Attached files

file filename
EX-32.2 - EXHIBIT 32.2 - Encompass Health Corphls10q93016ex322.htm
EX-32.1 - EXHIBIT 32.1 - Encompass Health Corphls10q93016ex321.htm
EX-31.2 - EXHIBIT 31.2 - Encompass Health Corphls10q93016ex312.htm
EX-31.1 - EXHIBIT 31.1 - Encompass Health Corphls10q93016ex311.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 ______________________________
FORM 10-Q
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2016
OR 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 001-10315
______________________________ 
HealthSouth Corporation
(Exact name of Registrant as specified in its Charter)

Delaware
63-0860407
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
 
 
3660 Grandview Parkway, Suite 200
Birmingham, Alabama
35243
(Address of Principal Executive Offices)
(Zip Code)
 
 
(205) 967-7116
(Registrant’s telephone number)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer  ý       Accelerated filer  o      Non-Accelerated filer  o       Smaller reporting company  o
 
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes o No ý
 
The registrant had 89,796,334 shares of common stock outstanding, net of treasury shares, as of October 21, 2016.




TABLE OF CONTENTS

NOTE TO READERS
As used in this report, the terms “HealthSouth,” “we,” “us,” “our,” and the “Company” refer to HealthSouth Corporation and its consolidated subsidiaries, unless otherwise stated or indicated by context. This drafting style is suggested by the Securities and Exchange Commission and is not meant to imply that HealthSouth Corporation, the publicly traded parent company, owns or operates any specific asset, business, or property. The hospitals, operations, and businesses described in this filing are primarily owned and operated by subsidiaries of the parent company. In addition, we use the term “HealthSouth Corporation” to refer to HealthSouth Corporation alone wherever a distinction between HealthSouth Corporation and its subsidiaries is required or aids in the understanding of this filing.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This quarterly report contains historical information, as well as forward-looking statements that involve known and unknown risks and relate to, among other things, future events, changes to Medicare reimbursement and other healthcare laws and regulations from time to time, our business strategy, our dividend and stock repurchase strategies, our financial plans, our growth plans, our future financial performance, our projected business results, or our projected capital expenditures. In some cases, the reader can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “targets,” “potential,” or “continue” or the negative of these terms or other comparable terminology. Such forward-looking statements are necessarily estimates based upon current information and involve a number of risks and uncertainties, many of which are beyond our control. Any forward-looking statement is based on information current as of the date of this report and speaks only as of the date on which such statement is made. Actual events or results may differ materially from the results anticipated in these forward-looking statements as a result of a variety of factors. While it is impossible to identify all such factors, factors that could cause actual results to differ, such as decreases in revenues or increases in costs or charges, materially from those estimated by us include, but are not limited to, the following:
each of the factors discussed in Item 1A, Risk Factors, of our Annual Report on Form 10-K for the year ended December 31, 2015, as well as uncertainties and factors discussed in Part II, Item 1A, Risk Factors, and elsewhere in this Form 10-Q, in our other filings from time to time with the SEC, or in materials incorporated therein by reference;
changes in the rules and regulations of the healthcare industry at either or both of the federal and state levels, including those contemplated now and in the future as part of national healthcare reform and deficit reduction such as the reinstatement of the “75% Rule” or the introduction of site neutral payments with skilled nursing facilities for certain conditions, and related increases in the costs of complying with such changes;
reductions or delays in, or suspension of, reimbursement for our services by governmental or private payors, including our ability to obtain and retain favorable arrangements with third-party payors;

i



delays in the administrative appeals process associated with denied Medicare reimbursement claims, including from various Medicare audit programs, and our exposure to the related delay or reduction in the receipt of the reimbursement amounts for services previously provided;
the ongoing evolution of the healthcare delivery system, including alternative payment models and value-based purchasing initiatives;
our ability to comply with extensive and changing healthcare regulations as well as the increased costs of regulatory compliance and compliance monitoring in the healthcare industry, including the costs of investigating and defending asserted claims, whether meritorious or not;
our ability to attract and retain nurses, therapists, and other healthcare professionals in a highly competitive environment with often severe staffing shortages and the impact on our labor expenses from potential union activity and staffing recruitment and retention;
competitive pressures in the healthcare industry and our response to those pressures;
changes in our payor mix or the acuity of our patients;
our ability to successfully complete and integrate de novo developments, acquisitions, investments, and joint ventures consistent with our growth strategy, including realization of anticipated revenues, cost savings, and productivity improvements arising from the related operations;
any adverse outcome of various lawsuits, claims, and legal or regulatory proceedings, including the ongoing investigations initiated by the U.S. Department of Health and Human Services, Office of the Inspector General;
increased costs of defending and insuring against alleged professional liability and other claims and the ability to predict the costs related to such claims;
potential incidents affecting the proper operation, availability, or security of our information systems;
new or changing quality reporting requirements impacting operational costs or our Medicare reimbursement;
the price of our common stock as it affects our willingness and ability to repurchase shares and the financial and accounting effects of any repurchases;
our ability and willingness to continue to declare and pay dividends on our common stock;
our ability to successfully integrate the inpatient rehabilitation hospitals acquired from Reliant Hospital Partners, LLC, and the home health agency operations of CareSouth Health System, Inc., including the realization of anticipated benefits from those acquisitions and avoidance of unanticipated difficulties, costs, or liabilities that could arise from the acquisitions or integrations;
our ability to maintain proper local, state and federal licensing where we and our subsidiaries do business;
our ability to attract and retain key management personnel, including as a part of executive management succession planning; and
general conditions in the economy and capital markets, including any instability or uncertainty related to governmental impasse over approval of the United States federal budget, an increase to the debt ceiling, or an international sovereign debt crisis.
The cautionary statements referred to in this section also should be considered in connection with any subsequent written or oral forward-looking statements that may be issued by us or persons acting on our behalf. We undertake no duty to update these forward-looking statements, even though our situation may change in the future. Furthermore, we cannot guarantee future results, events, levels of activity, performance, or achievements.

ii



PART I. FINANCIAL INFORMATION
Item 1.
Financial Statements (Unaudited)
HealthSouth Corporation and Subsidiaries
Condensed Consolidated Statements of Operations
(Unaudited)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
(In Millions)
Net operating revenues
$
926.8

 
$
778.6

 
$
2,757.3

 
$
2,283.6

Less: Provision for doubtful accounts
(14.8
)
 
(10.7
)
 
(46.7
)
 
(33.2
)
Net operating revenues less provision for doubtful accounts
912.0

 
767.9

 
2,710.6

 
2,250.4

Operating expenses:
 

 
 

 
 
 
 
Salaries and benefits
497.4

 
417.1

 
1,469.6

 
1,204.0

Other operating expenses
126.3

 
106.7

 
367.0

 
314.1

Occupancy costs
17.6

 
12.5

 
53.5

 
37.1

Supplies
34.8

 
31.0

 
104.2

 
94.1

General and administrative expenses
30.3

 
30.6

 
96.6

 
97.3

Depreciation and amortization
43.5

 
33.7

 
128.8

 
98.3

Government, class action, and related settlements

 

 

 
8.0

Professional fees—accounting, tax, and legal

 
0.4

 
1.9

 
2.7

Total operating expenses
749.9

 
632.0

 
2,221.6

 
1,855.6

Loss on early extinguishment of debt
2.6

 

 
7.4

 
20.0

Interest expense and amortization of debt discounts and fees
42.5

 
35.6

 
130.5

 
98.3

Other income
(0.8
)
 
(0.7
)
 
(2.1
)
 
(4.2
)
Equity in net income of nonconsolidated affiliates
(2.5
)
 
(2.4
)
 
(7.3
)
 
(6.3
)
Income from continuing operations before income tax expense
120.3

 
103.4

 
360.5

 
287.0

Provision for income tax expense
42.1

 
35.9

 
124.2

 
98.4

Income from continuing operations
78.2

 
67.5

 
236.3

 
188.6

(Loss) income from discontinued operations, net of tax
(0.1
)
 
