HLS 10Q 3/31/13

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 March 31, 2013
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 87,222,227 shares of common stock outstanding, net of treasury shares, as of April 22, 2013.



TABLE OF CONTENTS

 
 
Page
 
 
 
 
 
 
   
 
 
 
 


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.


i


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, regulatory investigations, our business strategy, our dividend and stock repurchase strategies, our financial plans, our growth plans, our future financial performance, our projected business results, our effective income tax rates, our leverage ratio, or our projected capital expenditures. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “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 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, 2012;
•
uncertainties and factors discussed 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 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, 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;
•
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;
•
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 involving us, including the ongoing investigations 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 disruptions or incidents affecting the proper operation, availability, or security of our information systems;
•
the price of our common or preferred stock as it affects our willingness and ability to repurchase shares;
•
our ability to attract and retain key management personnel; and
•
general conditions in the economy and capital markets.
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 March 31,
 
2013
 
2012
 
(In Millions, Except Per Share Data)
Net operating revenues
$
572.6

 
$
538.6

Less: Provision for doubtful accounts
(7.4
)
 
(6.3
)
Net operating revenues less provision for doubtful accounts
565.2

 
532.3

Operating expenses:
 

 
 

Salaries and benefits
274.6

 
261.0

Other operating expenses
78.1

 
73.8

Occupancy costs
12.2

 
12.5

Supplies
26.2

 
26.5

General and administrative expenses
30.2

 
30.0

Depreciation and amortization
22.1

 
19.5

Professional fees—accounting, tax, and legal
1.4

 
3.6

Total operating expenses
444.8

 
426.9

Interest expense and amortization of debt discounts and fees
24.2

 
23.3

Other income
(0.7
)
 
(0.9
)
Equity in net income of nonconsolidated affiliates
(2.9
)
 
(3.3
)
Income from continuing operations before income tax expense
99.8

 
86.3

Provision for income tax expense
33.5

 
29.1

Income from continuing operations
66.3

 
57.2

Loss from discontinued operations, net of tax
(0.4
)
 
(0.4
)
Net income
65.9

 
56.8

Less: Net income attributable to noncontrolling interests
(14.6
)
 
(12.6
)
Net income attributable to HealthSouth
51.3

 
44.2

Less: Convertible perpetual preferred stock dividends
(5.7
)
 
(6.4
)
Less: Repurchase of convertible perpetual preferred stock
—

 
(0.5
)
Net income attributable to HealthSouth common shareholders
$
45.6

 
$
37.3

Weighted average common shares outstanding:
 

 
 

Basic
94.0

 
94.5

Diluted
107.1

 
108.7

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

 
 

Continuing operations
$
0.49

 
$
0.40

Discontinued operations
—

 
(0.01
)
Net income
$
0.49

 
$
0.39

Diluted earnings per share attributable to HealthSouth common shareholders:
 
 
 
Continuing operations
$
0.48

 
$
0.40

Discontinued operations
—

 
(0.01
)
Net income
$
0.48

 
$
0.39

Amounts attributable to HealthSouth common shareholders:
 
 
 

Income from continuing operations
$
51.7

 
$
44.6

Loss from discontinued operations, net of tax
(0.4
)
 
(0.4
)
Net income attributable to HealthSouth
$
51.3

 
$
44.2


The accompanying notes to condensed consolidated financial statements are an integral part of these condensed statements.
1

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

 
Three Months Ended March 31,
 
2013
 
2012
 
(In Millions)
COMPREHENSIVE INCOME
 
 
 
Net income
$
65.9

 
$
56.8

Other comprehensive income, net of tax:
 

 
 

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

 
 

Unrealized net holding gain arising during the period
0.1

 
0.8

Other comprehensive income, net of tax
0.1

 
0.8

Comprehensive income
66.0

 
57.6

Comprehensive income attributable to noncontrolling interests
(14.6
)
 
(12.6
)
Comprehensive income attributable to HealthSouth
$
51.4

 
$
45.0


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

HealthSouth Corporation and Subsidiaries
Condensed Consolidated Balance Sheets
(Unaudited)

 
March 31,
2013
 
December 31,
2012
 
(In Millions)
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
80.1

 
$
132.8

Accounts receivable, net of allowance for doubtful accounts of $30.2 in 2013; $28.7 in 2012
266.3

 
249.3

Deferred income tax assets
137.5

 
137.5

Other current assets
113.4

 
117.2

Total current assets
597.3

 
636.8

Property and equipment, net
764.2

 
748.0

Goodwill
443.4

 
437.3

Intangible assets, net
82.7

 
73.2

Deferred income tax assets
359.8

 
393.5

Other long-term assets
144.9

 
135.4

Total assets
$
2,392.3

 
$
2,424.2

Liabilities and Shareholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
61.2

 
$
45.3

Accrued expenses and other current liabilities
255.8

 
255.6

Total current liabilities
317.0

 
300.9

Long-term debt, net of current portion
1,365.3

 
1,239.9

Other long-term liabilities
130.5

 
130.5

 
1,812.8

 
1,671.3

Commitments and contingencies


 


Convertible perpetual preferred stock
342.2

 
342.2

Redeemable noncontrolling interests
13.8

 
7.2

Shareholders’ equity:
 

 
 

HealthSouth shareholders’ equity
 
 
 
Common stock, $.01 par value; 200,000,000 shares authorized; issued: 101,826,251 in 2013; 100,919,297 in 2012
1.0

 
1.0

Capital in excess of par value
2,882.3

 
2,876.6

Accumulated deficit
(2,373.4
)
 
(2,424.7
)
Accumulated other comprehensive income
1.5

 
1.4

Treasury stock, at cost (14,606,381 shares in 2013 and 5,233,521 shares in 2012)
(403.1
)
 
(163.3
)
Total HealthSouth shareholders’ equity
108.3

 
291.0

Noncontrolling interests
115.2

 
112.5

Total shareholders’ equity
223.5

 
403.5

Total liabilities and shareholders’ equity
$
2,392.3

 
$
2,424.2


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

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


 
Three Months Ended March 31, 2013
 
(In Millions)
 
HealthSouth Common Shareholders
 
 
 
 
 
Number of Common
Shares Outstanding
 
Common Stock
 
Capital in Excess of
Par Value
 
Accumulated
Deficit
 
Accumulated Other
Comprehensive
Income
 
Treasury Stock
 
Noncontrolling
Interests
 
Total
Balance at beginning of period
95.7

 
$
1.0

 
$
2,876.6

 
$
(2,424.7
)
 
$
1.4

 
$
(163.3
)
 
$
112.5

 
$
403.5

Net income
—

 
—

 
—

 
51.3

 
—

 
—

 
13.3

 
64.6

Receipt of treasury stock
(0.2
)
 
—

 
—

 
—

 
—

 
(5.4
)
 
—

 
(5.4
)
Dividends declared on convertible perpetual preferred stock
—

 
—

 
(5.7
)
 
