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HLS > SEC Filings for HLS > Form 10-Q on 30-Jul-2013All Recent SEC Filings

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Quarterly Report

Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations

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, 2012 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, 2012 (the "2012 Form 10-K"). 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 2012 Form 10-K.
Executive Overview
Our Business
We are the nation's largest owner and operator of inpatient rehabilitation hospitals in terms of patients treated and discharged, revenues, and number of hospitals. While our national network of inpatient hospitals stretches across 28 states and Puerto Rico, we are concentrated in the eastern half of the United States and Texas. As of June 30, 2013, we operated 103 inpatient rehabilitation hospitals (including two hospitals that operate as joint ventures which we account for using the equity method of accounting), 22 outpatient rehabilitation satellite clinics (operated by our hospitals), and 25 licensed, hospital-based home health agencies. In addition to HealthSouth hospitals, we manage three inpatient rehabilitation units through management contracts. For additional information about our business, see Item 1, Business, of the 2012 Form 10-K. 2013 Overview
Our 2013 strategy focuses on the following priorities:
continuing to provide high-quality, cost-effective care to patients in our existing markets;

achieving organic growth at our existing hospitals;

         continuing to expand our services to more patients who require
          inpatient rehabilitative services by constructing and opportunistically
          acquiring new hospitals in new markets; and

         considering additional shareholder value-enhancing strategies such as
          repurchases of our common and preferred stock and common stock
          dividends, recognizing that some of these actions may increase our
          leverage ratio.

During the three months ended June 30, 2013, discharge growth of 6.3% coupled with a 0.3% increase in net patient revenue per discharge generated 6.5% growth in net patient revenue from our hospitals compared to the three months ended June 30, 2012. Discharge growth included a 3.3% increase in same-store discharges. During the six months ended June 30, 2013, discharge growth of 5.2% coupled with a 1.7% increase in net patient revenue per discharge generated 6.9% growth in net patient revenue from our hospitals compared to the six months ended June 30, 2012. Discharge growth included a 2.8% increase in same-store discharges. Our growth in net patient revenue per discharge was negatively impacted by the effect of sequestration for Medicare patients during the 2013 periods presented. See the "Results of Operations" section of this Item for additional information. Our quality and outcome measures, as reported through the Uniform Data System for Medical Rehabilitation (the "UDS"), remained well above the average for hospitals included in the UDS database. Our growth efforts thus far in 2013 have included the following:
acquired Walton Rehabilitation Hospital, a 58-bed inpatient rehabilitation hospital in Augusta, Georgia, in April 2013;

         acquired land for a new 50-bed inpatient rehabilitation hospital in
          Modesto, California. Construction is expected to begin in the third
          quarter of 2014;

         began accepting patients at our newly built, 40-bed inpatient
          rehabilitation hospital in Littleton, Colorado in May 2013;

         began accepting patients at our newly built, 34-bed inpatient
          rehabilitation hospital in Stuart, Florida in June 2013. This hospital
          is a joint venture with Martin Health System;

added 10 beds to existing hospitals; and

continued development of the following de novo hospitals:

                                             Actual / Expected
                                             Construction Start      Expected
           Location             # of Beds           Date         Operational Date
Altamonte Springs, Florida          50            Q3 2013            Q4 2014
Newnan, Georgia                     50            Q4 2013            Q4 2014

Awarded CON, but Award Remains Under Appeal Middletown, Delaware* 34 TBD TBD Franklin, Tennessee 40 TBD TBD

* In June 2013, Delaware enacted legislation that authorizes, subject to certain conditions, construction of a 34-bed inpatient rehabilitation hospital in Middletown, Delaware. We are evaluating this legislation, as well as its impact on us, and the pending litigation challenging the validity of the certificate of need previously awarded us in Middletown.

