for income tax expense of $11.2 million for the three months ended
June 30, 2011 included the following: (1) estimated income tax expense of
approximately $12 million based on the application of our estimated effective
blended federal and state income tax rate of approximately 39% to our pre-tax
income from continuing operations attributable to HealthSouth offset by (2) a
reduction in unrecognized tax benefits due to settlements with state taxing
authorities.
Our Provision for income tax expense of $3.8 million for the six months ended
June 30, 2011 included the following: (1) estimated income tax expense of
approximately $33 million based on the application of our estimated effective
blended federal and state income tax rate of approximately 39% to our pre-tax
income from continuing operations attributable to HealthSouth offset by (2) the
settlement of federal income tax claims with the Internal Revenue Service for
tax years 2007 and 2008 which resulted in an income tax benefit of approximately
$24 million and (3) other items, primarily related to a reduction in
unrecognized tax benefits due to the lapse of the applicable statute of
limitations for certain federal and state claims, which resulted in a tax
benefit of approximately $5 million.
In certain state jurisdictions, we do not expect to generate sufficient income
to use all of the available NOLs prior to their expiration. This determination
is based on our evaluation of all available evidence in these jurisdictions
including results of operations during the preceding three years, our forecast
of future earnings, and prudent tax planning strategies. It is possible we may
be required to increase or decrease our valuation allowance at some future time
if our forecast of future earnings varies from actual results on a consolidated
basis or in the applicable state tax jurisdiction, or if the timing of future
tax deductions differs from our expectations.
As part of our continued efforts to maximize our income tax benefits, we
requested a pre-filing agreement with the IRS, the primary purpose of which was
to consider whether certain amounts related to the restatement of our financial
statements for periods prior to 2003 result in net increases to our federal NOL
and adjustments to other tax attributes. The pre-filing agreement program
permits taxpayers to resolve certain tax issues in advance of filing their
corporate income tax returns. During the three and six months ended June 30,
2012, the amount of gross unrecognized tax benefits increased by approximately
$74 million based on these developments. Due to the unique nature of our claims
and uncertainties around this process, we did not recognize any amounts
associated with our request as of June 30, 2012. In July 2012, the IRS granted
our request to utilize the pre-filing agreement process. Depending upon the
process undertaken by the IRS to audit and settle these matters, the accounting
recognition criteria for these positions could be met either in part or in total
as the process continues or upon completion of the process. Therefore, as we
continue this process with the IRS, it is reasonably possible that over the next
twelve-month period we may experience an increase or decrease to our
unrecognized tax benefits, our NOLs, other tax attributes, or any combination
thereof that could have a material net favorable impact on income tax expense
and our effective income tax rate. Due to the aforementioned uncertainties
regarding the outcome of this process, it is not possible to determine the range
of any impact at this time.
See Note 6, Income Taxes, to the condensed consolidated financial statements
included in Part I, Item 1, Financial Statements (Unaudited), of this report and
Note 19, Income Taxes, to the consolidated financial statements accompanying the
2011 Form 10-K.
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Net Income Attributable to Noncontrolling Interests
Net income attributable to noncontrolling interests represents the share of net
income or loss allocated to members or partners in our consolidated affiliates.
Fluctuations in these amounts are primarily driven by the financial performance
of the applicable hospital population each period.
Results of Discontinued Operations
The operating results of discontinued operations are as follows (in millions):
Three Months Ended June 30, Six Months Ended June 30,
2012 2011 2012 2011
Net operating revenues $ 0.1 $ 29.5 $ 0.8 $ 86.5
Less: Provision for doubtful accounts (0.4 ) (0.6 ) (0.3 ) (1.2 )
Net operating revenues less provision
for doubtful accounts (0.3 ) 28.9 0.5 85.3
Costs and expenses (0.5 ) 25.7 1.0 53.3
Impairments - - - 1.3
Income (loss) from discontinued
operations 0.2 3.2 (0.5 ) 30.7
Gain on disposal of assets/sale of
investments of discontinued operations 5.0 - 5.0 -
Income tax expense (1.7 ) (1.6 ) (1.4 ) (11.6 )
Income from discontinued operations,
net of tax $ 3.5 $ 1.6 $ 3.1 $ 19.1
Our results of discontinued operations primarily included the operations of the
following hospitals: five of our long-term acute care hospitals ("LTCHs") (sold
in August 2011) and HealthSouth Hospital of Houston (an LTCH closed in August
2011). The decreases in net operating revenues and costs and expenses in the
periods presented were due primarily to the performance and eventual sale or
closure of these facilities.