—

 
—

 
—

 
—

 
(5.7
)
Stock-based compensation
—

 
—

 
6.3

 
—

 
—

 
—

 
—

 
6.3

Distributions declared
—

 
—

 
—

 
—

 
—

 
—

 
(10.6
)
 
(10.6
)
Repurchases of common stock through tender offer
(9.1
)
 
—

 
—

 
—

 
—

 
(234.1
)
 
—

 
(234.1
)
Other
0.8

 
—

 
5.1

 
—

 
0.1

 
(0.3
)
 
—

 
4.9

Balance at end of period
87.2

 
$
1.0

 
$
2,882.3

 
$
(2,373.4
)
 
$
1.5

 
$
(403.1
)
 
$
115.2

 
$
223.5


 
Three Months Ended March 31, 2012
 
(In Millions)
 
HealthSouth Common Shareholders
 
 
 
 
 
Number of Common Shares Outstanding
 
Common Stock
 
Capital in Excess of Par Value
 
Accumulated Deficit
 
Accumulated Other Comprehensive (Loss) Income
 
Treasury Stock
 
Noncontrolling Interests
 
Total
Balance at beginning of period
95.2

 
$
1.0

 
$
2,874.1

 
$
(2,609.7
)
 
$
(0.2
)
 
$
(148.8
)
 
$
84.6

 
$
201.0

Net income
—

 
—

 
—

 
44.2

 
—

 
—

 
11.6

 
55.8

Receipt of treasury stock
(0.7
)
 
—

 
—

 
—

 
—

 
(11.8
)
 
—

 
(11.8
)
Dividends declared on convertible perpetual preferred stock
—

 
—

 
(6.4
)
 
—

 
—

 
—

 
—

 
(6.4
)
Stock-based compensation
—

 
—

 
6.1

 
—

 
—

 
—

 
—

 
6.1

Distributions declared
—

 
—

 
—

 
—

 
—

 
—

 
(9.7
)
 
(9.7
)
Other
1.1

 
—

 
(0.2
)
 
—

 
0.8

 
(0.3
)
 
—

 
0.3

Balance at end of period
95.6

 
$
1.0

 
$
2,873.6

 
$
(2,565.5
)
 
$
0.6

 
$
(160.9
)
 
$
86.5

 
$
235.3


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 Cash Flows
(Unaudited)


 
Three Months Ended March 31,
 
2013
 
2012
 
(In Millions)
Cash flows from operating activities:
 
 
 
Net income
$
65.9

 
$
56.8

Loss from discontinued operations
0.4

 
0.4

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

 
 

Provision for doubtful accounts
7.4

 
6.3

Depreciation and amortization
22.1

 
19.5

Equity in net income of nonconsolidated affiliates
(2.9
)
 
(3.3
)
Distributions from nonconsolidated affiliates
3.4

 
3.3

Stock-based compensation
6.3

 
6.1

Deferred tax expense
31.7

 
27.0

Other
0.8

 
1.4

(Increase) decrease in assets—
 
 
 

Accounts receivable
(24.3
)
 
(27.5
)
Other assets
1.4

 
(4.0
)
Increase (decrease) in liabilities—
 
 
 

Accounts payable
12.1

 
6.0

Other liabilities
(2.2
)
 
(11.4
)
Net cash (used in) provided by operating activities of discontinued operations
(0.7
)
 
0.4

Total adjustments
55.1

 
23.8

Net cash provided by operating activities
121.4

 
81.0

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(30.1
)
 
(27.2
)
Capitalized software costs
(8.1
)
 
(6.9
)
Escrow deposit — acquisition of business
(11.0
)
 
—

Other
1.3

 
1.2

Net cash used in investing activities
(47.9
)
 
(32.9
)
Cash flows from financing activities:
 
 
 
Borrowings on revolving credit facility
122.0

 
25.0

Payments on revolving credit facility
—

 
(10.0
)
Repurchase of common stock, including fees and expenses
(232.6
)
 
—

Repurchase of convertible perpetual preferred stock
—

 
(24.7
)
Dividends paid on convertible perpetual preferred stock
(5.7
)
 
(6.8
)
Distributions paid to noncontrolling interests of consolidated affiliates
(13.2
)
 
(13.1
)
Other
3.3

 
(4.3
)
Net cash used in financing activities
(126.2
)
 
(33.9
)
(Decrease) increase in cash and cash equivalents
(52.7
)
 
14.2

Cash and cash equivalents at beginning of period
132.8

 
30.1

Cash and cash equivalents at end of period
$
80.1

 
$
44.3

 
 
 
 

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

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 the largest owner and operator of inpatient rehabilitation hospitals in the United States. We operate inpatient rehabilitation hospitals and provide specialized rehabilitative treatment on both an inpatient and outpatient basis.
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 19, 2013 (the “2012 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, 2012 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.
On April 1, 2013, we closed the transaction to acquire Walton Rehabilitation Hospital, a 58-bed inpatient rehabilitation hospital in Augusta, Georgia. Approximately $11.0 million was wired to an escrow agent related to this transaction on March 29, 2013 and is included in Other long-term assets in our condensed consolidated balance sheet as of March 31, 2013 and Escrow deposit — acquisition of business within investing activities of our condensed consolidated statement of cash flows for the three months ended March 31, 2013. This transaction was not material to our financial position, results of operations, or cash flows.
Reclassifications—
Certain immaterial amounts have been revised to conform to the current year presentation. In our condensed consolidated balance sheet as of December 31, 2012, we reclassified amounts previously reported as Other long-term liabilities to a combination of Capital in excess of par value, noncurrent Deferred income tax assets, and Redeemable noncontrolling interests. These amounts relate to a joint venture entity where the partner’s noncontrolling interest includes redemption features that are not solely within our control. This adjustment decreased liabilities by $6.2 million, decreased shareholders’ equity by $0.6 million, increased assets by $0.4 million, and increased amounts in the mezzanine section of our condensed consolidated balance sheet by $7.2 million. See Note 4, Redeemable Noncontrolling Interests.