We also completed a tender offer for our common stock during the first quarter of 2013. As a result of the tender offer, we repurchased approximately 9.1 million shares at a price of $25.50 per share for a total cost of $234.1 million, including fees and expenses relating to the tender offer. In addition, during the second quarter of 2013, we amended our credit agreement to, among other things, permit unlimited restricted payments so long as the senior secured leverage ratio remains less than or equal to 1.5x and extend the revolver maturity from August 2017 to June 2018. See the "Liquidity and Capital Resources" section of this Item.
In addition, in April 2013, we entered into closing agreements with the IRS that settled federal income tax matters related to the previous restatement of our 2000 and 2001 financial statements, as well as certain other tax matters, through December 31, 2008. As a result of these closing agreements, we increased our deferred tax assets, primarily our federal net operating loss carryforward ("NOL"), and recorded a net income tax benefit of approximately $115 million in the second quarter of 2013. This income tax benefit primarily resulted from an approximate $283 million increase to our federal NOL on a gross basis. See Note 8, Income Taxes, to the condensed consolidated financial statements included in Item 1, Financial Statements (Unaudited), of this report. Business Outlook
We believe our business outlook remains reasonably positive primarily for two reasons. First, demographic trends, specifically the aging of the population, will increase long-term demand for inpatient rehabilitative services. While we treat patients of all ages, most of our patients are persons 65 and older (the average age of a HealthSouth patient is 72 years) and have conditions such as strokes, hip fractures, and a variety of debilitating neurological conditions that are generally nondiscretionary in nature. We believe the demand for inpatient rehabilitative healthcare services will continue to increase as the U.S. population ages and life expectancies increase. The number of Medicare-eligible patients is expected to grow approximately 3% per year for the foreseeable future, creating an attractive market. We believe these market factors align 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. In addition, we 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.
Second, we are the industry leader in this growing sector. As the nation's largest owner and operator of inpatient rehabilitation hospitals, 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 have invested considerable resources into clinical and management systems and protocols that have allowed us to consistently lower costs. Our commitment to technology also includes the ongoing implementation of our rehabilitation-specific electronic clinical

information system. We believe this system will improve patient care and safety, enhance staff recruitment and retention, and set the stage for connectivity with referral sources and health information exchanges. Our hospitals also 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, 94 of our hospitals hold one or more disease-specific certifications. We also account for approximately 80% of all Joint Commission accredited Stroke Centers of Excellence nationwide. Healthcare has always been a highly regulated industry, and we have cautioned our stakeholders that future Medicare payment rates could be at risk. While the Medicare reimbursement environment may be challenging, the demand for inpatient rehabilitative services is expected to grow. HealthSouth has a proven track record of adapting to and succeeding in a highly regulated environment, and we believe we are well-positioned to continue to succeed and grow. Further, we believe the regulatory and reimbursement risks discussed throughout this report may present us with opportunities to grow by acquiring or consolidating the operations of other inpatient rehabilitation providers in our highly fragmented industry. We have been disciplined in creating a capital structure that is flexible with no significant debt maturities prior to 2018. Over the past few years, we have redeemed our most expensive debt and reduced our interest expense. We have invested in our core business and created an infrastructure that enables us to provide high-quality care on a cost-effective basis. Our balance sheet remains strong. Our leverage ratio is within our target range, we have ample availability under our revolving credit facility, and we continue to generate strong cash flows from operations. Importantly, we have flexibility with how we choose to invest our cash and return value to stakeholders including bed additions, de novos, acquisitions of other inpatient rehabilitation hospitals, purchases of leased properties, repurchases of our common and preferred stock, common stock dividends, and repayment of long-term debt. Specifically, on July 25, 2013, our board of directors approved the initiation of a quarterly cash dividend on our common stock of $0.18 per share. In addition, our board of directors authorized the optional redemption of 10% of the outstanding principal amount of our existing 7.25% Senior Notes due 2018 and 7.75% Senior Notes due 2022 pursuant to the terms of these senior notes. See the "Liquidity and Capital Resources - Authorizations for Returning Capital to Stakeholders" section of this Item for additional information.
For these and other reasons, we believe we will be able to adapt to any changes in reimbursement and sustain our business model. We also believe we will be in a position to take action should a properly sized and priced acquisition or consolidation opportunity arise.
Key Challenges
The healthcare industry is currently facing many well-publicized regulatory and reimbursement challenges. It always has been a highly regulated industry, and the inpatient rehabilitation sector is no exception. Successful healthcare providers are those who provide high-quality, cost-effective care and have the ability to adjust to changes in the regulatory environment. We believe we have the necessary capabilities-scale, infrastructure, and management-to adapt to and succeed in a highly regulated industry, and we have a proven track record of doing so.
As we continue to execute our business plan, the following are some of the challenges we face:

         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.

