HLS 10Q 6/30/13

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 June 30, 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 87,298,703 shares of common stock outstanding, net of treasury shares, as of July 23, 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 June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(In Millions, Except Per Share Data)
Net operating revenues
$
564.5

 
$
533.4

 
$
1,137.1

 
$
1,072.0

Less: Provision for doubtful accounts
(7.0
)
 
(6.5
)
 
(14.4
)
 
(12.8
)
Net operating revenues less provision for doubtful accounts
557.5

 
526.9

 
1,122.7

 
1,059.2

Operating expenses:
 

 
 

 
 
 
 

Salaries and benefits
273.6

 
257.4

 
548.2

 
518.4

Other operating expenses
81.0

 
75.0

 
159.1

 
148.8

Occupancy costs
11.9

 
12.3

 
24.1

 
24.8

Supplies
26.6

 
25.9

 
52.8

 
52.4

General and administrative expenses
29.5

 
28.0

 
59.7

 
58.0

Depreciation and amortization
23.1

 
20.0

 
45.2

 
39.5

Government, class action, and related settlements
(2.0
)
 
—

 
(2.0
)
 
—

Professional fees—accounting, tax, and legal
2.2

 
5.5

 
3.6

 
9.1

Total operating expenses
445.9

 
424.1

 
890.7

 
851.0

Interest expense and amortization of debt discounts and fees
24.4

 
23.0

 
48.6

 
46.3

Other income
(1.9
)
 
(0.4
)
 
(2.6
)
 
(1.3
)
Equity in net income of nonconsolidated affiliates
(3.3
)
 
(3.1
)
 
(6.2
)
 
(6.4
)
Income from continuing operations before income tax expense
92.4

 
83.3

 
192.2

 
169.6

Provision for income tax (benefit) expense
(86.5
)
 
26.9

 
(53.0
)
 
56.0

Income from continuing operations
178.9

 
56.4

 
245.2

 
113.6

Income (loss) from discontinued operations, net of tax
0.1

 
3.5

 
(0.3
)
 
3.1

Net income
179.0

 
59.9

 
244.9

 
116.7

Less: Net income attributable to noncontrolling interests
(13.8
)
 
(13.2
)
 
(28.4
)
 
(25.8
)
Net income attributable to HealthSouth
165.2

 
46.7

 
216.5

 
90.9

Less: Convertible perpetual preferred stock dividends
(5.8
)
 
(6.0
)
 
(11.5
)
 
(12.4
)
Less: Repurchase of convertible perpetual preferred stock
—

 
(0.3
)
 
—

 
(0.8
)
Net income attributable to HealthSouth common shareholders
$
159.4

 
$
40.4

 
$
205.0

 
$
77.7

Weighted average common shares outstanding:
 

 
 

 
 
 
 
Basic
86.1

 
94.6

 
90.0

 
94.5

Diluted
99.8

 
108.0

 
103.4

 
108.3

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

 
 
 
 
Continuing operations
$
1.85

 
$
0.39

 
$
2.28

 
$
0.79

Discontinued operations
—

 
0.04

 
—

 
0.03

Net income
$
1.85

 
$
0.43

 
$
2.28

 
$
0.82

Diluted earnings per share attributable to HealthSouth common shareholders:
 
 
 
 
 
 
Continuing operations
$
1.66

 
$
0.39

 
$
2.09

 
$
0.79

Discontinued operations
—

 
0.04

 
—

 
0.03

Net income
$
1.66

 
$
0.43

 
$
2.09

 
$
0.82

Amounts attributable to HealthSouth common shareholders:
 
 
 

 
 
 
 
Income from continuing operations
$
165.1

 
$
43.2

 
$
216.8

 
$
87.8

Income (loss) from discontinued operations, net of tax
0.1

 
3.5

 
(0.3
)
 
3.1

Net income attributable to HealthSouth
$
165.2

 
$
46.7

 
$
216.5

 
$
90.9


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 June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(In Millions)
COMPREHENSIVE INCOME
 
 
 
 
 
 
 
Net income
$
179.0

 
$
59.9

 
$
244.9

 
$
116.7

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
(0.9
)
 
0.2

 
(0.8
)
 
1.0

Reclassifications to net income
(1.0
)
 
—

 
(1.0
)
 
—

Other comprehensive (loss) income before income taxes
(1.9
)
 
0.2

 
(1.8
)
 