6
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

Net Operating Revenues—
During the three months ended March 31, 2013 and 2012, we derived consolidated Net operating revenues from the following payor sources:
 
Three Months Ended March 31,
 
2013
 
2012
Medicare
74.7
%
 
73.5
%
Medicaid
1.1
%
 
1.1
%
Workers’ compensation
1.3
%
 
1.5
%
Managed care and other discount plans
18.5
%
 
19.3
%
Other third-party payors
1.7
%
 
1.7
%
Patients
1.1
%
 
1.4
%
Other income
1.6
%
 
1.5
%
Total
100.0
%
 
100.0
%
See Note 1, Summary of Significant Accounting Policies, to the consolidated financial statements accompanying the 2012 Form 10-K for our policies related to Net operating revenues, Accounts receivable, and our Allowance for doubtful accounts.
2.
Investments in and Advances to Nonconsolidated Affiliates
As of March 31, 2013 and December 31, 2012, we had $20.3 million and $20.8 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 13 partially owned subsidiaries, of which 9 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 51%. 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 March 31,
 
2013
 
2012
Net operating revenues
$
18.9

 
$
23.0

Operating expenses
(10.4
)
 
(14.1
)
Income from continuing operations, net of tax
6.6

 
7.5

Net income
6.6

 
7.5



7
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

3.
Long-term Debt
Our long-term debt outstanding consists of the following (in millions):
 
March 31, 2013
 
December 31, 2012
Credit Agreement-
 
 
 
Advances under revolving credit facility
$
122.0

 
$
—

Bonds payable-
 
 
 
7.25% Senior Notes due 2018
302.8

 
302.9

8.125% Senior Notes due 2020
286.3

 
286.2

7.75% Senior Notes due 2022
280.6

 
280.7

5.75% Senior Notes due 2024
275.0

 
275.0

Other notes payable
42.3

 
36.8

Capital lease obligations
68.6

 
71.9

 
1,377.6

 
1,253.5

Less: Current portion
(12.3
)
 
(13.6
)
Long-term debt, net of current portion
$
1,365.3

 
$
1,239.9


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
April 1 through December 31, 2013
$
10.0

 
$
10.0

2014
10.7

 
10.7

2015
9.0

 
9.0

2016
9.0

 
9.0

2017
130.1

 
130.1

2018
310.1

 
311.5

Thereafter
899.5

 
897.3

Total
$
1,378.4

 
$
1,377.6

During the first quarter of 2013, a total of $122.0 million were drawn on our revolving credit facility. Of the amounts drawn, approximately $82 million were used for the repurchase of our common stock, as discussed in Note 8, Earnings per Common Share. The remainder was used for the acquisition of Walton Rehabilitation Hospital, as discussed in Note 1, Basis of Presentation, and for working capital and other general corporate purposes.
For additional information regarding our indebtedness, see Note 8, Long-term Debt, to the consolidated financial statements accompanying the 2012 Form 10-K.
4.
Redeemable Noncontrolling Interests
Redeemable noncontrolling interests relate to two joint venture entities:
•
In the first quarter of 2013, we entered into an agreement to convert our 100% owned hospital in Jonesboro, Arkansas into a joint venture with St. Bernards Healthcare. Following the formation of the joint venture, our ownership percentage was reduced to approximately 56%. The increase in Goodwill from December 31, 2012 to March 31, 2013 resulted from this transaction.


8
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

•
In 2009, we entered into an agreement to convert our 100% owned hospital in Altoona, Pennsylvania into a joint venture with Altoona Regional Health System. Following the formation of the joint venture, our ownership percentage was reduced to 55%. Historically, the noncontrolling interest related to this joint venture was included in Other long-term liabilities in our condensed consolidated balance sheets. See Note 1, Basis of Presentation, “Reclassifications.”

The joint venture agreements for these two entities contain provisions that allow our partners to require us to purchase their interests in the joint venture at fair value at certain points in the future. Because these noncontrolling interests provide for redemption features that are not solely within our control, we classify them as Redeemable noncontrolling interests outside of permanent equity in our condensed consolidated balance sheets. At the end of each reporting period, we compare the carrying value of the Redeemable noncontrolling interests to their estimated redemption value. If the estimated redemption value is greater than the current carrying value, the carrying value is adjusted to the estimated redemption value, with the adjustments recorded through equity in the line item Capital in excess of par value.
We determine the fair value of our Redeemable noncontrolling interests with these redemption options primarily using the income approach. The income approach includes the use of the hospital’s projected operating results and cash flows discounted using a rate that reflects market participant assumptions for the applicable hospitals, or Level 3 inputs. 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.
The following is a summary of the activity related to our Redeemable noncontrolling interests during the three months ended March 31, 2013 and 2012 (in millions):
 
Three Months Ended March 31,
 
2013
 
2012
Balance at beginning of period
$
7.2

 
$
7.3

Net income attributable to noncontrolling interests
1.3

 
1.0

Distributions declared
(0.9
)
 
(1.1
)
Contribution to joint venture
6.2

 
—

Balance at end of period
$
13.8

 
$
7.2

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 on the condensed consolidated statements of operations for the three months ended March 31, 2013 and 2012 (in millions):
 
Three Months Ended March 31,
 
 
2013
 
2012
Net income attributable to nonredeemable noncontrolling interests
$
13.3

 
$
11.6

Net income attributable to redeemable noncontrolling interests
1.3

 
1.0

Net income attributable to noncontrolling interests
$
14.6

 
$
12.6



9
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

5.
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 March 31, 2013
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
$
16.9

 
$
—

 
$
16.9

 
$
—

 
M
Other long-term assets:
 
 
 
 
 
 
 
 
 
Restricted marketable securities
39.1

 
—

 
39.1

 
—

 
M
As of December 31, 2012
 
 
 
 
 
 
 
 
 
Other current assets:
 
 
 
 
 
 
 
 
 
Current portion of restricted marketable securities
$
16.4

 
$
—

 
$
16.4

 
$
—

 
M
Other long-term assets:
 
 
 
 
 
 
 
 
 
Restricted marketable securities
39.4

 
—

 
39.4

 
—

 
M
(1)The three valuation techniques are: market approach (M), cost approach (C), and income approach (I).
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 months ended March 31, 2013 and March 31, 2012, 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.
As discussed in Note 1, Summary of Significant Accounting Policies, to the consolidated financial statements accompanying the 2012 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 March 31, 2013
 
As of December 31, 2012
 
Carrying Amount
 
Estimated Fair Value
 
Carrying Amount
 
Estimated Fair Value
Long-term debt:
 

 
 

 
 

 
 

Advances under revolving credit facility
$
122.0

 
$
122.0

 
$
—

 
$
—

7.25% Senior Notes due 2018
302.8

 
324.9

 
302.9

 
328.6

8.125% Senior Notes due 2020
286.3

 
321.2

 
286.2

 
321.5

7.75% Senior Notes due 2022
280.6

 
303.4

 
280.7

 
306.5

5.75% Senior Notes due 2024
275.0

 
277.0

 
275.0

 
277.1

Other notes payable
42.3

 
42.3

 
36.8

 
36.8

Financial commitments:
 

 
 

 
 

 
 