0.3

 
(0.3
)
 
(1.6
)
Net income
78.1

 
67.8

 
236.0

 
187.0

Less: Net income attributable to noncontrolling interests
(16.4
)
 
(17.1
)
 
(53.7
)
 
(50.9
)
Net income attributable to HealthSouth
61.7

 
50.7

 
182.3

 
136.1

Less: Convertible perpetual preferred stock dividends

 

 

 
(1.6
)
Net income attributable to HealthSouth common shareholders
$
61.7

 
$
50.7

 
$
182.3

 
$
134.5


(Continued)
1



HealthSouth Corporation and Subsidiaries
Condensed Consolidated Statements of Operations (Continued)
(Unaudited)

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
(In Millions, Except Per Share Data)
Weighted average common shares outstanding:
 

 
 

 
 
 
 
Basic
89.1

 
90.6

 
89.3

 
89.1

Diluted
99.4

 
101.5

 
99.5

 
101.4

 
 
 
 
 
 
 
 
Earnings per common share:
 
 
 
 
 
 
 
Basic earnings per share attributable to HealthSouth common shareholders:
 
 
 

 
 
 
 
Continuing operations
$
0.69

 
$
0.56

 
$
2.03

 
$
1.52

Discontinued operations

 

 

 
(0.02
)
Net income
$
0.69

 
$
0.56

 
$
2.03

 
$
1.50

Diluted earnings per share attributable to HealthSouth common shareholders:
 
 
 
 
 
 
 
Continuing operations
$
0.64

 
$
0.52

 
$
1.90

 
$
1.43

Discontinued operations

 

 

 
(0.02
)
Net income
$
0.64

 
$
0.52

 
$
1.90

 
$
1.41

 
 
 
 
 
 
 
 
Cash dividends per common share
$
0.24

 
$
0.23

 
$
0.70

 
$
0.65

 
 
 
 
 
 
 
 
Amounts attributable to HealthSouth common shareholders:
 
 
 

 
 
 
 
Income from continuing operations
$
61.8

 
$
50.4

 
$
182.6

 
$
137.7

(Loss) income from discontinued operations, net of tax
(0.1
)
 
0.3

 
(0.3
)
 
(1.6
)
Net income attributable to HealthSouth
$
61.7

 
$
50.7

 
$
182.3

 
$
136.1


The accompanying notes to condensed consolidated financial statements are an integral part of these condensed statements.
2



HealthSouth Corporation and Subsidiaries
Condensed Consolidated Statements of Comprehensive Income
(Unaudited)

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
(In Millions)
COMPREHENSIVE INCOME
 
 
 
 
 
 
 
Net income
$
78.1

 
$
67.8

 
$
236.0

 
$
187.0

Other comprehensive (loss) income, net of tax:
 

 
 

 
 
 
 
Net change in unrealized (loss) gain on available-for-sale securities:
 

 
 

 
 
 
 
Unrealized net holding (loss) gain arising during the period
(0.2
)
 
(0.7
)
 
0.4

 
0.2

Reclassifications to net income

 
(0.6
)
 

 
(1.2
)
Other comprehensive (loss) income before income taxes
(0.2
)
 
(1.3
)
 
0.4

 
(1.0
)
Provision for income tax benefit (expense) related to other comprehensive income items
0.1

 
0.5

 
(0.2
)
 
0.4

Other comprehensive (loss) income, net of tax
(0.1
)
 
(0.8
)
 
0.2

 
(0.6
)
Comprehensive income
78.0

 
67.0

 
236.2

 
186.4

Comprehensive income attributable to noncontrolling interests
(16.4
)
 
(17.1
)
 
(53.7
)
 
(50.9
)
Comprehensive income attributable to HealthSouth
$
61.6

 
$
49.9

 
$
182.5

 
$
135.5


The accompanying notes to condensed consolidated financial statements are an integral part of these condensed statements.
3



HealthSouth Corporation and Subsidiaries
Condensed Consolidated Balance Sheets
(Unaudited)

 
September 30,
2016
 
December 31,
2015
 
(In Millions)
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
76.4

 
$
61.6

Accounts receivable, net of allowance for doubtful accounts of $52.2 in 2016; $39.3 in 2015
419.2

 
410.5

Other current assets
170.4

 
126.6

Total current assets
666.0

 
598.7

Property and equipment, net
1,353.1

 
1,310.1

Goodwill
1,915.6

 
1,890.1

Intangible assets, net
410.1

 
419.4

Deferred income tax assets
72.6

 
190.8

Other long-term assets
213.9

 
197.0

Total assets(1)
$
4,631.3

 
$
4,606.1

Liabilities and Shareholders’ Equity
 
 
 
Current liabilities:
 
 
 
Current portion of long-term debt
$
36.8

 
$
36.8

Accounts payable
67.5

 
61.6

Accrued expenses and other current liabilities
371.7

 
328.0

Total current liabilities
476.0

 
426.4

Long-term debt, net of current portion
2,974.0

 
3,134.7

Other long-term liabilities
158.1

 
144.6

 
3,608.1

 
3,705.7

Commitments and contingencies


 


Redeemable noncontrolling interests
109.4

 
121.1

Shareholders’ equity:
 

 
 

HealthSouth shareholders’ equity
726.3

 
611.4

Noncontrolling interests
187.5

 
167.9

Total shareholders’ equity
913.8

 
779.3

Total liabilities(1) and shareholders’ equity
$
4,631.3

 
$
4,606.1

(1) 
Our consolidated assets as of September 30, 2016 include total assets of variable interest entities of $258.0 million, which cannot be used by us to settle the obligations of other entities. Our consolidated liabilities as of September 30, 2016 include total liabilities of the variable interest entities of $51.1 million. See Note 3, Variable Interest Entities.


The accompanying notes to condensed consolidated financial statements are an integral part of these condensed statements.
4



HealthSouth Corporation and Subsidiaries
Condensed Consolidated Statements of Shareholders’ Equity
(Unaudited)


 
Nine Months Ended September 30, 2016
 
(In Millions)
 
HealthSouth Common Shareholders
 
 
 
 
 
Number of Common
Shares Outstanding
 
Common Stock
 
Capital in Excess of
Par Value
 
Accumulated
Deficit
 
Accumulated Other
Comprehensive
Loss
 
Treasury Stock
 
Noncontrolling
Interests
 
Total
Balance at beginning of period
90.1

 
$
1.1

 
$
2,834.9

 
$
(1,696.0
)
 
$
(1.2
)
 
$
(527.4
)
 
$
167.9

 
$
779.3

Net income

 

 

 
182.3

 

 

 
42.5

 
224.8

Receipt of treasury stock
(0.4
)
 

 

 

 

 
(9.9
)
 

 
(9.9
)
Dividends declared on common stock

 

 
(63.4
)
 

 

 

 

 
(63.4
)
Stock-based compensation

 

 
16.1

 

 

 

 

 
16.1

Stock options exercised
0.3

 

 
6.6

 

 

 
(4.8
)
 

 
1.8

Distributions declared

 

 

 

 

 

 
(43.1
)
 
(43.1
)
Capital contributions from consolidated affiliates

 

 

 

 

 

 
17.0

 
17.0

Fair value adjustments to redeemable noncontrolling interests, net of tax

 

 
10.2

 

 

 

 

 
10.2

Repurchases of common stock in open market
(0.7
)
 

 

 

 

 
(24.1
)
 

 
(24.1
)
Other
0.5

 

 
2.4

 

 
0.2

 
(0.7
)
 
3.2

 
5.1

Balance at end of period
89.8

 
$
1.1

 
$
2,806.8

 
$
(1,513.7
)
 
$
(1.0
)
 
$
(566.9
)
 
$
187.5

 
$
913.8


 
Nine Months Ended September 30, 2015
 
(In Millions)
 
HealthSouth Common Shareholders
 
 
 
 
 