1.0

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

 
—

 
0.1

 
—

Other comprehensive (loss) income, net of tax
(1.8
)
 
0.2

 
(1.7
)
 
1.0

Comprehensive income
177.2

 
60.1

 
243.2

 
117.7

Comprehensive income attributable to noncontrolling interests
(13.8
)
 
(13.2
)
 
(28.4
)
 
(25.8
)
Comprehensive income attributable to HealthSouth
$
163.4

 
$
46.9

 
$
214.8

 
$
91.9


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)

 
June 30,
2013
 
December 31,
2012
 
(In Millions)
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
68.7

 
$
132.8

Accounts receivable, net of allowance for doubtful accounts of $32.0 in 2013; $28.7 in 2012
273.7

 
249.3

Deferred income tax assets
137.5

 
137.5

Other current assets
111.6

 
117.2

Total current assets
591.5

 
636.8

Property and equipment, net
793.3

 
748.0

Goodwill
457.2

 
437.3

Intangible assets, net
86.8

 
73.2

Deferred income tax assets
444.8

 
393.5

Other long-term assets
138.1

 
135.4

Total assets
$
2,511.7

 
$
2,424.2

Liabilities and Shareholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
57.3

 
$
45.3

Accrued expenses and other current liabilities
254.3

 
255.6

Total current liabilities
311.6

 
300.9

Long-term debt, net of current portion
1,319.7

 
1,239.9

Other long-term liabilities
131.4

 
130.5

 
1,762.7

 
1,671.3

Commitments and contingencies


 


Convertible perpetual preferred stock
342.2

 
342.2

Redeemable noncontrolling interests
14.1

 
7.2

Shareholders’ equity:
 

 
 

HealthSouth shareholders’ equity
 
 
 
Common stock, $.01 par value; 200,000,000 shares authorized; issued: 101,934,201 in 2013; 100,919,297 in 2012
1.0

 
1.0

Capital in excess of par value
2,886.3

 
2,876.6

Accumulated deficit
(2,208.2
)
 
(2,424.7
)
Accumulated other comprehensive (loss) income
(0.3
)
 
1.4

Treasury stock, at cost (14,639,430 shares in 2013 and 5,233,521 shares in 2012)
(404.0
)
 
(163.3
)
Total HealthSouth shareholders’ equity
274.8

 
291.0

Noncontrolling interests
117.9

 
112.5

Total shareholders’ equity
392.7

 
403.5

Total liabilities and shareholders’ equity
$
2,511.7

 
$
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)


 
Six Months Ended June 30, 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 (Loss)
 
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
—

 
—

 
—

 
216.5

 
—

 
—

 
25.8

 
242.3

Receipt of treasury stock
(0.3
)
 
—

 
—

 
—

 
—

 
(5.8
)
 
—

 
(5.8
)
Dividends declared on convertible perpetual preferred stock
—

 
—

 
(11.5
)
 
—

 
—

 
—

 
—

 
(11.5
)
Stock-based compensation
—

 
—

 
12.8

 
—

 
—

 
—

 
—

 
12.8

Stock options exercised
0.2

 
—

 
4.0

 
—

 
—

 
—

 
—

 
4.0

Distributions declared
—

 
—

 
—

 
—

 
—

 
—

 
(20.4
)
 
(20.4
)
Repurchases of common stock through tender offer
(9.1
)
 
—

 
—

 
—

 
—

 
(234.1
)
 
—

 
(234.1
)
Other
0.8

 
—

 
4.4

 
—

 
(1.7
)
 
(0.8
)
 
—

 
1.9

Balance at end of period
87.3

 
$
1.0

 
$
2,886.3

 
$
(2,208.2
)
 
$
(0.3
)
 
$
(404.0
)
 
$
117.9

 
$
392.7


 
Six Months Ended June 30, 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
—

 
—

 
—

 
90.9

 
—

 
—

 
23.9

 
114.8

Receipt of treasury stock
(0.7
)
 
—

 
—

 
—

 
—

 
(11.9
)
 
—

 
(11.9
)
Dividends declared on convertible perpetual preferred stock
—

 
—

 
(12.4
)
 
—

 
—

 
—

 
—

 
(12.4
)
Stock-based compensation
—

 
—

 
12.0

 
—

 
—

 
—

 
—

 
12.0

Distributions declared
—

 
—

 
—

 
—

 
—

 
—

 
(20.5
)
 