In addition, and as discussed in Note 21, Settlements, to the consolidated
financial statements accompanying the 2011 Form 10-K, in April 2011, we entered
into a definitive settlement and release agreement with the state of Delaware
(the "Delaware Settlement") relating to a previously disclosed audit of
unclaimed property conducted on behalf of Delaware and two other states by
Kelmar Associates, LLC. During the six months ended June 30, 2011, we recorded a
$24.8 million gain in connection with this settlement as part of our results of
discontinued operations.
During the three and six months ended June 30, 2012, we recognized gains
associated with the sale of the real estate associated with the Dallas Medical
Center (closed in October 2008) and an investment we had in a cancer treatment
center that was part of our former diagnostic division. During the six months
ended June 30, 2011, we recorded an impairment charge of $1.3 million related to
the Dallas Medical Center. We determined the fair value of the impaired
long-lived assets at this closed facility primarily based on the assets'
estimated fair value using valuation techniques that included third-party
appraisals and offers from potential buyers.
Income tax expense recorded as part of our results of discontinued operations
during the three and six months ended June 30, 2011 primarily related to the
Delaware Settlement.
See Note 18, Assets and Liabilities in and Results of Discontinued Operations,
to the consolidated financial statements accompanying the 2011 Form 10-K for
additional information.
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Liquidity and Capital Resources
Our primary sources of liquidity are cash on hand, cash flows from operations,
and availability under our revolving credit facility.
The objectives of our capital structure strategy are to ensure we maintain
adequate liquidity and flexibility. Maintaining adequate liquidity includes
supporting the execution of our operating and strategic plans and allowing us to
weather temporary disruptions in the capital markets and general business
environment. Maintaining flexibility in our capital structure includes limiting
concentrations of debt maturities in any given year, allowing for debt
prepayments without onerous penalties, and ensuring our debt agreements are
limited in restrictive terms and maintenance covenants.
We have been disciplined in creating a capital structure that is flexible with
no significant debt maturities prior to 2016, and, in the second quarter of
2012, both Moody's and S&P upgraded our corporate credit rating. Our balance
sheet is strong, our leverage ratio is within our target range, we have ample
availability under our revolving credit facility, we continue to generate strong
cash flows from operations, and we have flexibility with how we choose to invest
our cash.
Current Liquidity
As of June 30, 2012, we had $41.1 million in Cash and cash equivalents. This
amount excludes $30.7 million in Restricted cash and $50.5 million of restricted
marketable securities ($21.2 million included in Other current assets and $29.3
million included in Other long-term assets in our condensed consolidated balance
sheet as of June 30, 2012). Our restricted assets pertain primarily to
obligations associated with our captive insurance company, as well as
obligations we have under agreements with external joint venture partners. See
Note 3, Cash and Marketable Securities, to the consolidated financial statements
accompanying the 2011 Form 10-K.
In addition to Cash and cash equivalents, as of June 30, 2012, we had
approximately $357 million available to us under our revolving credit facility.
Our credit agreement governs the majority of our senior secured borrowing
capacity and contains a leverage ratio and an interest coverage ratio as
financial covenants. Our leverage ratio is defined in our credit agreement as
the ratio of consolidated total debt (less up to $75 million of cash on hand) to
Adjusted EBITDA for the trailing four quarters. Our interest coverage ratio is
defined in our credit agreement as the ratio of Adjusted EBITDA to consolidated
interest expense, excluding the amortization of financing fees, for the trailing
four quarters. As of June 30, 2012, the maximum leverage ratio requirement per
our credit agreement was 4.75x and the minimum interest coverage ratio
requirement was 2.5x, and we were in compliance with these covenants.
As discussed above in the "Executive Overview" section of this Item, and despite
the regulatory uncertainty currently facing healthcare providers, we anticipate
we will continue to generate strong cash flows from operations that, together
with availability under our revolving credit facility, will allow us to invest
in growth opportunities and continue to improve our existing core business. We
will also consider opportunistic repurchases of our preferred and common stock,
common stock dividends, and, if warranted, further reductions to our long-term
debt (subject to changes in our operating environment). As noted above, during
the first half of 2012, we have repurchased 46,645 shares of our preferred
stock.
As of June 30, 2012, we have scheduled principal payments of $9.8 million and
$19.6 million in the remainder of 2012 and 2013, respectively, related to
long-term debt obligations (see Note 8, Long-term Debt, to the consolidated
financial statements accompanying the 2011 Form 10-K). We do not face near-term
refinancing risk, as the majority of amounts outstanding under our credit
agreement do not mature until 2016, and none of our bonds are due until 2018 and
beyond.