Number of Common Shares Outstanding
 
Common Stock
 
Capital in Excess of Par Value
 
Accumulated Deficit
 
Accumulated Other Comprehensive Loss
 
Treasury Stock
 
Noncontrolling Interests
 
Total
Balance at beginning of period
87.8

 
$
1.0

 
$
2,810.5

 
$
(1,879.1
)
 
$
(0.5
)
 
$
(458.7
)
 
$
146.3

 
$
619.5

Net income

 

 

 
136.1

 

 

 
40.8

 
176.9

Conversion of preferred stock
3.3

 

 
93.2

 

 

 

 

 
93.2

Receipt of treasury stock
(0.6
)
 

 

 

 

 
(17.2
)
 

 
(17.2
)
Dividends declared on common stock

 

 
(59.1
)
 

 

 

 

 
(59.1
)
Dividends declared on convertible perpetual preferred stock

 

 
(1.6
)
 

 

 

 

 
(1.6
)
Stock-based compensation

 

 
19.0

 

 

 

 

 
19.0

Stock options exercised
0.2

 

 
6.6

 

 

 
(4.4
)
 

 
2.2

Distributions declared

 

 

 

 

 

 
(36.7
)
 
(36.7
)
Capital contributions from consolidated affiliates

 

 

 

 

 

 
9.5

 
9.5

Fair value adjustments to redeemable noncontrolling interests, net of tax

 

 
(14.9
)
 

 

 

 

 
(14.9
)
Other
0.7

 
0.1

 
1.6

 

 
(0.6
)
 
(1.6
)
 
(0.1
)
 
(0.6
)
Balance at end of period
91.4

 
$
1.1

 
$
2,855.3

 
$
(1,743.0
)
 
$
(1.1
)
 
$
(481.9
)
 
$
159.8

 
$
790.2


The accompanying notes to condensed consolidated financial statements are an integral part of these condensed statements.
5



HealthSouth Corporation and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)


 
Nine Months Ended September 30,
 
2016
 
2015
 
(In Millions)
Cash flows from operating activities:
 
 
 
Net income
$
236.0

 
$
187.0

Loss from discontinued operations, net of tax
0.3

 
1.6

Adjustments to reconcile net income to net cash provided by operating activities—
 

 
 

Provision for doubtful accounts
46.7

 
33.2

Provision for government, class action, and related settlements

 
8.0

Depreciation and amortization
128.8

 
98.3

Loss on early extinguishment of debt
7.4

 
20.0

Equity in net income of nonconsolidated affiliates
(7.3
)
 
(6.3
)
Distributions from nonconsolidated affiliates
5.9

 
4.5

Stock-based compensation
17.4

 
21.8

Deferred tax expense
110.6

 
88.0

Other
11.7

 
8.2

Change in assets and liabilities, net of acquisitions—
 
 
 

Accounts receivable
(75.7
)
 
(83.7
)
Other assets
(4.4
)
 
(8.3
)
Accounts payable
1.9

 
4.4

Accrued payroll
(1.2
)
 
(16.6
)
Accrued interest payable
6.0

 
13.9

Other liabilities
11.8

 
(3.0
)
Premium received on bond issuance

 
9.8

Premium paid on redemption of bonds
(5.8
)
 
(11.8
)
Net cash used in operating activities of discontinued operations
(0.6
)
 
(0.8
)
Total adjustments
253.2

 
179.6

Net cash provided by operating activities
489.5

 
368.2

 
 
 
 

(Continued)
6



HealthSouth Corporation and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Continued)
(Unaudited)


 
Nine Months Ended September 30,
 
2016
 
2015
 
(In Millions)
Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(113.9
)
 
(85.2
)
Capitalized software costs
(17.5
)
 
(20.7
)
Acquisitions of businesses, net of cash acquired
(19.6
)
 
(87.1
)
Proceeds from sale of marketable securities

 
12.8

Purchase of restricted investments
(0.8
)
 
(6.5
)
Net change in restricted cash
(7.1
)
 
3.2

Other
2.6

 
4.1

Net cash used in investing activities
(156.3
)
 
(179.4
)
Cash flows from financing activities:
 
 
 
Principal borrowings on term loan facilities

 
125.0

Proceeds from bond issuance

 
1,400.0

Principal payments on debt, including pre-payments
(195.2
)
 
(546.3
)
Borrowings on revolving credit facility
260.0


315.0

Payments on revolving credit facility
(240.0
)

(615.0
)
Debt amendment and issuance costs

 
(31.3
)
Repurchases of common stock, including fees and expenses
(24.1
)
 

Dividends paid on common stock
(62.4
)
 
(56.3
)
Distributions paid to noncontrolling interests of consolidated affiliates
(49.5
)
 
(39.7
)
Other
(7.2
)
 
(5.3
)
Net cash (used in) provided by financing activities
(318.4
)
 
546.1

Increase in cash and cash equivalents
14.8

 
734.9

Cash and cash equivalents at beginning of period
61.6

 
66.7

Cash and cash equivalents at end of period
$
76.4

 
$
801.6

 
 
 
 
Supplemental schedule of noncash financing activity:
 
 
 
Conversion of preferred stock to common stock
$

 
$
93.2


The accompanying notes to condensed consolidated financial statements are an integral part of these condensed statements.
7


HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements


1.
Basis of Presentation
HealthSouth Corporation, incorporated in Delaware in 1984, including its subsidiaries, is one of the nation’s largest providers of post-acute healthcare services, offering both facility-based and home-based post-acute services in 34 states and Puerto Rico through its network of inpatient rehabilitation hospitals, home health agencies, and hospice agencies.
The accompanying unaudited condensed consolidated financial statements of HealthSouth Corporation and Subsidiaries should be read in conjunction with the consolidated financial statements and accompanying notes filed with the United States Securities and Exchange Commission in HealthSouth’s Annual Report on Form 10-K filed on February 24, 2016 (the “2015 Form 10-K”). The unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the SEC applicable to interim financial information. Certain information and note disclosures included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been omitted in these interim statements, as allowed by such SEC rules and regulations. The condensed consolidated balance sheet as of December 31, 2015 has been derived from audited financial statements, but it does not include all disclosures required by GAAP. However, we believe the disclosures are adequate to make the information presented not misleading.
The unaudited results of operations for the interim periods shown in these financial statements are not necessarily indicative of operating results for the entire year. In our opinion, the accompanying condensed consolidated financial statements recognize all adjustments of a normal recurring nature considered necessary to fairly state the financial position, results of operations, and cash flows for each interim period presented.
See also Note 12, Segment Reporting.
Variable Interest Entities
Effective January 1, 2016, in connection with our adoption of ASU 2015-02, we updated our evaluation of all jointly held legal entities to determine whether they are now variable interest entities (“VIEs”) under the new guidance. Any entity considered a VIE is evaluated to determine which party is the primary beneficiary and thus should consolidate the VIE. This analysis is complex, involves uncertainties, and requires significant judgment on various matters. In order to determine if we are the primary beneficiary of a VIE, we must determine what activities most significantly impact the economic performance of the entity, whether we have the power to direct those activities, and if our obligation to absorb losses or receive benefits from the VIE could potentially be significant to the VIE.
Net Operating Revenues
We derived consolidated Net operating revenues from the following payor sources:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Medicare
74.8
%
 
75.1
%
 
75.0
%
 
74.8
%
Medicare Advantage
7.9
%
 
7.5
%
 
7.9
%
 
7.8
%
Managed care
10.1
%
 
9.9
%
 
9.9
%
 
10.0
%
Medicaid
3.3
%
 
3.4
%
 
3.3
%
 
3.0
%
Other third-party payors
1.5
%
 
1.5
%
 
1.4
%
 
1.6
%
Workers’ compensation
0.8
%
 
0.8
%
 
0.8
%
 
0.9
%
Patients
0.5
%
 
0.5
%
 
0.5
%
 
0.6
%
Other income
1.1
%
 
1.3
%
 
1.2
%
 
1.3
%
Total
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%



8

HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

Inpatient Rehabilitation Revenues
Our inpatient rehabilitation segment derived its Net operating revenues from the following payor sources:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Medicare
73.3
%
 