(20.5
)
Capital contributions from consolidated affiliates
—

 
—

 
—

 
—

 
—

 
—

 
9.8

 
9.8

Other
1.2

 
—

 
0.9

 
—

 
1.0

 
(1.7
)
 
0.1

 
0.3

Balance at end of period
95.7

 
$
1.0

 
$
2,874.6

 
$
(2,518.8
)
 
$
0.8

 
$
(162.4
)
 
$
97.9

 
$
293.1


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)


 
Six Months Ended June 30,
 
2013
 
2012
 
(In Millions)
Cash flows from operating activities:
 
 
 
Net income
$
244.9

 
$
116.7

Loss (income) from discontinued operations
0.3

 
(3.1
)
Adjustments to reconcile net income to net cash provided by operating activities—
 

 
 

Provision for doubtful accounts
14.4

 
12.8

Depreciation and amortization
45.2

 
39.5

Equity in net income of nonconsolidated affiliates
(6.2
)
 
(6.4
)
Distributions from nonconsolidated affiliates
5.0

 
5.5

Stock-based compensation
12.8

 
12.0

Deferred tax (benefit) expense
(53.5
)
 
51.7

Other
0.3

 
3.0

Increase in assets—
 
 
 

Accounts receivable
(38.8
)
 
(35.7
)
Other assets
(0.7
)
 
(7.0
)
Increase (decrease) in liabilities—
 
 
 

Accounts payable
9.5

 
10.3

Other liabilities
(6.2
)
 
(6.0
)
Net cash (used in) provided by operating activities of discontinued operations
(0.2
)
 
1.7

Total adjustments
(18.4
)
 
81.4

Net cash provided by operating activities
226.8

 
195.0


(Continued)
5


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


 
Six Months Ended June 30,
 
2013
 
2012
 
(In Millions)
Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(69.0
)
 
(82.8
)
Capitalized software costs
(11.9
)
 
(11.6
)
Acquisition of business, net of cash acquired
(28.9
)
 
(2.1
)
Proceeds from sale of restricted investments
10.3

 
0.2

Purchase of restricted investments
(5.4
)
 
(4.4
)
Net change in restricted cash
4.7

 
4.6

Other
(1.2
)
 
0.1

Net cash provided by investing activities of discontinued operations
—

 
7.7

Net cash used in investing activities
(101.4
)
 
(88.3
)
Cash flows from financing activities:
 
 
 
Principal payments on debt, including pre-payments
(0.7
)
 
(4.7
)
Principal borrowings on notes
11.4

 
—

Borrowings on revolving credit facility
132.0

 
40.0

Payments on revolving credit facility
(59.0
)
 
(50.0
)
Principal payments under capital lease obligations
(6.7
)
 
(5.7
)
Repurchase of common stock, including fees and expenses
(234.1
)
 
—

Repurchase of convertible perpetual preferred stock
—

 
(46.0
)
Dividends paid on convertible perpetual preferred stock
(11.5
)
 
(13.1
)
Distributions paid to noncontrolling interests of consolidated affiliates
(23.9
)
 
(24.0
)
Contributions from consolidated affiliates
—

 
7.9

Other
3.0

 
(0.1
)
Net cash used in financing activities
(189.5
)
 
(95.7
)
(Decrease) increase in cash and cash equivalents
(64.1
)
 
11.0

Cash and cash equivalents at beginning of period
132.8

 
30.1

Cash and cash equivalents at end of period
$
68.7

 
$
41.1



The accompanying notes to condensed consolidated financial statements are an integral part of these condensed statements.
6

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.
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 5, Redeemable Noncontrolling Interests.
Net Operating Revenues—
During the three and six months ended June 30, 2013 and 2012, we derived consolidated Net operating revenues from the following payor sources:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Medicare
74.6
%
 
72.9
%
 
74.6
%
 
73.3
%
Medicaid
1.0
%
 
1.3
%
 
1.1
%
 
1.2
%
Workers’ compensation
1.2
%
 
1.5
%
 
1.3
%
 
1.5
%
Managed care and other discount plans
18.4
%
 
19.6
%
 
18.4
%
 
19.5
%
Other third-party payors
1.7
%
 
1.8
%
 
1.7
%
 
1.7
%
Patients
1.2
%
 
1.3
%
 
1.2
%
 
1.3
%
Other income
1.9
%
 
1.6
%
 
1.7
%
 
1.5
%
Total
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
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.