Letters of credit
—

 
35.9

 
—

 
39.5



10
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

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 2012 Form 10-K.
See also Note 4, Redeemable Noncontrolling Interests.
6.
Share-Based Payments
In February 2013, we issued 0.9 million of restricted stock awards to members of our management team and our board of directors. Approximately 0.3 million of these awards contain only a service condition, while the remainder contain both a service and a performance or market condition. For the awards that include a performance or market 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 2013, 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 14, Share-Based Payments, to the consolidated financial statements accompanying the 2012 Form 10-K.
7.
Income Taxes
Our Provision for income tax expense of $33.5 million and $29.1 million for the three months ended March 31, 2013 and 2012, respectively, primarily resulted from the application of our estimated effective blended federal and state income tax rate of approximately 39% to our pre-tax income from continuing operations attributable to HealthSouth.
We have significant federal and state net operating loss carryforwards (“NOLs”) that expire in various amounts at varying times through 2031. Our utilization of NOLs could be subject to limitations under Internal Revenue Code Section 382 (“Section 382”) and may be limited in the event of certain cumulative changes in ownership interests of significant stockholders over a three-year period in excess of 50%. Section 382 imposes an annual limitation on the use of these losses to an amount that approximates the value of a company at the time of an ownership change multiplied by the long-term tax exempt rate. At this time, we do not believe these limitations will restrict our ability to use any NOLs before they expire. However, no such assurances can be provided.
The $497.3 million of net deferred tax assets included in the accompanying condensed consolidated balance sheet as of March 31, 2013 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 March 31, 2013, we maintained a valuation allowance of $39.8 million due to uncertainties regarding our ability to utilize a portion of our deferred tax assets, primarily related to state NOLs, 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 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.
Our reported federal NOL of $317.2 million (approximately $906.2 million on a gross basis) as of March 31, 2013 excludes $6.5 million related to operating loss carryforwards resulting from excess tax benefits related to share-based awards, the tax benefits of which, when recognized, will be accounted for as a credit to Capital in excess of par value when they reduce taxes payable.
On April 25, 2013, we entered into closing agreements with the IRS that settle federal income tax matters related to the previous restatement of our financial statements, as well as certain other tax matters, through December 31, 2008. As a result of these closing agreements, we expect to increase our deferred tax assets, primarily our federal NOL, and record a net federal income tax benefit of at least $91 million in the second quarter of 2013. This federal income tax benefit is expected to result in at least a $260 million increase to our federal NOL on a gross basis. Certain of the federal tax benefits recognized as a result of these settlements will be evaluated to determine whether it is more likely than not these attributes will be realized in the future.


11
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

In addition, it is reasonably possible this amount may increase as we continue to analyze the related state income tax implications of these settlements. However, it is not possible to determine the range of any state income tax impact at this time.
We recognize the financial statement effects of uncertain tax positions when it is more likely than not, based on the technical merits, a position will be sustained upon examination by and resolution with the taxing authorities. Total remaining gross unrecognized tax benefits were $116.4 million and $78.0 million as of March 31, 2013 and December 31, 2012, respectively. The amount of gross unrecognized tax benefits changed during the three months ended March 31, 2013 primarily based on the status of our discussions with the IRS, as discussed above, as of March 31, 2013. We expect to decrease our unrecognized tax benefits by approximately $112 million in the second quarter of 2013 as a result of the IRS settlements discussed above.
A reconciliation of the beginning and ending liability for unrecognized tax benefits is as follows (in millions):
 
Gross Unrecognized Income Tax Benefits
 
Accrued Interest and Penalties
Balance at December 31, 2012
$
78.0

 
$
—

Gross amount of increases in unrecognized tax benefits related to prior periods
38.4

 
—

Balance at March 31, 2013
$
116.4

 
$
—

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 months ended March 31, 2013 and 2012 was not material. Accrued interest income related to income taxes as of March 31, 2013 and December 31, 2012 was not material.
HealthSouth and its subsidiaries’ federal and state income tax returns are periodically examined by various regulatory taxing authorities. In connection with such examinations, we have settled federal income tax examinations with the IRS for all tax years through 2008. We are currently under audit by the IRS for the 2009 and 2010 tax years and by two states for tax years ranging from 2008 through 2011.
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. We do not expect a material change in our unrecognized tax benefits within the next 12 months due to the closing of the applicable statutes of limitation.


12
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

8.
Earnings per Common Share
The calculation of earnings per common share is based on the weighted-average number of our common shares outstanding during the applicable period. The calculation for diluted earnings per common share recognizes the effect of all dilutive potential common shares that were outstanding during the respective periods, unless their impact would be antidilutive. The following table sets forth the computation of basic and diluted earnings per common share (in millions, except per share amounts):
 
Three Months Ended March 31,
 
2013
 
2012
Basic:
 
 
 
Numerator:
 
 
 
Income from continuing operations
$
66.3

 
$
57.2

Less: Net income attributable to noncontrolling interests included in continuing operations
(14.6
)
 
(12.6
)
Less: Convertible perpetual preferred stock dividends
(5.7
)
 
(6.4
)
Less: Repurchase of convertible perpetual preferred stock
—

 
(0.5
)
Income from continuing operations attributable to HealthSouth common shareholders
46.0

 
37.7

Loss from discontinued operations, net of tax, attributable to HealthSouth common shareholders
(0.4
)
 
(0.4
)
Net income attributable to HealthSouth common shareholders
$
45.6

 
$
37.3

Denominator:
 
 
 
Basic weighted average common shares outstanding
94.0

 
94.5

Basic earnings per share attributable to HealthSouth common shareholders:
 
 
 
Continuing operations
$
0.49

 
$
0.40

Discontinued operations
—

 
(0.01
)
Net income
$
0.49

 
$
0.39

 
 
 
 
Diluted:
 
 
 
Numerator:
 
 
 
Income from continuing operations
$
66.3

 
$
57.2

Less: Net income attributable to noncontrolling interests included in continuing operations
(14.6
)
 
(12.6
)
Income from continuing operations attributable to HealthSouth common shareholders
51.7

 
44.6

Loss from discontinued operations, net of tax, attributable to HealthSouth common shareholders
(0.4
)
 
(0.4
)
Net income attributable to HealthSouth common shareholders
$
51.3

 
$
44.2

Denominator:
 
 
 
Diluted weighted average common shares outstanding
107.1

 
108.7

Diluted earnings per share attributable to HealthSouth common shareholders:
 
 
 