73.2
%
 
73.3
%
 
73.0
%
Medicare Advantage
7.6
%
 
7.7
%
 
7.7
%
 
7.9
%
Managed care
11.4
%
 
11.2
%
 
11.3
%
 
11.3
%
Medicaid
3.0
%
 
3.0
%
 
3.0
%
 
2.6
%
Other third-party payors
1.8
%
 
1.7
%
 
1.7
%
 
1.9
%
Workers’ compensation
1.0
%
 
1.0
%
 
1.0
%
 
1.1
%
Patients
0.6
%
 
0.6
%
 
0.6
%
 
0.7
%
Other income
1.3
%
 
1.6
%
 
1.4
%
 
1.5
%
Total
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
Home Health and Hospice Revenues
Our home health and hospice segment derived its Net operating revenues from the following payor sources:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Medicare
81.8
%
 
84.7
%
 
82.4
%
 
84.1
%
Medicare Advantage
8.8
%
 
6.7
%
 
8.9
%
 
7.1
%
Managed care
4.5
%
 
2.9
%
 
3.7
%
 
2.9
%
Medicaid
4.7
%
 
5.7
%
 
4.8
%
 
5.7
%
Other third-party payors
%
 
%
 
%
 
0.1
%
Patients
0.1
%
 
%
 
0.1
%
 
0.1
%
Other income
0.1
%
 
%
 
0.1
%
 
%
Total
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
See Note 1, Summary of Significant Accounting Policies, to the consolidated financial statements accompanying the 2015 Form 10-K for our policies related to Net operating revenues, Accounts receivable, and our Allowance for doubtful accounts.
Recent Accounting Pronouncements
In February 2015, the FASB issued ASU 2015-02, “Consolidations (Topic 810) - Amendments to the Consolidation Analysis,” which provided guidance on evaluating whether a reporting entity should consolidate certain legal entities. Specifically, the amendments modified the evaluation of whether limited partnerships and similar legal entities are VIEs. Under this analysis, limited partnerships and other similar entities are considered a VIE unless the limited partners hold substantive kick-out rights or participating rights. Further, the amendments eliminated the presumption that a general partner should consolidate a limited partnership under the voting interest model, as well as affect the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships. This standard was effective for annual periods beginning after December 15, 2015 and interim periods within those annual periods. We elected to adopt this guidance using the modified retrospective approach. Our adoption of this guidance resulted in certain limited partnership-like entities that were previously consolidated as voting interest entities to now be consolidated as VIEs, for


9

HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

which additional disclosures are required. Our adoption of ASU 2015-02 did not have a material impact on our financial position, results of operations, or cash flows. See Note 3, Variable Interest Entities.
In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842),” in order to increase transparency and comparability by recognizing lease assets and liabilities on the balance sheet and disclosing key information about leasing arrangements. Under the new standard, lessees will recognize a right-of-use asset and a corresponding lease liability for all leases other than leases that meet the definition of a short-term lease. The liability will be equal to the present value of lease payments. The asset will be based on the liability, subject to adjustment, such as for initial direct costs. For income statement purposes, the FASB retained a dual model, requiring leases to be classified as either operating or finance. Operating leases will result in straight-line expense while finance leases will result in an expense pattern similar to current capital leases. Classification will be based on criteria that are similar to those applied in current lease accounting. This standard will be effective for HealthSouth for the annual reporting period beginning after December 15, 2018. Early adoption is permitted. We continue to review the requirements of this standard and its impact on our financial position, results of operations, or cash flows.
In March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting (Topic 718),” to simplify various aspects of share-based payment accounting and presentation. The new standard requires entities to record all of the tax effects related to share-based payments at settlement (or expiration) through the income statement. This will require us to reclassify tax benefits in excess of compensation cost (“windfalls”) and tax deficiencies (“shortfalls”) to the extent of previous windfalls from Capital in excess of par value to Provision for income tax expense. This change is required to be applied prospectively to all excess tax benefits and tax deficiencies resulting from settlements after the date of adoption of the ASU. The standard eliminates the requirement to delay recognition of a windfall tax benefit until it reduces current taxes payable. This change is required to be applied on a modified retrospective basis, with a cumulative-effect adjustment to opening retained earnings. In addition, all income tax-related cash flows resulting from share-based windfall tax benefits are required to be reported as operating activities on the statement of cash flows as opposed to the current presentation as an inflow from financing activities and an outflow from operating activities. Either prospective or retrospective transition of this provision is permitted. Finally, the standard clarifies that all cash payments made to taxing authorities on the employees’ behalf for withheld shares should be presented as financing activities on the statement of cash flows. This change will be applied retrospectively. For HealthSouth, this guidance is effective for annual reporting periods beginning after December 15, 2016 and interim periods within that reporting period. Early adoption is permitted, with any adjustments reflected as of the beginning of the fiscal year of adoption. Upon adoption, we anticipate recognizing our net windfall balance as an increase to Deferred income tax assets and a corresponding decrease to Accumulated deficit. Additionally, the historical and future amount of cash flows resulting from share-based windfall benefits and cash payments made to taxing authorities on the employees’ behalf for withheld shares will result in an increase to our historical and future Cash flows from operating activities and a decrease to Cash flows from financing activities.
In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326),” which provides guidance for accounting for credit losses on financial instruments. The new guidance introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments and modifies the impairment model for available-for-sale debt securities. The new guidance is effective for HealthSouth for the annual period beginning after December 15, 2019 and interim periods within that reporting period. Early adoption is permitted beginning after December 15, 2018. We continue to review the requirements of this standard and any potential impact it may have on our financial position, results of operations, or cash flows.
In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments,” to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. In addition, the standard clarifies when cash receipts and cash payments have aspects of more than one class of cash flows and cannot be separated, classification will depend on the predominant source or use. The new guidance is effective retrospectively for HealthSouth for the annual reporting period beginning after December 15, 2017 and interim periods within that reporting period. Early adoption is permitted. We continue to review the requirements of this standard and any potential impact it may have on our financial position, results of operations, or cash flows.


10

HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

2.
Business Combinations
Inpatient Rehabilitation
In February 2016, we acquired 50% of the inpatient rehabilitation hospital at CHI St. Vincent Hot Springs (“Hot Springs”), a 20-bed inpatient rehabilitation hospital in Hot Springs, Arkansas, through a joint venture with St. Vincent Community Health Services, Inc. The acquisition, which was funded through a contribution to the consolidated joint venture, was not material to our financial position, results of operations, or cash flows.
In August 2016, we acquired 50% of the inpatient rehabilitation hospital at St. Joseph Regional Health Center (“Bryan”), a 19-bed inpatient rehabilitation hospital in Bryan, Texas, through a joint venture with St. Joseph Health System. The acquisition, which was funded through a contribution to the consolidated joint venture, was not material to our financial position, results of operations, or cash flows.
Also in August 2016, we acquired 51% of the inpatient rehabilitation hospital at The Bernsen Rehabilitation Center at St. John (“Broken Arrow”), a 24-bed inpatient rehabilitation hospital in Broken Arrow, Oklahoma, through a joint venture with St. John Health System. The acquisition, which was funded through a contribution to the consolidated joint venture, was not material to our financial position, results of operations, or cash flows.
Each of the above transactions was made to enhance our position and ability to provide inpatient rehabilitation services to patients in the applicable geographic areas. We accounted for these transactions under the acquisition method of accounting and reported the results of operations of the acquired hospitals from their respective dates of acquisition. Assets acquired and liabilities assumed, if any, were recorded at their estimated fair values as of the respective acquisition dates. The fair values of the identifiable intangible assets were based on valuations using the income approach. The income approach is based on management’s estimates of future operating results and cash flows discounted using a weighted-average cost of capital that reflects market participant assumptions. The excess of the fair value of the consideration conveyed over the fair value of the net assets acquired was recorded as goodwill. The goodwill reflects our expectations of our ability to gain access to and penetrate the acquired hospital’s historical patient base and the benefits of being able to leverage operational efficiencies with favorable growth opportunities based on positive demographic trends in these markets. None of the goodwill recorded as a result of these transactions is deductible for federal income tax purposes.
The fair value of the assets acquired at the acquisition date were as follows (in millions):
Property and equipment
$
5.3