7
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

2.
Business Combinations
In April 2013, we closed the transaction to acquire Walton Rehabilitation Hospital, a 58-bed inpatient rehabilitation hospital in Augusta, Georgia. The acquisition was not material to our financial position, results of operations, or cash flows. As a result of this transaction, Goodwill increased by $13.7 million. The acquisition was funded using availability under our revolving credit facility.
This acquisition was made to enhance our position and ability to provide inpatient rehabilitative services to patients in Georgia. All of the goodwill resulting from this transaction is deductible for federal income tax purposes. 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 this market.
We accounted for this transaction under the acquisition method of accounting and reported the results of operations of the acquired hospital from the date of acquisition. Assets acquired and liabilities assumed were recorded at their estimated fair values as of the acquisition date. 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 fair value of the assets acquired and liabilities assumed at the acquisition date were as follows (in millions):
Property and equipment, net
$
11.3

Identifiable intangible assets:
 

Noncompete agreement (useful life of 5 years)
0.1

Tradename (useful life of 20 years)
0.9

Certificate of need (useful life of 20 years)
3.3

Goodwill
13.7

Total assets acquired
29.3

Total current liabilities assumed
(0.4
)
Net assets acquired
$
28.9



8
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

The Company’s reported Net operating revenues and Net income for the three and six months ended June 30, 2013 include operating results for Walton Rehabilitation Hospital from April 1, 2013 through June 30, 2013. The following table summarizes the results of operations of the above mentioned transaction from the date of acquisition included in our consolidated results of operations and the results of operations of the combined entity had the date of the acquisition been January 1, 2012 (in millions):
 
Net Operating Revenues
 
Net (Loss) Income Attributable to HealthSouth
Acquired entity only: Actual from acquisition date to June 30, 2013
$
2.7

 
$
(1.2
)
Combined entity: Supplemental pro forma from 04/01/2013-06/30/2013*
564.5

 
165.2

Combined entity: Supplemental pro forma from 04/01/2012-06/30/2012
539.4

 
46.5

Combined entity: Supplemental pro forma from 01/01/2013-06/30/2013
1,142.0

 
216.1

Combined entity: Supplemental pro forma from 01/01/2012-06/30/2012
1,083.5

 
90.9

*Pro forma amounts equal reported operating results due to the acquisition of Walton Rehabilitation Hospital effective April 1, 2013.
Information regarding the net cash paid for all acquisitions during each period presented is as follows (in millions):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Fair value of assets acquired
$
15.6

 
$
2.1

 
$
15.6

 
$
2.1

Goodwill
13.7

 
—

 
13.7

 
—

Fair value of liabilities assumed
(0.4
)
 
—

 
(0.4
)
 
—

Net cash paid for acquisitions
$
28.9

 
$
2.1

 
$
28.9

 
$
2.1


3.
Investments in and Advances to Nonconsolidated Affiliates
As of June 30, 2013 and December 31, 2012, we had $21.9 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 12 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.


9
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

The following summarizes the combined results of operations of our equity method affiliates (on a 100% basis, in millions):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Net operating revenues
$
19.7

 
$
22.6

 
$
39.2

 
$
45.6

Operating expenses
(11.0
)
 
(13.8
)
 
(22.2
)
 
(27.9
)
Income from continuing operations, net of tax
7.3

 
6.9

 
14.0

 
14.4

Net income
7.3

 
6.9

 
14.0

 
14.4

4.
Long-term Debt
Our long-term debt outstanding consists of the following (in millions):
 
June 30, 2013
 
December 31, 2012
Credit Agreement—
 
 
 
Advances under revolving credit facility
$
73.0

 
$
—

Bonds payable—
 
 
 
7.25% Senior Notes due 2018
302.8

 
302.9

8.125% Senior Notes due 2020
286.4

 
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
47.7

 
36.8

Capital lease obligations
65.2

 
71.9

 
1,330.7

 
1,253.5

Less: Current portion
(11.0
)
 
(13.6
)
Long-term debt, net of current portion
$
1,319.7

 
$
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
July 1 through December 31, 2013
$
6.3

 
$
6.3

2014
10.7

 
10.7

2015
10.0

 
10.0

2016
9.0

 
9.0

2017
8.1

 
8.1

2018
383.1

 
384.4

Thereafter
904.2

 
902.2

Total
$
1,331.4

 
$
1,330.7

The amounts drawn on our revolving credit facility during the first six months of 2013 were primarily used for the repurchase of our common stock, as discussed in Note 9, Earnings per Common Share.