Continuing operations
$
0.48

 
$
0.40

Discontinued operations
—

 
(0.01
)
Net income
$
0.48

 
$
0.39



13
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

Diluted earnings per share report the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. These potential shares include convertible perpetual preferred stock, restricted stock awards, dilutive stock options, and restricted stock units. For the three months ended March 31, 2013 and 2012, the number of potential shares approximated 13.1 million and 14.2 million, respectively. For the three months ended March 31, 2013 and 2012, approximately 11.6 million and 12.9 million of the potential shares, respectively, related to our Convertible perpetual preferred stock. For the three months ended March 31, 2012, adding back the dividends for the Convertible perpetual preferred stock to our Income from continuing operations attributable to HealthSouth common shareholders causes a per share increase when calculating diluted earnings per common share resulting in an anti-dilutive per share amount. Therefore, basic and diluted earnings per common share are the same for the three months ended March 31, 2012.
Options to purchase approximately 1.4 million and 2.4 million shares of common stock were outstanding as of March 31, 2013 and 2012, respectively, but were not included in the computation of diluted weighted-average shares because to do so would have been antidilutive.
On February 15, 2013, our board of directors approved an increase in our existing common stock repurchase authorization from $125 million to $350 million. During the first quarter of 2013, we completed a tender offer for our common stock. As a result of the tender offer, we purchased approximately 9.1 million shares at a price of $25.50 per share for a total cost of approximately $234.1 million, including fees and expenses relating to the tender offer. The remaining repurchase authorization expired at the end of the tender offer.
See Note 11, Convertible Perpetual Preferred Stock, and Note 18, Earnings per Common Share, to the consolidated financial statements accompanying the 2012 Form 10-K for additional information related to common stock, common stock warrants, and convertible perpetual preferred stock.
9.
Contingencies
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.
Litigation By and Against Former Independent Auditor—
In March 2003, claims on behalf of HealthSouth were brought against Ernst & Young, LLP in a stockholder derivative lawsuit initially filed in the Circuit Court of Jefferson County, Alabama on August 28, 2002 and captioned Tucker v. Scrushy. The Tucker derivative litigation, including the claims against various other defendants and the $2.9 billion judgment against Mr. Scrushy, our former chairman and chief executive officer, is more fully described in “Derivative Litigation” and “Litigation Against Richard M. Scrushy” in Note 19, Contingencies and Other Commitments, to the consolidated financial statements accompanying the 2012 Form 10-K. The Tucker complaint alleges that from 1996 through 2002, when Ernst & Young served as our independent auditor, Ernst & Young acted recklessly and with gross negligence in performing its duties, and specifically that Ernst & Young failed to perform reviews and audits of our financial statements with due professional care as required by law and by its contractual agreements with us. The claims further allege Ernst & Young either knew of or, in the exercise of due care, should have discovered and investigated the fraudulent and improper accounting practices being directed by certain officers and employees, and should have reported them to our board of directors and the audit committee. The claims seek compensatory and punitive damages, disgorgement of fees received from us by Ernst & Young, and attorneys’ fees and costs.

On March 18, 2005, Ernst & Young filed a lawsuit captioned Ernst & Young LLP v. HealthSouth Corp. in the Circuit Court of Jefferson County, Alabama. The complaint alleges we provided Ernst & Young with fraudulent management representation letters, financial statements, invoices, bank reconciliations, and journal entries in an effort to conceal accounting fraud. Ernst & Young claims that as a result of our actions, Ernst & Young’s reputation has been injured and it has and will incur damages, expenses, and legal fees. On April 1, 2005, we answered Ernst & Young’s claims and asserted counterclaims related or identical to those asserted in the Tucker action. Upon Ernst & Young’s motion, the Alabama state court referred Ernst & Young’s claims and our counterclaims to arbitration pursuant to a clause in the engagement agreements between HealthSouth and Ernst & Young. In August 2006, we and the derivative plaintiffs agreed to jointly prosecute the claims against Ernst & Young in arbitration.


14
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements


The trial phase of the arbitration process began on July 12, 2010 before a three-person arbitration panel selected under rules of the American Arbitration Association (the “AAA”). On December 18, 2012, the AAA panel granted Ernst & Young’s motion to dismiss our claims on the grounds that HealthSouth is not permitted to pursue its claims since certain of its former officers and employees committed fraudulent acts. The panel also denied and dismissed Ernst & Young’s claims against us. On December 18, 2012, we, together with the stockholder derivative plaintiffs, filed a notice of appeal of the panel’s decision in the Circuit Court of Jefferson County, Alabama. On December 28, 2012, we filed a motion to vacate the decision. We assert that the panel’s decision is contrary to the Federal Arbitration Act and the duties of a public accounting firm to its corporate clients, and that the arbitrators exceeded their authority by entering an award contrary to Alabama law. The court heard arguments on the motion to vacate on April 16, 2013. Pursuant to the current schedule, we expect the court to rule on the motion by early May 2013.
Based on the ruling of the arbitration panel, we do not believe there is a reasonable possibility of a loss that might result from an adverse judgment or a settlement of this case.
General Medicine Action—
On August 16, 2004, General Medicine, P.C. filed a lawsuit against us captioned General Medicine, P.C. v. HealthSouth Corp. seeking the recovery of allegedly fraudulent transfers involving assets of Horizon/CMS Healthcare Corporation, a former subsidiary of HealthSouth. The lawsuit is pending in the Circuit Court of Jefferson County, Alabama (the “Alabama Action”).
General Medicine’s underlying claim against Horizon/CMS originates from a services contract entered into in 1995 between General Medicine and Horizon/CMS whereby General Medicine agreed to provide medical director services to skilled nursing facilities owned by Horizon/CMS for a term of three years. Horizon/CMS terminated the agreement for cause six months after it was executed, and General Medicine then initiated a lawsuit against Horizon/CMS in the United States District Court for the Eastern District of Michigan in 1996 (the “Michigan Action”). General Medicine’s complaint in the Michigan Action alleged that Horizon/CMS breached the services contract by wrongfully terminating General Medicine. We acquired Horizon/CMS in 1997 and sold it to Meadowbrook Healthcare, Inc. in 2001 pursuant to a stock purchase agreement. In 2004, Meadowbrook, without the knowledge of HealthSouth, consented to the entry of a final judgment in the Michigan Action in favor of General Medicine against Horizon/CMS for the alleged wrongful termination of the contract with General Medicine in the amount of $376 million, plus interest from the date of the judgment until paid at the rate of 10% per annum (the “Consent Judgment”). The $376 million damages figure was unilaterally selected by General Medicine and was not tested or opposed by Meadowbrook. Additionally, the settlement agreement (the “Settlement”) used as the basis for the Consent Judgment provided that Meadowbrook would pay only $300,000 to General Medicine to settle the Michigan Action and that General Medicine would seek to recover the remaining balance of the Consent Judgment solely from us. We were not a party to the Michigan Action, the Settlement negotiated by Meadowbrook, or the Consent Judgment.
The complaint filed by General Medicine against us in the Alabama Action alleges that while Horizon/CMS was our wholly owned subsidiary, General Medicine was an existing creditor of Horizon/CMS by virtue of the breach of contract claim underlying the Settlement. The complaint also alleges we caused Horizon/CMS to transfer its assets to us for less than a reasonably equivalent value or, in the alternative, with the actual intent to defraud creditors of Horizon/CMS, including General Medicine, in violation of the Alabama Uniform Fraudulent Transfer Act. General Medicine further alleges in its amended complaint that we are liable for the Consent Judgment despite not being a party to it because as Horizon/CMS’s parent we failed to observe corporate formalities in our operation and ownership of Horizon/CMS, misused our control of Horizon/CMS, stripped assets from Horizon/CMS, and engaged in other conduct which amounted to a fraud on Horizon/CMS’s creditors. General Medicine has requested relief including recovery of the unpaid amount of the Consent Judgment, the avoidance of the subject transfers of assets, attachment of the assets transferred to us, appointment of a receiver over the transferred properties, and a monetary judgment for the value of properties transferred.
We have denied liability to General Medicine and asserted counterclaims against General Medicine for fraud, injurious falsehood, tortious interference with business relations, conspiracy, unjust enrichment, abuse of process, and other causes of action. In our counterclaims, we alleged the Consent Judgment is the product of fraud, collusion and bad faith by General Medicine and Meadowbrook and, further, that these parties were guilty of a conspiracy to manufacture a lawsuit against