Identifiable intangible assets:
 

Noncompete agreements (useful lives of 1 to 3 years)
0.4

Trade names (useful lives of 20 years)
1.0

Goodwill
9.4

Total assets acquired
$
16.1

Information regarding the net cash paid for all inpatient rehabilitation acquisitions during each period presented is as follows (in millions):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Fair value of assets acquired
$
1.4

 
$

 
$
6.7

 
$
62.8

Goodwill
7.6

 

 
9.4

 
0.7

Fair value of liabilities assumed

 

 

 
(2.7
)
Fair value of noncontrolling interest owned by joint venture partner
(9.0
)
 

 
(16.1
)
 
(4.2
)
Net cash paid for acquisition
$

 
$

 
$

 
$
56.6



11

HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

Home Health and Hospice
During the nine months ended September 30, 2016, we completed the following home health and hospice acquisitions, none of which were individually material to our financial position, results of operations, or cash flows. Each acquisition was made to enhance our position and ability to provide post-acute healthcare services to patients in the applicable geographic areas. Each acquisition was funded using cash on hand.
In May, 2016, we acquired Home Health Agency of Georgia, LLC (“Camellia”), a home health and hospice provider with two home health locations and two hospice locations in the Greater Atlanta area.
In July 2016, we acquired Advantage Health Inc. (“Advantage”), a home health provider with one location in Yuma, Arizona.
In September, 2016, we acquired three hospice agencies from Sotto International, Inc. (“Serenity”) located in Texarkana, Arkansas, Magnolia, Arkansas, and Texarkana, Texas.
We accounted for all of these transactions under the acquisition method of accounting and reported the results of operations of the acquired locations from their respective dates of acquisition. Assets acquired and liabilities assumed were recorded at their estimated fair values as of the respective acquisition dates. The fair values of identifiable intangible assets were based on valuations using the cost and income approaches. The cost approach is based on amounts that would be required to replace the asset (i.e., replacement cost). The income approach is based on management’s estimates of future operating results and cash flows discounted using a weighted-average cost of capital that reflects market participant assumptions. The excess of the fair value of the consideration conveyed over the fair value of the net assets acquired was recorded as goodwill. The goodwill reflects our expectations of our ability to utilize the acquired locations’ mobile workforce and established relationships within each community and the benefits of being able to leverage operational efficiencies with favorable growth opportunities based on positive demographic trends in these markets. All goodwill recorded as a result of these transactions is deductible for federal income tax purposes.
The fair value of the assets acquired and liabilities assumed at the acquisition date were as follows (in millions):
Identifiable intangible asset:
 

Noncompete agreements (useful lives of 5 years)
$
0.2

Trade names (useful lives of 1 year)
0.2

Certificate of needs (useful lives of 10 years)
1.9

Licenses (useful lives of 10 years)
1.1

Goodwill
16.3

Total assets acquired
19.7

Total liabilities assumed
(0.1
)
Net assets acquired
$
19.6

Information regarding the net cash paid for home health and hospice acquisitions during each period presented is as follows (in millions):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Fair value of assets acquired
$
1.9

 
$
1.9

 
$
3.4

 
$
10.4

Goodwill
8.3

 
7.5

 
16.3

 
20.3

Fair value of liabilities assumed

 
(0.1
)
 
(0.1
)
 
(0.2
)
Net cash paid for acquisitions
$
10.2

 
$
9.3

 
$
19.6

 
$
30.5



12

HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

Pro Forma Results of Operations
The following table summarizes the results of operations of the above mentioned inpatient rehabilitation hospitals and home health and hospice agencies from their respective dates of acquisition included in our consolidated results of operations and the unaudited pro forma results of operations of the combined entity had the date of the acquisitions been January 1, 2015 (in millions):
 
Net Operating Revenues
 
Net Income Attributable to HealthSouth
Acquired entities only: Actual from acquisition date to September 30, 2016
$
8.7

 
$
(2.3
)
Combined entity: Supplemental pro forma from 07/01/2016-09/30/2016
929.2

 
62.0

Combined entity: Supplemental pro forma from 07/01/2015-09/30/2015
786.7

 
51.4

Combined entity: Supplemental pro forma from 01/01/2016-09/30/2016
2,773.9

 
184.0

Combined entity: Supplemental pro forma from 01/01/2015-09/30/2015
2,308.2

 
136.8

See Note 2, Business Combinations, to the consolidated financial statements accompanying the 2015 Form 10-K for information regarding acquisitions completed in 2015.
3.
Variable Interest Entities
As of September 30, 2016, we consolidated ten limited partnership-like entities that are VIEs and of which we are the primary beneficiary. All ten of these entities were also consolidated as of December 31, 2015. Our ownership percentages in these entities range from 6.8% to 99.5%. Through partnership and management agreements with or governing each of these entities, we manage all of these entities and handle all day-to-day operating decisions. Accordingly, we have the decision making power over the activities that most significantly impact the economic performance of our VIEs and an obligation to absorb losses or receive benefits from the VIE that could potentially be significant to the VIE. These decisions and significant activities include, but are not limited to, marketing efforts, oversight of patient admissions, medical training, nurse and therapist scheduling, provision of healthcare services, billing, collections and creation and maintenance of medical records. The terms of the agreements governing each of our VIEs prohibit us from using the assets of each VIE to satisfy the obligations of other entities.


13

HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

The carrying amounts and classifications of the consolidated VIEs’ assets and liabilities, which are included in our consolidated balance sheet, are as follows (in millions):
 
September 30, 2016
Assets
 
Current assets:
 
Cash and cash equivalents
$
1.2

Accounts receivable, net of allowance for doubtful accounts
32.3

Other current assets
3.1

Total current assets
36.6

Property and equipment, net
137.6

Goodwill
73.5

Intangible assets, net
9.3

Other long-term assets
1.0

Total assets
$
258.0

Liabilities
 
Current liabilities:
 
Current portion of long-term debt
$
1.4

Accounts payable
7.0

Accrued expenses and other current liabilities
12.5

Total current liabilities
20.9

Long-term debt, net of current portion
30.2

Total liabilities
$
51.1

4.
Investments in and Advances to Nonconsolidated Affiliates
As of September 30, 2016 and December 31, 2015, we had $13.0 million and $11.7 million, respectively, of investments in and advances to nonconsolidated affiliates included in Other long-term assets in our condensed consolidated balance sheets. Investments in and advances to nonconsolidated affiliates represent our investments in seven partially owned subsidiaries, of which six are general or limited partnerships, limited liability companies, or joint ventures in which HealthSouth or one of its subsidiaries is a general or limited partner, managing member, member, or venturer, as applicable. We do not control these affiliates but have the ability to exercise significant influence over the operating and financial policies of certain of these affiliates. Our ownership percentages in these affiliates range from approximately 1% to 60%. We account for these investments using the cost and equity methods of accounting.
The following summarizes the combined results of operations of our equity method affiliates (on a 100% basis, in millions):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Net operating revenues
$
11.3

 
$
9.2

 
$
33.4

 
$
26.3

Operating expenses
(6.0
)
 
(4.0
)
 
(18.1
)
 
(11.7
)
Income from continuing operations, net of tax
5.2

 
5.1

 
15.2

 
13.8

Net income
5.2

 
5.1

 
15.2

 
13.8



14

HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

5.
Long-term Debt
Our long-term debt outstanding consists of the following (in millions):
 
September 30, 2016
 
December 31, 2015
Credit Agreement—
 
 
 