10
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

In June 2013, we amended our existing credit agreement to, among other things, permit unlimited restricted payments (as defined in the credit agreement) so long as the senior secured leverage ratio remains less than or equal to 1.5x and to extend the maturity date of the revolving credit facility from August 2017 to June 2018. All other material terms of the existing credit agreement remained the same and are described in more detail in Note 8, Long-term Debt, to the consolidated financial statements accompanying the 2012 Form 10‑K.
On July 25, 2013, our board of directors authorized the optional redemption of 10% of the outstanding principal amount of our existing 7.25% Senior Notes due 2018 and 7.75% Senior Notes due 2022 pursuant to the terms of these senior notes. Our right to call these bonds at 103% of the principal amount and the discretion provided by this authorization are not synonymous with an exercise of the call option.
Our bonds payable were issued pursuant to an indenture (the “Base Indenture”) between us and The Bank of Nova Scotia Trust Company of New York, as trustee (the “Original Trustee”), as supplemented by subsequent supplemental indentures relating to each respective series of senior notes (collectively with the Base Indenture, the “Indenture”). The Original Trustee notified us of its intention to discontinue its corporate trust operations and, accordingly, to resign upon the appointment of a successor trustee. Effective July 29, 2013, Wells Fargo Bank, National Association, was appointed as successor trustee under the Indenture.
For additional information regarding our indebtedness, see Note 8, Long-term Debt, to the consolidated financial statements accompanying the 2012 Form 10-K.
5.
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%. As a result of this transaction, Goodwill increased by $6.2 million.
•
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.


11
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

The following is a summary of the activity related to our Redeemable noncontrolling interests during the six months ended June 30, 2013 and 2012 (in millions):
 
Six Months Ended June 30,
 
2013
 
2012
Balance at beginning of period
$
7.2

 
$
7.3

Net income attributable to noncontrolling interests
2.6

 
1.9

Distributions declared
(1.9
)
 
(2.2
)
Contribution to joint venture
6.2

 
—

Balance at end of period
$
14.1

 
$
7.0

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 and six months ended June 30, 2013 and 2012 (in millions):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2013
 
2012
 
2013
 
2012
Net income attributable to nonredeemable noncontrolling interests
$
12.5

 
$
12.3

 
$
25.8

 
$
23.9

Net income attributable to redeemable noncontrolling interests
1.3

 
0.9

 
2.6

 
1.9

Net income attributable to noncontrolling interests
$
13.8

 
$
13.2

 
$
28.4

 
$
25.8



12
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

6.
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 June 30, 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
$
8.4

 
$
—

 
$
8.4

 
$
—

 
M
Other long-term assets:
 
 
 
 
 
 
 
 
 
Restricted marketable securities
41.8

 
—

 
41.8

 
—

 
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 and six months ended June 30, 2013 and 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 June 30, 2013
 
As of December 31, 2012
 
Carrying Amount
 
Estimated Fair Value
 
Carrying Amount
 
Estimated Fair Value
Long-term debt:
 

 
 

 
 

 
 

Advances under revolving credit facility
$
73.0

 
$
73.0

 
$
—

 
$
—

7.25% Senior Notes due 2018
302.8

 
322.6

 
302.9

 
328.6

8.125% Senior Notes due 2020
286.4

 
315.4

 
286.2

 
321.5

7.75% Senior Notes due 2022
280.6

 
300.6

 
280.7

 
306.5

5.75% Senior Notes due 2024
275.0

 
272.3

 
275.0

 
277.1

Other notes payable
47.7

 
47.7

 
36.8

 
36.8

Financial commitments:
 

 
 

 
 

 
 