See Item 1A, Risk Factors, of the 2011 Form 10-K and Note 1, Summary of
Significant Accounting Policies, to the consolidated financial statements
accompanying the 2011 Form 10-K for a discussion of risks and uncertainties
facing us.
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Sources and Uses of Cash
The following table shows the cash flows provided by or used in operating,
investing, and financing activities for the six months ended June 30, 2012 and
2011 (in millions):
Six Months Ended June 30,
2012 2011
Net cash provided by operating activities $ 195.0 $ 158.1
Net cash used in investing activities
(88.3 ) (49.2 )
Net cash used in financing activities (95.6 ) (97.0 )
Increase in cash and cash equivalents $ 11.1 $ 11.9
Operating activities. Net cash provided by operating activities increased during
the six months ended June 30, 2012 compared to the same period of 2011 due
primarily to increased Net operating revenues, improved operating leverage, and
a decrease in interest expense. Net cash provided by operating activities for
the six months ended June 30, 2011 included the use of $18.0 million related to
the premium associated with the redemption of a portion of our 10.75% Senior
Notes in June 2011 and a $16.7 million decrease in the liability associated with
Refunds due patients and other third-party payors. The decrease in this
liability primarily related to a settlement discussed in Note 21, Settlements,
to the 2011 Form 10-K.
Investing activities. The increase in Cash flows used in investing activities
resulted from increased capital expenditures, including capitalized software
costs, in the first half of 2012 compared to the first half of 2011. The
increase in our capital expenditures in the first half of 2012 compared to the
first half of 2011 primarily resulted from increased hospital refresh projects,
the purchase of the real estate associated with our joint venture hospital in
Fayetteville, Arkansas (see also "financing activities" below), implementation
of our electronic clinical information system, and our de novo development
activities, including land purchases. Cash flows used in investing activities
during the six months ended June 30, 2011 included $10.9 million related to our
final net settlement on our former interest rate swaps.
Financing activities. Cash flows used in financing activities decreased modestly
during the first half of 2012 compared to the same period of 2011. Cash flows
used in financing activities during the first half of 2012 included the
repurchase of 46,645 shares of our convertible perpetual preferred stock,
distributions to noncontrolling interests of consolidated affiliates, net
principal payments on debt, and dividends paid on our preferred stock offset by
capital contributions from consolidated affiliates primarily associated with the
purchase of the real estate associated with our joint venture hospital in
Fayetteville, Arkansas. Cash flows used in financing activities during the first
half of 2011 included net principal payments on debt and debt issuance costs,
distributions to noncontrolling interests of consolidated affiliates, and
dividends paid on our preferred stock.
Funding Commitments
We have scheduled principal payments of $9.8 million and $19.6 million in the
remainder of 2012 and 2013, respectively, related to long-term debt obligations.
For additional information about our long-term debt obligations, see Note 8,
Long-term Debt, to the consolidated financial statements accompanying the 2011
Form 10-K.
Our capital expenditures include costs associated with our hospital refresh
program, capacity expansions, de novo projects, technology initiatives, and
building and equipment upgrades and purchases. During the six months ended
June 30, 2012, we made capital expenditures of $94.4 million for property and
equipment and capitalized software. These expenditures included the purchase of
the real estate associated with our joint venture hospital in Fayetteville,
Arkansas for approximately $15 million, half of which was reimbursed to us by
our joint venture partner through a capital contribution. Based on our
year-to-date expenditures through June, we are increasing our estimated capital
expenditures for 2012 to a range of approximately $155 million to $190 million
from a range of approximately $145 million to $180 million, exclusive of
acquisitions. Actual amounts spent will be dependent upon the timing of
construction projects. Approximately $80 million to $105 million of this
budgeted amount is considered discretionary.
As discussed earlier in this report, we believe continued growth in our Adjusted
EBITDA and our strong cash flows from operations will allow us to invest in
growth opportunities and continue to invest in our core business. We will also
consider opportunistic repurchases of our preferred and common stock, common
stock dividends, and, if warranted, further reductions to our long-term debt
(subject to changes in our operating environment). For a discussion of risk
factors related to our business and our industry, see Item 1A, Risk Factors, of
the 2011 Form 10-K and Note 1, Summary of Significant Accounting Policies, to
the consolidated financial statements accompanying the 2011 Form 10-K.
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Adjusted EBITDA
Management believes Adjusted EBITDA as defined in our credit agreement is a
measure of our ability to service our debt and our ability to make capital
expenditures. We reconcile Adjusted EBITDA to Net income and to Net cash
provided by operating activities.