Advances under revolving credit facility
$
150.0

 
$
130.0

Term loan facilities
426.8

 
443.3

Bonds payable—
 
 
 
7.75% Senior Notes due 2022

 
174.3

5.125% Senior Notes due 2023
295.1

 
294.6

5.75% Senior Notes due 2024
1,193.1

 
1,192.6

5.75% Senior Notes due 2025
343.7

 
343.4

2.00% Convertible Senior Subordinated Notes due 2043
273.2

 
265.9

Other notes payable
47.1

 
39.2

Capital lease obligations
281.8

 
288.2

 
3,010.8

 
3,171.5

Less: Current portion
(36.8
)
 
(36.8
)
Long-term debt, net of current portion
$
2,974.0

 
$
3,134.7

The following chart shows scheduled principal payments due on long-term debt for the next five years and thereafter (in millions):
 
Face Amount
 
Net Amount
October 1 through December 31, 2016
$
8.7

 
$
8.7

2017
37.3

 
37.3

2018
37.8

 
37.8

2019
40.4

 
40.4

2020
834.2

 
786.1

2021
10.7

 
10.7

Thereafter
2,108.0

 
2,089.8

Total
$
3,077.1

 
$
3,010.8

On February 23, 2016, we gave notice of, and made an irrevocable commitment for, the redemption of $50 million of the outstanding principal amount of our existing 7.75% Senior Notes due 2022 (the “2022 Notes”). On March 24, 2016, we completed this redemption using cash on hand and capacity under our revolving credit facility. Pursuant to the terms of the 2022 Notes, this optional redemption was made at a price of 103.875%, which resulted in a total cash outlay of approximately $52 million. As a result of this redemption, we recorded a $2.4 million Loss on early extinguishment of debt in the first quarter of 2016.
On April 6, 2016, we gave notice of, and made an irrevocable commitment for, the redemption of an additional $50 million of the outstanding principal amount of the 2022 Notes. On May 6, 2016, we completed this redemption using cash on hand and capacity under our revolving credit facility. Pursuant to the terms of the 2022 Notes, this optional redemption was also made at a price of 103.875%, which resulted in a total cash outlay of approximately $52 million. As a result of this redemption, we recorded a $2.4 million Loss on early extinguishment of debt in the second quarter of 2016.
On July 28, 2016, we gave notice of, and made an irrevocable commitment for, the redemption of the remaining outstanding principal balance of $76.0 million of the 2022 Notes. On September 15, 2016, we completed this redemption using


15

HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

cash on hand and capacity under our revolving credit facility. Pursuant to the terms of the 2022 Notes, this optional redemption was made at a price of 102.583%, which resulted in a total cash outlay of approximately $78 million. As a result of this redemption, we recorded a $2.6 million Loss on early extinguishment of debt in the third quarter of 2016.
In February 2016, we entered into a development/lease agreement with CR HQ, LLC (the “Developer”) to construct our new corporate headquarters in Birmingham, Alabama. Under the terms of this agreement, the Developer is responsible for all costs of constructing the new facility ‘shell’ which will then be leased to us for an initial term of 15 years with four, five-year renewal options. The lease is expected to commence in the first half of 2018. We are responsible for the costs associated with improvements to the interior of the building. Due to the nature and extent of the tenant improvements we will be making to the new corporate headquarters and certain provisions of the development/lease agreement, we are deemed to be the accounting owner of the new corporate headquarters during the construction period. Construction commenced in the second quarter of 2016. Accordingly, we increased Property and equipment, net by $10.3 million, based on the construction costs incurred to date by the Developer, and recorded a corresponding noncurrent financing obligation liability of $10.3 million in Long-term debt, net of current portion within our condensed consolidated balance sheet as of September 30, 2016. The total financing obligation associated with the Developer’s costs to construct the new corporate headquarters is estimated at $56 million. The amounts recorded for construction costs and the corresponding liability are non-cash activities for purposes of our condensed consolidated statement of cash flows.
For additional information regarding our indebtedness, see Note 8, Long-term Debt, to the consolidated financial statements accompanying the 2015 Form 10-K.
6.
Redeemable Noncontrolling Interests
The following is a summary of the activity related to our Redeemable noncontrolling interests during the nine months ended September 30, 2016 and 2015 (in millions):
 
Nine Months Ended September 30,
 
2016
 
2015
Balance at beginning of period
$
121.1

 
$
84.7

Net income attributable to noncontrolling interests
11.2

 
10.1

Distributions declared
(6.4
)
 
(5.6
)
Change in fair value
(16.5
)
 
24.9

Balance at end of period
$
109.4

 
$
114.1

The following table reconciles the net income attributable to nonredeemable Noncontrolling interests, as recorded in the shareholders’ equity section of the condensed consolidated balance sheets, and the net income attributable to Redeemable noncontrolling interests, as recorded in the mezzanine section of the condensed consolidated balance sheets, to the Net income attributable to noncontrolling interests presented in the condensed consolidated statements of operations for the three and nine months ended September 30, 2016 and 2015 (in millions):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
Net income attributable to nonredeemable noncontrolling interests
$
12.7

 
$
13.4

 
$
42.5

 
$
40.8

Net income attributable to redeemable noncontrolling interests
3.7

 
3.7

 
11.2

 
10.1

Net income attributable to noncontrolling interests
$
16.4

 
$
17.1

 
$
53.7

 
$
50.9



16

HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

7.
Fair Value Measurements
Our financial assets and liabilities that are measured at fair value on a recurring basis are as follows (in millions):
 
 
 
Fair Value Measurements at Reporting Date Using
As of September 30, 2016
Fair Value
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
 
Valuation Technique (1)
Other current assets:
 
 
 
 
 
 
 
 
 
Current portion of restricted marketable securities
$
24.2

 
$

 
$
24.2

 
$

 
M
Other long-term assets:
 
 
 
 
 
 
 
 
 
Restricted marketable securities
33.3

 

 
33.3

 

 
M
Redeemable noncontrolling interests
109.4

 

 

 
109.4

 
I
As of December 31, 2015
 
 
 
 
 
 
 
 
 
Other current assets:
 
 
 
 
 
 
 
 
 
Current portion of restricted marketable securities
$
16.1

 
$

 
$
16.1

 
$

 
M
Other long-term assets:
 
 
 
 
 
 
 
 
 
Restricted marketable securities
40.1

 

 
40.1

 

 
M
Redeemable noncontrolling interests
121.1

 

 

 
121.1

 
I
(1) The three valuation techniques are: market approach (M), cost approach (C), and income approach (I).
The fair values of our financial assets and liabilities are determined as follows:
Restricted marketable securities - The fair values of our available-for-sale restricted marketable securities are determined based on quoted market prices in active markets or quoted prices, dealer quotations, or alternative pricing sources supported by observable inputs in markets that are not considered to be active.
Redeemable noncontrolling interests - The fair value of the Redeemable noncontrolling interest related to our home health segment is determined using the product of a twelve-month specified performance measure and a specified median market price multiple based on a basket of public health companies. To determine the fair value of the Redeemable noncontrolling interests in our joint venture hospitals, we use the applicable hospitals’ projected operating results and cash flows discounted using a rate that reflects market participant assumptions for the applicable facilities. The projected operating results use management’s best estimates of economic and market conditions over the forecasted periods including assumptions for pricing and volume, operating expenses, and capital expenditures. See also Note 6, Redeemable Noncontrolling Interests.
In addition to assets and liabilities recorded at fair value on a recurring basis, we are also required to record assets and liabilities at fair value on a nonrecurring basis. Generally, assets are recorded at fair value on a nonrecurring basis as a result of impairment charges or similar adjustments made to the carrying value of the applicable assets. During the three and nine months ended September 30, 2016 and September 30, 2015, we did not record any gains or losses related to our nonfinancial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis as part of our continuing operations.