Letters of credit
—

 
35.9

 
—

 
39.5



13
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 5, Redeemable Noncontrolling Interests.
7.
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.
8.
Income Taxes
In April 2013, we entered into closing agreements with the IRS that settled federal income tax matters related to the previous restatement of our 2000 and 2001 financial statements, as well as certain other tax matters, through December 31, 2008. As a result of these closing agreements, we increased our deferred tax assets, primarily our federal net operating loss carryforward (“NOL”), and recorded a net federal income tax benefit of approximately $115 million in the second quarter of 2013. This federal income tax benefit primarily resulted from an approximate $283 million increase to our federal NOL on a gross basis.
Our Provision for income tax benefit of $86.5 million and $53.0 million for the three and six months ended June 30, 2013, respectively, primarily resulted from the settlement discussed above. It also includes an approximate $3 million decrease in our valuation allowance related primarily to our capital loss carryforwards. During the second quarter of 2013, we determined a valuation allowance related to these assets was no longer required as sufficient positive evidence existed to substantiate their utilization. This evidence included our partial utilization of these capital loss carryforwards as a result of realizing capital gains in the current year and the identification of sufficient taxable capital gain income within the available capital loss carryforward period.
We have significant federal and state 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 $582.3 million of net deferred tax assets included in the accompanying condensed consolidated balance sheet as of June 30, 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 June 30, 2013, we maintained a valuation allowance of $37.2 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 $391.9 million (approximately $1.1 billion on a gross basis) as of June 30, 2013 excludes $6.3 million related to operating loss carryforwards resulting from excess tax benefits related to share-based awards, the tax


14
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

benefits of which, when recognized, will be accounted for as a credit to Capital in excess of par value when they reduce taxes payable.
Our Provision for income tax expense of $26.9 million and $56.0 million for the three and six months ended June 30, 2012, respectively, primarily resulted from the application of our estimated effective blended federal and state income tax rate.
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 $2.4 million and $78.0 million as of June 30, 2013 and December 31, 2012, respectively. The amount of gross unrecognized tax benefits changed during the three and six months ended June 30, 2013 primarily due to the IRS settlement 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
46.1

 
—

Decreases in unrecognized tax benefits relating to settlements with taxing authorities
(121.7
)
 
—

Balance at June 30, 2013
$
2.4

 
$
—

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 and six months ended June 30, 2013 and 2012 was not material. Accrued interest income related to income taxes as of June 30, 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 2010. We are currently under audit 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.


15
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

9.
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 June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Basic:
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
Income from continuing operations
$
178.9

 
$
56.4

 
$
245.2

 
$
113.6

Less: Net income attributable to noncontrolling interests included in continuing operations
(13.8
)
 
(13.2
)
 
(28.4
)
 
(25.8
)
Less: Convertible perpetual preferred stock dividends
(5.8
)
 
(6.0
)
 
(11.5
)
 
(12.4
)
Less: Repurchase of convertible perpetual preferred stock
—

 
(0.3
)
 
—

 
(0.8
)
Income from continuing operations attributable to HealthSouth common shareholders
159.3

 
36.9

 
205.3

 
74.6

Income (loss) from discontinued operations, net of tax, attributable to HealthSouth common shareholders
0.1

 
3.5

 
(0.3
)
 
3.1

Net income attributable to HealthSouth common shareholders
$
159.4

 
$
40.4

 
$
205.0

 
$
77.7

Denominator:
 
 
 
 
 
 
 
Basic weighted average common shares outstanding
86.1

 
94.6

 
90.0

 
94.5

Basic earnings per share attributable to HealthSouth common shareholders:
 
 
 
 
 
 
 
Continuing operations
$
1.85

 
$
0.39

 
$
2.28

 
$
0.79

Discontinued operations
—

 
0.04

 
—

 
0.03

Net income
$
1.85

 
$
0.43

 
$
2.28

 
$
0.82

 
 
 
 
 
 
 
 
Diluted:
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
Income from continuing operations
$
178.9

 
$
56.4

 
$
245.2

 
$
113.6

Less: Net income attributable to noncontrolling interests included in continuing operations
(13.8
)
 
(13.2
)
 
(28.4
)
 
(25.8
)
Income from continuing operations attributable to HealthSouth common shareholders
165.1

 
43.2

 
216.8

 
87.8

Income (loss) from discontinued operations, net of tax, attributable to HealthSouth common shareholders
0.1

 
3.5

 
(0.3
)
 
3.1

Net income attributable to HealthSouth common shareholders
$
165.2

 
$
46.7

 
$
216.5

 
$
90.9

Denominator:
 
 
 
 
 
 
 
Diluted weighted average common shares outstanding
99.8

 
108.0

 
103.4

 
108.3

Diluted earnings per share attributable to HealthSouth common shareholders:
 
 
 
 
 
 
 