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 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 Revenues" and "Regulation," and Item 1A, Risk Factors, to the 2012 Form 10-K and Note 10, Contingencies and Other Commitments, "HHS-OIG Investigations," to the condensed consolidated financial statements included in Item 1, Financial Statements (Unaudited), of this report. Our challenges related to reduced Medicare reimbursement are discussed in Item 1, Business, "Regulatory and Reimbursement Challenges," and Item 1A, Risk Factors, of the 2012 Form 10?K. We currently estimate sequestration will result in a net decrease in our Net operating revenues of approximately $28 million in 2013. Unless the United States Congress acts to change or eliminate sequestration, it will continue to result in a 2% decrease to reimbursements otherwise due from Medicare, after taking into consideration other changes to reimbursement rates such as market basket updates. 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. For example, the Health Subcommittee of the Ways and Means Committee of the United States House of Representatives recently held a hearing to examine legislative proposals contained in President Obama's fiscal year 2014 budget submission to Congress that would affect post-acute care providers, which includes, among other issues, elevating the 60% Rule to a 75% Rule and paying rehabilitation hospitals nursing home-based rates for certain conditions (also referred to as "site-neutral payment"). As a point of follow-up to this hearing, we provided constructive input on legislative and regulatory initiatives as well as information on the quality of care and value that inpatient rehabilitation hospitals bring to the Medicare program and its beneficiaries to the Ways and Means Health Subcommittee, and we will continue providing such input to policymakers. We cannot predict what alternative or additional deficit reduction initiatives, Medicare payment reductions, or post acute care reforms, 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 our efficient cost structure and substantial owned real estate coupled with the steps we have taken to reduce our debt and corresponding debt service obligations should allow us to absorb, adjust to, or mitigate any potential initiative or payment reductions more easily than most other inpatient rehabilitation providers.

         Changes to Our Operating Environment Resulting from Healthcare Reform.
          Our challenges related to healthcare reform are discussed in Item 1,
          Business, "Regulatory and Reimbursement Challenges," and "Sources of
          Revenue - Medicare Reimbursement," and Item 1A, Risk Factors, to the
          2012 Form 10-K. Many provisions within the 2010 Healthcare Reform Laws
          (as defined in Item 1, Business, "Regulatory and Reimbursement
          Challenges" to the 2012 Form 10-K) have impacted, or could in the
          future impact, our business. Most notably for us are the reductions to
          our annual market basket updates, including productivity adjustments
          and future payment reforms such as Accountable Care Organizations and
          bundled payments.

In May 2013, the United States Centers for Medicare and Medicaid Services released its notice of proposed rulemaking for fiscal year 2014 (the "2014 Rule") for inpatient rehabilitation facilities ("IRFs") under the prospective payment system ("IRF?PPS"). The proposed rule would implement a net 1.8% market basket increase effective for discharges between October 1, 2013 and September 30, 2014, calculated as follows:
Market basket update 2.5%
Healthcare reform reduction 30 basis points Productivity adjustment 40 basis points

The proposed rule also includes other pricing changes that impact our hospital-by-hospital base rate for Medicare reimbursement. Such changes include, but are not limited to, updates to the IRF-PPS facility-level rural adjustment factor, low-income patient factor, teaching status adjustment factor, and updates to the outlier fixed loss threshold. 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 and incorporates other adjustments included in the proposed rule, we believe the 2014 Rule will result in a net increase to our Medicare payment rates of approximately 2.0% effective October 1, 2014. Given the complexity and the number of changes in the 2010 Healthcare Reform Laws, we cannot predict their ultimate impact. We will continue to evaluate these laws, and, based on our track record, we believe we can adapt to these regulatory changes. Further, we have engaged, and will continue to engage, actively in discussions with

key legislators and regulators to attempt to ensure any healthcare laws or regulations adopted or amended promote our goal of high-quality, cost-effective care.

         Maintaining Strong Volume Growth. The majority of patients we serve
          experience significant physical and cognitive disabilities due to
          medical conditions, such as neurological disorders, strokes, hip
          fractures, head injuries, and spinal cord injuries, that are generally
          nondiscretionary 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. 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.

         Recruiting and Retaining High-Quality Personnel. See Item 1A, Risk
          Factors, of the 2012 Form 10-K for a discussion of competition for
          staffing, shortages of qualified personnel, and other factors that may
          increase our labor costs. Recruiting and retaining qualified personnel
          for our hospitals remain a high priority for us. We attempt to maintain
          a comprehensive compensation and benefits package that allows us to
          remain competitive in this challenging staffing environment while
          remaining consistent with our goal of being a high-quality,
          cost-effective provider of inpatient rehabilitative services.