We use Adjusted EBITDA on a consolidated basis as a liquidity measure. We
believe this financial measure on a consolidated basis is important in analyzing
our liquidity because it is the key component of certain material covenants
contained within our credit agreement, which is discussed in more detail in
Note 8, Long-term Debt, to the consolidated financial statements accompanying
the 2011 Form 10-K. These covenants are material terms of the credit agreement.
Non?compliance with these financial covenants under our credit agreement-our
interest coverage ratio and our leverage ratio-could result in our lenders
requiring us to immediately repay all amounts borrowed. If we anticipated a
potential covenant violation, we would seek relief from our lenders, which would
have some cost to us, and such relief might not be on terms favorable to those
in our existing credit agreement. In addition, if we cannot satisfy these
financial covenants, we would be prohibited under our credit agreement from
engaging in certain activities, such as incurring additional indebtedness,
making certain payments, and acquiring and disposing of assets. Consequently,
Adjusted EBITDA is critical to our assessment of our liquidity.
In general terms, the credit agreement definition of Adjusted EBITDA, referred
to as "Adjusted Consolidated EBITDA" there, allows us to add back to
consolidated Net income interest expense, income taxes, and depreciation and
amortization and then add back to consolidated Net income (1) all unusual or
non-recurring items reducing consolidated Net income (of which only up to $10
million in a year may be cash expenditures), (2) costs and expenses related to
refinancing transactions, (3) any losses from discontinued operations and closed
locations, (4) costs and expenses, including legal fees and expert witness fees,
incurred with respect to litigation associated with stockholder derivative
litigation, including the matters related to Ernst & Young LLP and Richard M.
Scrushy discussed in Note 21, Settlements, and Note 22, Contingencies and Other
Commitments, to the consolidated financial statements accompanying the 2011 Form
10-K and Note 8, Contingencies, to the condensed consolidated financial
statements included in Part I, Item 1, Financial Statements (Unaudited), of this
report, and (5) share-based compensation expense. We also subtract from
consolidated Net income all unusual or non-recurring items to the extent they
increase consolidated Net income.
Under the credit agreement, the Adjusted EBITDA calculation does not include
adjustments for the following items: (1) net income attributable to
noncontrolling interests, (2) gain or loss on disposal of assets,
(3) professional fees unrelated to the stockholder derivative litigation, and
(4) unusual or non-recurring cash expenditures in excess of $10 million. These
items may not be indicative of our ongoing performance, so the Adjusted EBITDA
calculation presented here includes adjustments for them.
Adjusted EBITDA is not a measure of financial performance under generally
accepted accounting principles in the United States of America, and the items
excluded from Adjusted EBITDA are significant components in understanding and
assessing financial performance. Therefore, Adjusted EBITDA should not be
considered a substitute for Net income or cash flows from operating, investing,
or financing activities. Because Adjusted EBITDA is not a measurement determined
in accordance with GAAP and is thus susceptible to varying calculations,
Adjusted EBITDA, as presented, may not be comparable to other similarly titled
measures of other companies. Revenues and expenses are measured in accordance
with the policies and procedures described in Note 1, Summary of Significant
Accounting Policies, to the consolidated financial statements accompanying the
2011 Form 10-K.
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Our Adjusted EBITDA for the three and six months ended June 30, 2012 and 2011
was as follows (in millions):
Reconciliation of Net Income to Adjusted EBITDA
Three Months Ended June 30, Six Months Ended June 30,
2012 2011 2012 2011
Net income $ 59.9 $ 32.3 $ 116.7 $ 123.8
Income from discontinued operations,
net of tax, attributable to
HealthSouth (3.5 ) (2.5 ) (3.1 ) (20.1 )
Provision for income tax expense 26.9 11.2 56.0 3.8
Interest expense and amortization of
debt discounts and fees 23.0 34.9 46.3 70.0
Loss on early extinguishment of debt - 26.1 - 26.1
Professional fees-accounting, tax, and
legal 5.5 8.4 9.1 12.2
Government, class action, and related
settlements - (10.6 ) - (10.6 )
Net noncash loss on disposal of assets 0.6 1.0 1.4 1.1
Depreciation and amortization 20.0 19.6 39.5 39.1
Stock-based compensation expense 5.9 5.3 12.0 9.5
Net income attributable to
noncontrolling interests (13.2 ) (10.4 ) (25.8 ) (22.1 )
Adjusted EBITDA $ 125.1 $ 115.3 $ 252.1 $ 232.8
Reconciliation of Net Cash Provided by Operating Activities to Adjusted EBITDA