15
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

HealthSouth in favor of General Medicine. Consequently, we assert that the Consent Judgment is not evidence of a legitimate debt owed by Horizon/CMS to General Medicine that is collectible from HealthSouth under any theory of liability.
In 2008, after we obtained discovery concerning the circumstances that led to the entry of the Consent Judgment, we filed a motion in the Michigan Action asking the court to set aside the Consent Judgment on grounds that it was the product of fraud on the court and collusion by the parties. On May 21, 2009, the court granted our motion to set aside the Consent Judgment on grounds that it was the product of fraud on the court. On March 9, 2010, General Medicine filed an appeal of the court’s decision to the Sixth Circuit Court of Appeals. The parties agreed to a voluntary stay of the Alabama Action pending the outcome of General Medicine’s appeal to the Sixth Circuit Court of Appeals. On April 10, 2012, the Sixth Circuit Court of Appeals reversed the lower court’s ruling and reinstated the Consent Judgment. Due to the conclusion of the appeal in the Michigan Action, General Medicine requested reactivation of the Alabama Action in the Circuit Court of Jefferson County, Alabama. On January 10, 2013, we filed a motion for partial summary judgment in the Alabama Action seeking a declaration that the Consent Judgment obtained by General Medicine is not enforceable against us because, among other reasons, it was the result of collusion. On February 27, 2013, the court denied our motion but did not address or decide the issue of collusion at that time. The court's ruling provides that the Consent Judgment is admissible as evidence of the amount of General Medicine's claim in the Alabama Action. However, the ruling also provides that the amount of the damages in the Consent Judgment is not binding on us, so we may challenge the damages alleged, including the value of the underlying contract-related claim that is the basis for the Consent Judgment. The court further ruled that we may only challenge the merits of the Consent Judgment by presenting evidence of collusion. The case is still in the discovery phase and no trial date has been set.
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. We intend to vigorously defend ourselves against General Medicine’s claims and to vigorously prosecute our counterclaims against General Medicine.
Other 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 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 consolidated with the Tucker case for discovery and other pretrial purposes and 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. At this time, we do not know when the court will rule on the motion to remand. 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.
We were named as a defendant in a lawsuit filed March 3, 2009 by an individual in the Court of Common Pleas, Richland County, South Carolina, captioned Sulton v. HealthSouth Corp, et al. The plaintiff alleged that certain treatment he received at a HealthSouth facility complicated a pre-existing infectious injury. The plaintiff sought recovery for pain and suffering, medical expenses, punitive damages, and other damages. On July 30, 2010, the jury in this case returned a verdict in favor of the plaintiff for $12.3 million in damages. We appealed that verdict, and on November 21, 2012, the Supreme Court of South Carolina reversed the jury verdict in its entirety and remanded the case to the court of common pleas for retrial. On March 8, 2013, the Court of Common Pleas, Richland County, South Carolina approved our comprehensive settlement agreement with the plaintiff in the Sulton case. While the terms of the settlement are confidential, the amount paid to the


16
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

plaintiff to settle all claims was not material to us and was less than amounts previously accrued. See Note 10, Self-Insured Risks, to the consolidated financial statements accompanying the 2012 Form 10-K.
HHS-OIG Investigations—
On June 24, 2011, we received a document subpoena addressed to HealthSouth Hospital of Houston, a long-term acute care hospital (“LTCH”) we closed in August 2011, and issued from the Dallas, Texas office of the U.S. Department of Health and Human Services, Office of the Inspector General (the “HHS-OIG”). The subpoena is in connection with an investigation of possible false or otherwise improper claims submitted to Medicare and Medicaid and requests documents and materials relating to this closed LTCH’s patient admissions, length of stay, and discharge matters.
On March 4, 2013, we received document subpoenas addressed to four of our wholly owned hospitals and issued from the Miami Lakes, Florida office of the HHS-OIG. These hospitals process all of their Medicare claims through the same Medicare administrative contractor, Cahaba Government Benefit Administrators, LLC. Each subpoena is in connection with an investigation of alleged improper or fraudulent claims submitted to Medicare and Medicaid and requests documents and materials relating to practices, procedures, protocols and policies, of certain pre- and post-admissions activities at these hospitals including, among other things, marketing functions, pre-admission screening, post-admission physician evaluations, patient assessment instruments, individualized patient plans of care, and compliance with the Medicare 60% rule. Under the Medicare rule commonly referred to as the “60% rule,” an inpatient rehabilitation hospital must treat 60% or more of its patients from at least one of a specified list of medical conditions in order to be reimbursed at the inpatient rehabilitation hospital payment rates, rather than at the lower acute care hospital payment rates. The subpoenas also request complete copies of medical records for 100 patients treated at each of these hospitals between September 2008 and June 2012.

We are cooperating fully with the HHS-OIG in connection with these subpoenas and are currently unable to predict the timing or outcome of the related investigations.

Other Matters—
The False Claims Act, 18 U.S.C. § 287, allows private citizens, called “relators,” to institute civil proceedings alleging violations of the False Claims Act. These qui tam cases are generally sealed by the court at the time of filing. The only parties privy to the information contained in the complaint are the relator, the federal government, and the presiding court. It is possible that qui tam lawsuits have been filed against us and that we are unaware of such filings or have been ordered by the presiding court not to discuss or disclose the filing of such lawsuits. We may be subject to liability under one or more undisclosed qui tam cases brought pursuant to the False Claims Act.
It is our obligation as a participant in Medicare and other federal healthcare programs to routinely conduct audits and reviews of the accuracy of our billing systems and other regulatory compliance matters. As a result of these reviews, we have made, and will continue to make, disclosures to the HHS-OIG and CMS relating to amounts we suspect represent over-payments from these programs, whether due to inaccurate billing or otherwise. Some of these disclosures have resulted in, or may result in, HealthSouth refunding amounts to Medicare or other federal healthcare programs.