17

HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

As discussed in Note 1, Summary of Significant Accounting Policies, “Fair Value Measurements,” to the consolidated financial statements accompanying the 2015 Form 10-K, the carrying value equals fair value for our financial instruments that are not included in the table below and are classified as current in our condensed consolidated balance sheets. The carrying amounts and estimated fair values for all of our other financial instruments are presented in the following table (in millions):
 
As of September 30, 2016
 
As of December 31, 2015
 
Carrying Amount
 
Estimated Fair Value
 
Carrying Amount
 
Estimated Fair Value
Long-term debt:
 

 
 

 
 

 
 

Advances under revolving credit facility
$
150.0

 
$
150.0

 
$
130.0

 
$
130.0

Term loan facilities
426.8

 
428.1

 
443.3

 
445.0

7.75% Senior Notes due 2022

 

 
174.3

 
183.7

5.125% Senior Notes due 2023
295.1

 
299.3

 
294.6

 
288.0

5.75% Senior Notes due 2024
1,193.1

 
1,239.0

 
1,192.6

 
1,146.0

5.75% Senior Notes due 2025
343.7

 
364.9

 
343.4

 
332.5

2.00% Convertible Senior Subordinated Notes due 2043
273.2

 
377.3

 
265.9

 
345.0

Other notes payable
47.1

 
47.1

 
39.2

 
39.2

Financial commitments:
 
 
 
 
 
 
 
Letters of credit

 
33.3

 

 
34.2

Fair values for our long-term debt and financial commitments are determined using inputs, including quoted prices in nonactive markets, that are observable either directly or indirectly, or Level 2 inputs within the fair value hierarchy. See Note 1, Summary of Significant Accounting Policies, “Fair Value Measurements,” to the consolidated financial statements accompanying the 2015 Form 10-K.
8.
Share-Based Payments
In February and May 2016, we issued a total of 0.8 million restricted stock awards to members of our management team and our board of directors. Approximately 0.2 million of these awards contain only a service condition, while the remainder contain both a service and a performance condition. For the awards that include a performance condition, the number of shares that will ultimately be granted to employees may vary based on the Company’s performance during the applicable two-year performance measurement period. Additionally, in February 2016, we granted 0.1 million stock options to members of our management team. The fair value of these awards and options was determined using the policies described in Note 1, Summary of Significant Accounting Policies, and Note 13, Share-Based Payments, to the consolidated financial statements accompanying the 2015 Form 10-K.
9.
Income Taxes
Our Provision for income tax expense of $42.1 million and $124.2 million for the three and nine months ended September 30, 2016, respectively, primarily resulted from the application of our estimated effective blended federal and state income tax rate. Our Provision for income tax expense of $35.9 million and $98.4 million for the three and nine months ended September 30, 2015, respectively, primarily resulted from the application of our estimated effective blended federal and state income tax rate.
The $72.6 million of net deferred tax assets included in the accompanying condensed consolidated balance sheet as of September 30, 2016 reflects management’s assessment it is more likely than not we will be able to generate sufficient future taxable income to utilize those deferred tax assets based on our current estimates and assumptions. As of September 30, 2016, we maintained a valuation allowance of $28.3 million due to uncertainties regarding our ability to utilize a portion of our state net operating losses (“NOLs”) and other credits before they expire. The amount of the valuation allowance has been determined for each tax jurisdiction based on the weight of all available evidence including management’s estimates of taxable income for each jurisdiction in which we operate over the periods in which the related deferred tax assets will be recoverable. It is possible


18

HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

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 jurisdictions, or if the timing of future tax deductions differs from our expectations.
As of September 30, 2016, we estimate the tax benefit of combined federal NOLs and tax credits to be approximately $18 million. There is $15.6 million related to operating loss carryforwards resulting from excess tax benefits related to share-based awards, the benefits of which, when recognized, will be accounted for as a credit to Capital in excess of par value when they reduce taxes payable. Federal NOLs and tax credits expire in various amounts at varying times through 2036. We also have state NOLs that expire in various amounts at varying times through 2031.
During the three months ended September 30, 2016, we filed an automatic tax accounting method change related to the deductibility of bad debts pursuant to the non-accrual experience method which resulted in a tax benefit of approximately $7 million. This change did not have a material impact on our effective tax rate. We also filed a non-automatic tax accounting method change related to billings denied under pre-payment claims reviews conducted by certain of our Medicare Administrative Contractors and are awaiting acceptance by the IRS. If our request for the non-automatic tax accounting method change is accepted as filed, we anticipate additional tax benefits of approximately $50 million through September 30, 2016. Approximately $44 million of this amount represents pre-payment claims received in years prior to and including the year ending December 31, 2015. This change, if approved, is not expected to have a material impact on our effective tax rate.
Total remaining gross unrecognized tax benefits were $2.8 million and $2.9 million as of September 30, 2016 and December 31, 2015, respectively, all of which would affect our effective tax rate if recognized. A reconciliation of the beginning and ending liability for unrecognized tax benefits is as follows (in millions):
 
Gross Unrecognized Income Tax Benefits
Balance at December 31, 2015
$
2.9

Gross amount of increases in unrecognized tax benefits related to prior periods
0.3

Gross amount of decreases in unrecognized tax benefits related to prior periods
(0.4
)
Gross amount of increases in unrecognized tax benefits related to current periods
0.1

Gross amount of decreases in unrecognized tax benefits related to current periods
(0.1
)
Balance at September 30, 2016
$
2.8

Our continuing practice is to recognize interest and penalties related to income tax matters in income tax expense. Interest recorded as part of our income tax provision during the three and nine months ended September 30, 2016 and 2015 was not material. Accrued interest income related to income taxes as of September 30, 2016 and December 31, 2015 was not material.
In December 2014, we signed an agreement with the IRS to begin participating in their Compliance Assurance Process, a program in which we and the IRS endeavor to agree on the treatment of significant tax positions prior to the filing of our federal income tax return. We signed a new agreement in December 2015 for the 2016 tax year. As a result of these agreements, the IRS surveyed our 2013, 2012 and 2011 federal income tax returns, will examine our 2016 return when filed and is currently examining our 2015 return. Our 2014 federal income tax return has been filed, and the IRS has not indicated its intent to examine or survey this return. We have settled federal income tax examinations with the IRS for all tax years through 2013. Our state income tax returns are also periodically examined by various regulatory taxing authorities. We are currently under audit by five states for tax years ranging from 2007 through 2014.
For the tax years that remain open under the applicable statutes of limitation, amounts related to unrecognized tax benefits have been considered by management in its estimate of our potential net recovery of prior years’ income taxes. Based on discussions with taxing authorities, we anticipate up to $2.6 million of our unrecognized tax benefits may be released within the next 12 months.


19

HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

10.Earnings per Common Share
The following table sets forth the computation of basic and diluted earnings per common share (in millions, except per share amounts):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Basic:
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
Income from continuing operations
$
78.2

 
$
67.5

 
$
236.3

 
$
188.6

Less: Net income attributable to noncontrolling interests included in continuing operations
(16.4
)
 
(17.1
)
 
(53.7
)
 
(50.9
)
Less: Income allocated to participating securities
(0.2
)
 
(0.3
)
 
(0.6
)
 
(0.9
)
Less: Convertible perpetual preferred stock dividends

 

 

 
(1.6
)
Income from continuing operations attributable to HealthSouth common shareholders
61.6

 
50.1

 
182.0

 
135.2

(Loss) income from discontinued operations, net of tax, attributable to HealthSouth common shareholders
(0.1
)
 
0.3

 
(0.3
)
 
(1.6
)
Net income attributable to HealthSouth common shareholders
$
61.5

 
$
50.4

 
$
181.7

 
$
133.6

Denominator:
 
 
 
 
 
 
 
Basic weighted average common shares outstanding
89.1

 
90.6

 
89.3

 
89.1

Basic earnings per share attributable to HealthSouth common shareholders:
 
 
 
 
 
 
 
Continuing operations
$
0.69

 
$
0.56

 
$
2.03

 
$
1.52

Discontinued operations

 

 