These key challenges notwithstanding, we have a strong business model, a strong balance sheet, and a proven track record of achieving strong financial and operational results. We are in a position to continue to grow, adapt to external events, and create value for our shareholders in 2013 and beyond. Results of Operations
Payor Mix
During the three and six months ended June 30, 2013 and 2012, we derived consolidated Net operating revenues from the following payor sources:

                                         Three Months Ended June 30,        Six Months Ended June 30,
                                           2013               2012            2013             2012
Medicare                                     74.6 %              72.9 %         74.6 %           73.3 %
Medicaid                                      1.0 %               1.3 %          1.1 %            1.2 %
Workers' compensation                         1.2 %               1.5 %          1.3 %            1.5 %
Managed care and other discount plans        18.4 %              19.6 %         18.4 %           19.5 %
Other third-party payors                      1.7 %               1.8 %          1.7 %            1.7 %
Patients                                      1.2 %               1.3 %          1.2 %            1.3 %
Other income                                  1.9 %               1.6 %          1.7 %            1.5 %
Total                                       100.0 %             100.0 %        100.0 %          100.0 %

For additional information regarding our payors, see the "Sources of Revenues" section of Item 1, Business, of the 2012 Form 10-K.

Our Results
For the three and six months ended June 30, 2013 and 2012, our consolidated
results of operations were as follows:
                              Three Months Ended June 30,      Percentage Change       Six Months Ended June 30,       Percentage Change
                                  2013              2012         2013 vs. 2012            2013             2012          2013 vs. 2012
                                                               (In Millions, Except Percentage Change)
Net operating revenues       $      564.5         $ 533.4               5.8  %      $     1,137.1       $ 1,072.0               6.1  %
Less: Provision for doubtful
accounts                             (7.0 )          (6.5 )             7.7  %              (14.4 )         (12.8 )            12.5  %
Net operating revenues less
provision for doubtful
accounts                            557.5           526.9               5.8  %            1,122.7         1,059.2               6.0  %
Operating expenses:
Salaries and benefits               273.6           257.4               6.3  %              548.2           518.4               5.7  %
Hospital-related expenses:
Other operating expenses             81.0            75.0               8.0  %              159.1           148.8               6.9  %
Occupancy costs                      11.9            12.3              (3.3 )%               24.1            24.8              (2.8 )%
Supplies                             26.6            25.9               2.7  %               52.8            52.4               0.8  %
General and administrative
expenses                             29.5            28.0               5.4  %               59.7            58.0               2.9  %
Depreciation and
amortization                         23.1            20.0              15.5  %               45.2            39.5              14.4  %
Government, class action,
and related settlements              (2.0 )   -         -            (100.0 )%               (2.0 )             -            (100.0 )%
fees-accounting, tax, and
legal                                 2.2             5.5             (60.0 )%                3.6             9.1             (60.4 )%
Total operating expenses            445.9           424.1               5.1  %              890.7           851.0               4.7  %
Interest expense and
amortization of debt
discounts and fees                   24.4            23.0               6.1  %               48.6            46.3               5.0  %
Other income                         (1.9 )          (0.4 )           375.0  %               (2.6 )          (1.3 )           100.0  %
Equity in net income of
nonconsolidated affiliates           (3.3 )          (3.1 )             6.5  %               (6.2 )          (6.4 )            (3.1 )%
Income from continuing
operations before income tax
(benefit) expense                    92.4            83.3              10.9  %              192.2           169.6              13.3  %
Provision for income tax
(benefit) expense                   (86.5 )          26.9            (421.6 )%              (53.0 )          56.0            (194.6 )%
Income from continuing
operations                          178.9            56.4             217.2  %              245.2           113.6             115.8  %
Income (loss) from
discontinued operations, net
of tax                                0.1             3.5             (97.1 )%               (0.3 )           3.1            (109.7 )%
Net income                          179.0            59.9             198.8  %              244.9           116.7             109.9  %
Less: Net income
attributable to
noncontrolling interests            (13.8 )         (13.2 )             4.5  %              (28.4 )         (25.8 )            10.1  %
. . .
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