17
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

10.
Condensed Consolidating Financial Information
The accompanying condensed consolidating financial information has been prepared and presented pursuant to SEC Regulation S-X, Rule 3-10, “Financial Statements of Guarantors and Issuers of Guaranteed Securities Registered or Being Registered.” Each of the subsidiary guarantors is 100% owned by HealthSouth, and all guarantees are full and unconditional and joint and several, subject to certain customary conditions for release. HealthSouth’s investments in its consolidated subsidiaries, as well as guarantor subsidiaries’ investments in nonguarantor subsidiaries and nonguarantor subsidiaries’ investments in guarantor subsidiaries, are presented under the equity method of accounting with the related investment presented within the line items Intercompany receivable and Intercompany payable in the accompanying condensed consolidating balance sheets.
As described in Note 8, Long-term Debt, to the consolidated financial statements accompanying the 2012 Form 10-K, the terms of our credit agreement restrict us from declaring or paying cash dividends on our common stock unless: (1) we are not in default under our credit agreement and (2) the amount of the dividend, when added to the aggregate amount of certain other defined payments made during the same fiscal year, does not exceed certain maximum thresholds. However, as described in Note 11, Convertible Perpetual Preferred Stock, to the consolidated financial statements accompanying the 2012 Form 10-K, our preferred stock generally provides for the payment of cash dividends, subject to certain limitations.
In the third quarter of 2012, we revised our condensed consolidating statement of cash flows for the three months ended March 31, 2012 to adjust cash flows from operating activities to eliminate equity in earnings from affiliates, which is a noncash activity. The impact of this revision, along with other immaterial classification revisions, was to decrease cash flows from operating activities (and, correspondingly increase cash flows from financing activities) during the applicable periods for HealthSouth Corporation, Guarantor Subsidiaries, and Nonguarantor Subsidiaries, with an offset to Eliminating Entries, as shown in the table below (in millions). This revision is not material to the related financial statements for any prior periods and had no impact on our condensed consolidated statement of cash flows for the three months ended March 31, 2012.
 
For the Three Months Ended March 31, 2012
HealthSouth Corporation
$
68.5

Guarantor Subsidiaries
5.7

Nonguarantor Subsidiaries
7.3





18
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements
Condensed Consolidating Statement of Operations


 
Three Months Ended March 31, 2013
 
HealthSouth Corporation
 
Guarantor Subsidiaries
 
Nonguarantor Subsidiaries
 
Eliminating Entries
 
HealthSouth Consolidated
 
(In Millions)
Net operating revenues
$
5.0

 
$
411.9

 
$
172.6

 
$
(16.9
)
 
$
572.6

Less: Provision for doubtful accounts
—

 
(5.3
)
 
(2.1
)
 
—

 
(7.4
)
Net operating revenues less provision for doubtful accounts
5.0

 
406.6

 
170.5

 
(16.9
)
 
565.2

Operating expenses:
 

 
 

 
 

 
 

 


Salaries and benefits
7.8

 
188.7

 
81.7

 
(3.6
)
 
274.6

Other operating expenses
4.2

 
56.4

 
25.7

 
(8.2
)
 
78.1

Occupancy costs
1.1

 
11.9

 
4.2

 
(5.0
)
 
12.2

Supplies
—

 
18.6

 
7.6

 
—

 
26.2

General and administrative expenses
30.2

 
—

 
—

 
—

 
30.2

Depreciation and amortization
2.1

 
15.2

 
4.8

 
—

 
22.1

Professional fees—accounting, tax, and legal
1.4

 
—

 
—

 
—

 
1.4

Total operating expenses
46.8

 
290.8

 
124.0

 
(16.8
)
 
444.8

Interest expense and amortization of debt discounts and fees
22.1

 
1.7

 
0.7

 
(0.3
)
 
24.2

Other income
(0.3
)
 
—

 
(0.7
)
 
0.3

 
(0.7
)
Equity in net income of nonconsolidated affiliates
(0.9
)
 
(2.0
)
 
—

 
—

 
(2.9
)
Equity in net income of consolidated affiliates
(69.7
)
 
(5.5
)
 
—

 
75.2

 
—

Management fees
(25.9
)
 
20.0

 
5.9

 
—

 
—

Income from continuing operations before income tax (benefit) expense
32.9

 
101.6

 
40.6

 
(75.3
)
 
99.8

Provision for income tax (benefit) expense
(18.5
)
 
41.2

 
10.8

 
—

 
33.5

Income from continuing operations
51.4

 
60.4

 
29.8

 
(75.3
)
 
66.3

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

 
(0.4
)
 
—

 
(0.4
)
Net Income
51.3

 
60.5

 
29.4

 
(75.3
)
 
65.9

Less: Net income attributable to noncontrolling interests
—

 
—

 
(14.6
)
 
—

 
(14.6
)
Net income attributable to HealthSouth
$
51.3

 
$
60.5

 
$
14.8

 
$
(75.3
)
 
$
51.3

Comprehensive income
$
51.4

 
$
60.5

 
$
29.4

 
$
(75.3
)
 
$
66.0

Comprehensive income attributable to HealthSouth
$
51.4

 
$
60.5

 
$
14.8

 
$
(75.3
)
 
$
51.4



19
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements
Condensed Consolidating Statement of Operations


 
Three Months Ended March 31, 2012
 
HealthSouth Corporation
 
Guarantor Subsidiaries
 
Nonguarantor Subsidiaries
 
Eliminating Entries
 
HealthSouth Consolidated
 
(In Millions)
Net operating revenues
$
3.3

 
$
392.3

 
$
157.0

 
$
(14.0
)
 
$
538.6

Less: Provision for doubtful accounts
(0.5
)
 
(4.1
)
 
(1.7
)
 
—

 
(6.3
)
Net operating revenues less provision for doubtful accounts
2.8

 
388.2

 
155.3

 
(14.0
)
 
532.3

Operating expenses:
 

 
 

 
 

 
 

 


Salaries and benefits
7.2

 
182.5

 
74.7

 
(3.4
)
 
261.0

Other operating expenses
4.0

 
53.3

 
23.0

 
(6.5
)
 
73.8

Occupancy costs
1.1

 
11.1

 
4.4

 
(4.1
)
 
12.5

Supplies
—

 
19.0

 
7.5

 
—

 
26.5

General and administrative expenses
30.0

 
—

 
—

 
—

 
30.0

Depreciation and amortization
2.2

 
13.5

 
3.8

 
—

 
19.5

Professional fees—accounting, tax, and legal
3.6

 
—

 
—

 
—

 
3.6

Total operating expenses
48.1

 
279.4

 
113.4

 
(14.0
)
 
426.9

Interest expense and amortization of debt discounts and fees
21.1

 
1.9

 
0.6

 
(0.3
)
 
23.3

Other income
(0.5
)
 
—

 
(0.7
)
 
0.3

 
(0.9
)
Equity in net income of nonconsolidated affiliates
(1.0
)
 
(2.3
)
 
—

 
—

 
(3.3
)
Equity in net income of consolidated affiliates
(69.0
)
 
(5.7
)
 
—

 
74.7

 
—

Management fees
(24.6
)
 
19.2

 
5.4

 
—

 
—

Income from continuing operations before income tax (benefit) expense
28.7

 
95.7

 
36.6

 
(74.7
)
 
86.3

Provision for income tax (benefit) expense
(15.6
)
 
35.9

 
8.8

 
—

 
29.1

Income from continuing operations
44.3

 
59.8

 
27.8

 
(74.7
)
 
57.2

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

 
—

 
(0.4
)
Net Income
44.2

 
59.5

 
27.8

 
(74.7
)
 