 
(0.02
)
Net income
$
0.69

 
$
0.56

 
$
2.03

 
$
1.50

 
 
 
 
 
 
 
 
Diluted:
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
Income from continuing operations
$
78.2

 
$
67.5

 
$
236.3

 
$
188.6

Less: Net income attributable to noncontrolling interests included in continuing operations
(16.4
)
 
(17.1
)
 
(53.7
)
 
(50.9
)
Add: Interest on convertible debt, net of tax
2.4

 
2.4

 
7.2

 
7.0

Income from continuing operations attributable to HealthSouth common shareholders
64.2

 
52.8

 
189.8

 
144.7

(Loss) income from discontinued operations, net of tax, attributable to HealthSouth common shareholders
(0.1
)
 
0.3

 
(0.3
)
 
(1.6
)
Net income attributable to HealthSouth common shareholders
$
64.1

 
$
53.1

 
$
189.5

 
$
143.1

Denominator:
 
 
 
 
 
 
 
Diluted weighted average common shares outstanding
99.4

 
101.5

 
99.5

 
101.4

Diluted earnings per share attributable to HealthSouth common shareholders:
 
 
 
 
 
 
 
Continuing operations
$
0.64

 
$
0.52

 
$
1.90

 
$
1.43

Discontinued operations

 

 

 
(0.02
)
Net income
$
0.64

 
$
0.52

 
$
1.90

 
$
1.41



20

HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

The following table sets forth the reconciliation between basic weighted average common shares outstanding and diluted weighted average common shares outstanding (in millions):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Basic weighted average common shares outstanding
89.1

 
90.6

 
89.3

 
89.1

Convertible perpetual preferred stock

 

 

 
1.3

Convertible senior subordinated notes
8.5

 
8.4

 
8.5

 
8.3

Restricted stock awards, dilutive stock options, restricted stock units, and common stock warrants
1.8

 
2.5

 
1.7

 
2.7

Diluted weighted average common shares outstanding
99.4

 
101.5

 
99.5

 
101.4

In October 2015, February 2016, and May 2016, our board of directors declared cash dividends of $0.23 per share that were paid in January 2016, April 2016, and July 2016, respectively. On July 21, 2016, our board of directors approved an increase in our quarterly dividend and declared a cash dividend of $0.24 per share, payable on October 17, 2016 to stockholders of record on October 3, 2016. On October 20, 2016, our board of directors declared a cash dividend of $0.24 per share, payable on January 17, 2017 to stockholders of record on January 3, 2017. As of September 30, 2016 and December 31, 2015, accrued common stock dividends of $22.3 million and $21.3 million, respectively, were included in Accrued expenses and other current liabilities in our condensed consolidated balance sheets. Future dividend payments are subject to declaration by our board of directors.
On April 22, 2015, we delivered notice of the exercise of our rights to force conversion of all outstanding shares of our Convertible perpetual preferred stock (par value of $0.10 per share and liquidation preference of $1,000 per share) pursuant to the underlying certificate of designations. The effective date of the conversion was April 23, 2015. On that date, each share of preferred stock automatically converted into 33.9905 shares of our common stock (par value of $0.01 per share). We completed the forced conversion by issuing and delivering in the aggregate 3,271,415 shares of our common stock to the registered holders of the 96,245 shares of the preferred stock outstanding and paying cash in lieu of fractional shares due to those holders.
The indenture underlying our convertible notes includes antidilutive protection that requires adjustments to the number of shares of common stock issuable upon conversion and the exercise price for common stock upon the occurrence of certain events, including payment of cash dividends on our common stock after a de minimis threshold. At issuance, the convertible notes had a conversion price of $39.65 per share, which was equal to an initial conversion rate of 25.2194 shares per $1,000 principal amount of the convertible notes. The payment of dividends on our common stock has triggered and will continue to trigger, from time to time, the antidilutive adjustment provisions of the convertible notes. The current conversion price of the convertible notes is $37.16 per share, and the conversion rate is 26.9106 for each $1,000 principal amount of the convertible notes.
See Note 8, Long-term Debt, Note 10, Convertible Perpetual Preferred Stock, and Note 16, Earnings per Common Share, to the consolidated financial statements accompanying the 2015 Form 10-K for additional information related to our convertible notes, common stock, common stock warrants, and convertible perpetual preferred stock.
11.
Contingencies and Other Commitments
We operate in a highly regulated and litigious industry. As a result, various lawsuits, claims, and legal and regulatory proceedings have been and can be expected to be instituted or asserted against us. The resolution of any such lawsuits, claims, or legal and regulatory proceedings could materially and adversely affect our financial position, results of operations, and cash flows in a given period.
Nichols Litigation—
We have been named as a defendant in a lawsuit filed March 28, 2003 by several individual stockholders in the Circuit Court of Jefferson County, Alabama, captioned Nichols v. HealthSouth Corp. The plaintiffs allege that we, some of our former


21

HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

officers, and our former investment bank engaged in a scheme to overstate and misrepresent our earnings and financial position. The plaintiffs are seeking compensatory and punitive damages. This case was stayed in the Circuit Court on August 8, 2005. The plaintiffs filed an amended complaint on November 9, 2010 to which we responded with a motion to dismiss filed on December 22, 2010. During a hearing on February 24, 2012, plaintiffs’ counsel indicated his intent to dismiss certain claims against us. Instead, on March 9, 2012, the plaintiffs amended their complaint to include additional securities fraud claims against HealthSouth and add several former officers to the lawsuit. On September 12, 2012, the plaintiffs further amended their complaint to request certification as a class action. One of those named officers has repeatedly attempted to remove the case to federal district court, most recently on December 11, 2012. We filed our latest motion to remand the case back to state court on January 10, 2013. On September 27, 2013, the federal court remanded the case back to state court. On November 25, 2014, the plaintiffs filed another amended complaint to assert new allegations relating to the time period of 1997 to 2002. On December 10, 2014, we filed a motion to dismiss on the grounds the plaintiffs lack standing because their claims are derivative in nature, and the claims are time-barred by the statute of limitations. On May 26, 2016, the court granted our motion to dismiss. The plaintiffs appealed the dismissal of the case to the Supreme Court of Alabama on June 28, 2016. The Supreme Court has not yet scheduled a hearing on the appeal.
We intend to vigorously defend ourselves in this case. Based on the stage of litigation, review of the current facts and circumstances as we understand them, the nature of the underlying claim, the results of the proceedings to date, and the nature and scope of the defense we continue to mount, we do not believe an adverse judgment or settlement is probable in this matter, and it is also not possible to estimate the amount of loss, if any, or range of possible loss that might result from an adverse judgment or settlement of this case.
Other Litigation—
One of our hospital subsidiaries was named as a defendant in a lawsuit filed August 12, 2013 by an individual in the Circuit Court of Etowah County, Alabama, captioned Honts v. HealthSouth Rehabilitation Hospital of Gadsden, LLC. The plaintiff alleged that her mother, who died more than three months after being discharged from our hospital, received an unprescribed opiate medication at the hospital. We deny the patient received any such medication, accounted for all the opiates at the hospital and argued the plaintiff established no causal liability between the actions of our staff and her mother’s death. The plaintiff sought recovery for punitive damages. On May 18, 2016, the jury in this case returned a verdict in favor of the plaintiff for $20.0 million. On June 17, 2016, we filed a renewed motion for judgment as a matter of law or, in the alternative, a motion for new trial or, in the further alternative, a motion seeking reduction of the damages awarded (collectively, the “post-judgment motions”). The trial court denied the post-judgment motions. We appealed the verdict as well as the rulings on the post-judgment motions to the Supreme Court of Alabama on October 12, 2016. The Supreme Court has not yet scheduled a hearing on the appeal. We posted a bond in the amount of the judgment pending resolution of our appeal. We intend to vigorously defend ourselves in this case. Although we continue to believe in the merit of our defenses and counterarguments, we have recorded a liability of $21.0 million (including $1.0 million