56.8

Less: Net income attributable to noncontrolling interests
—

 
—

 
(12.6
)
 
—

 
(12.6
)
Net income attributable to HealthSouth
$
44.2

 
$
59.5

 
$
15.2

 
$
(74.7
)
 
$
44.2

Comprehensive income
$
45.0

 
$
59.5

 
$
27.8

 
$
(74.7
)
 
$
57.6

Comprehensive income attributable to HealthSouth
$
45.0

 
$
59.5

 
$
15.2

 
$
(74.7
)
 
$
45.0



20
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements
Condensed Consolidating Balance Sheet

 
As of March 31, 2013
 
HealthSouth Corporation
 
Guarantor Subsidiaries
 
Nonguarantor Subsidiaries
 
Eliminating Entries
 
HealthSouth Consolidated
 
(In Millions)
Assets
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
75.9

 
$
2.0

 
$
2.2

 
$
—

 
$
80.1

Accounts receivable, net
0.2

 
189.3

 
76.8

 
—

 
266.3

Deferred income tax assets
106.5

 
19.7

 
11.3

 
—

 
137.5

Other current assets
55.3

 
14.4

 
114.4

 
(70.7
)
 
113.4

Total current assets
237.9

 
225.4

 
204.7

 
(70.7
)
 
597.3

Property and equipment, net
13.3

 
562.1

 
188.8

 
—

 
764.2

Goodwill
—

 
266.1

 
177.3

 
—

 
443.4

Intangible assets, net
20.9

 
42.2

 
19.6

 
—

 
82.7

Deferred income tax assets
308.3

 
0.9

 
50.6

 
—

 
359.8

Other long-term assets
69.1

 
32.0

 
43.8

 
—

 
144.9

Intercompany receivable
1,284.2

 
—

 
—

 
(1,284.2
)
 
—

Total assets
$
1,933.7

 
$
1,128.7

 
$
684.8

 
$
(1,354.9
)
 
$
2,392.3

Liabilities and Shareholders’ Equity (Deficit)
 

 
 

 
 

 
 

 


Current liabilities:
 

 
 

 
 

 
 

 


Accounts payable
$
8.9

 
$
38.2

 
$
14.1

 
$
—

 
$
61.2

Accrued expenses and other current liabilities
166.5

 
68.8

 
91.2

 
(70.7
)
 
255.8

Total current liabilities
175.4

 
107.0

 
105.3

 
(70.7
)
 
317.0

Long-term debt, net of current portion
1,269.2

 
62.8

 
33.3

 
—

 
1,365.3

Other long-term liabilities
38.6

 
11.7

 
80.2

 
—

 
130.5

Intercompany payable
—

 
481.3

 
1,025.3

 
(1,506.6
)
 
—

 
1,483.2

 
662.8

 
1,244.1

 
(1,577.3
)
 
1,812.8

Commitments and contingencies


 


 


 


 


Convertible perpetual preferred stock
342.2

 
—

 
—

 
—

 
342.2

Redeemable noncontrolling interests
—

 
—

 
13.8

 
—

 
13.8

Shareholders’ equity (deficit):
 

 
 

 
 

 
 

 


HealthSouth shareholders’ equity (deficit)
108.3

 
465.9

 
(688.3
)
 
222.4

 
108.3

Noncontrolling interests
—

 
—

 
115.2

 
—

 
115.2

Total shareholders’ equity (deficit)
108.3

 
465.9

 
(573.1
)
 
222.4

 
223.5

Total liabilities and shareholders’ equity (deficit)
$
1,933.7

 
$
1,128.7

 
$
684.8

 
$
(1,354.9
)
 
$
2,392.3



21
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements
Condensed Consolidating Balance Sheet

 
As of December 31, 2012
 
HealthSouth Corporation
 
Guarantor Subsidiaries
 
Nonguarantor Subsidiaries
 
Eliminating Entries
 
HealthSouth Consolidated
 
(In Millions)
Assets
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
131.3

 
$
0.3

 
$
1.2

 
$
—

 
$
132.8

Accounts receivable, net
0.2

 
178.8

 
70.3

 
—

 
249.3

Deferred income tax assets
106.5

 
19.7

 
11.3

 
—

 
137.5

Other current assets
30.6

 
15.1

 
89.0

 
(17.5
)
 
117.2

Total current assets
268.6

 
213.9

 
171.8

 
(17.5
)
 
636.8

Property and equipment, net
13.1

 
549.9

 
185.0

 
—

 
748.0

Goodwill
—

 
266.1

 
171.2

 
—

 
437.3

Intangible assets, net
18.1

 
41.5

 
13.6

 
—

 
73.2

Deferred income tax assets
340.7

 
0.9

 
51.9

 
—

 
393.5

Other long-term assets
69.9

 
21.3

 
44.2

 
—

 
135.4

Intercompany receivable
1,244.3

 
—

 
—

 
(1,244.3
)
 
—

Total assets
$
1,954.7

 
$
1,093.6

 
$
637.7

 
$
(1,261.8
)
 
$
2,424.2

Liabilities and Shareholders’ Equity (Deficit)
 

 
 

 
 

 
 

 


Current liabilities:
 

 
 

 
 

 
 

 


Accounts payable
$
7.7

 
$
28.0

 
$
9.6

 
$
—

 
$
45.3

Accrued expenses and other current liabilities
128.7

 
73.7

 
70.7

 
(17.5
)
 
255.6

Total current liabilities
136.4

 
101.7


80.3


(17.5
)
 
300.9

Long-term debt, net of current portion
1,147.3

 
64.2

 
28.4

 
—

 
1,239.9

Other long-term liabilities
37.8

 
11.2

 
81.5

 
—

 
130.5

Intercompany payable
—

 
517.4

 
1,021.4

 
(1,538.8
)
 
—

 
1,321.5

 
694.5


1,211.6


(1,556.3
)
 
1,671.3

Commitments and contingencies


 


 


 


 


Convertible perpetual preferred stock
342.2

 
—

 
—

 
—

 
342.2

Redeemable noncontrolling interests
—

 
—

 
7.2

 
—

 
7.2

Shareholders’ equity (deficit):
 

 
 

 
 

 
 

 


HealthSouth shareholders’ equity (deficit)
291.0

 
399.1

 
(693.6
)
 
294.5

 
291.0

Noncontrolling interests
—

 
—

 
112.5

 
—

 
112.5

Total shareholders’ equity (deficit)
291.0

 
399.1


(581.1
)

294.5

 
403.5

Total liabilities and shareholders’ equity (deficit)
$
1,954.7

 
$
1,093.6


$
637.7


$
(1,261.8
)
 
$
2,424.2



22
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements
Condensed Consolidating Statement of Cash Flows

 
Three Months Ended March 31, 2013
 
HealthSouth Corporation
 
Guarantor Subsidiaries
 
Nonguarantor Subsidiaries
 
Eliminating Entries
 
HealthSouth Consolidated
 
(In Millions)
Net cash provided by operating activities
$
31.3