Continuing operations
$
1.66

 
$
0.39

 
$
2.09

 
$
0.79

Discontinued operations
—

 
0.04

 
—

 
0.03

Net income
$
1.66

 
$
0.43

 
$
2.09

 
$
0.82



16
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 and six months ended June 30, 2013, the number of potential shares approximated 13.7 million and 13.4 million, respectively. For the three and six months ended June 30, 2012, the number of potential shares approximated 13.4 million and 13.8 million, respectively. For the three and six months ended June 30, 2013, approximately 11.6 million of the potential shares related to our Convertible perpetual preferred stock. For the three and six months ended June 30, 2012, approximately 12.0 million and 12.5 million of the potential shares, respectively, related to our Convertible perpetual preferred stock. For the three and six months ended June 30, 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 and six months ended June 30, 2012.
Options to purchase approximately 1.2 million and 1.8 million shares of common stock were outstanding as of June 30, 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.
On July 25, 2013, our board of directors approved the initiation of a quarterly cash dividend on our common stock of $0.18 per share. The first quarterly dividend will be payable on or about October 15, 2013 to stockholders of record as of the close of business on October 1, 2013. Future dividend payments are subject to declaration by our board of directors.
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.
10.
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.
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


17
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

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.

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. On April 25, 2013, the court denied our motion to vacate. On June 4, 2013, we filed a notice of appeal to the Supreme Court of Alabama seeking review of the Circuit Court's denial of our motion to vacate the arbitration panel's decision. Once the record on appeal is deemed complete, briefing will begin on that appeal. At this time, we do not know how long the appellate process will take.
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


18
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

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 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 and reserved the issue of collusion for a later time. The court issued a supplemental order on April 11, 2013, clarifying its February 27, 2103 ruling. The court's rulings provide that the Consent Judgment is admissible as evidence of General Medicine's claim in the Alabama Action but the amount of the Consent Judgment is not binding on us. Therefore, we remain free to present evidence challenging the amount of the damages figure contained in the Consent Judgment, including the value of the underlying contract-related claim that is the basis for the Consent Judgment. The court further ruled that we may develop and present evidence that the Consent Judgment is void in its entirety as the product of collusion by General Medicine and Horizon/CMS. The court also indicated it concurred with the Sixth Circuit Court of Appeals that the Consent Judgment did nothing more than establish Horizon/CMS's liability to General Medicine and did not establish the merits of General Medicine's separate fraudulent conveyance claims against HealthSouth. The Alabama Action is still in the discovery phase and has been set for trial beginning in June 2014.
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


19
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

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 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 the United States Centers for Medicare and Medicaid Services 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.
In March 2008, we sold our corporate campus to Daniel Corporation (“Daniel”), a Birmingham, Alabama-based real estate company. The sale included a deferred purchase price component related to an incomplete 13-story building located on


20
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements

the property, often referred to as the Digital Hospital. Under the agreement, Daniel is obligated upon sale of its interest in the building to pay to us 40% of the net profit realized from the sale. In June 2013, Daniel sold the building to Trinity Medical Center. We are currently in discussions with Daniel to finalize the amount owed to us in connection with the sale of the building.
11.
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 six months ended June 30, 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 six months ended June 30, 2012.
 
For the Six Months Ended June 30, 2012
HealthSouth Corporation
$
137.0

Guarantor Subsidiaries
10.8

Nonguarantor Subsidiaries
7.3





21
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements
Condensed Consolidating Statement of Operations


 
Three Months Ended June 30, 2013
 
HealthSouth Corporation
 
Guarantor Subsidiaries
 
Nonguarantor Subsidiaries
 
Eliminating Entries
 
HealthSouth Consolidated
 
(In Millions)
Net operating revenues
$
4.8

 
$
399.7

 
$
177.4

 
$
(17.4
)
 
$
564.5

Less: Provision for doubtful accounts
—

 
(4.7
)
 
(2.3
)
 
—

 
(7.0
)
Net operating revenues less provision for doubtful accounts
4.8

 
395.0

 
175.1

 
(17.4
)
 
557.5

Operating expenses:
 

 
 

 
 

 
 

 
 
Salaries and benefits
6.3

 
188.9

 
82.0

 
(3.6
)
 
273.6

Other operating expenses
4.5

 
58.7

 
26.2

 
(8.4
)
 
81.0

Occupancy costs
1.1

 
11.8

 
4.4

 
(5.4
)
 
11.9

Supplies
—

 
18.5

 
8.1

 
—

 
26.6

General and administrative expenses
29.5

 
—

 
—

 
—

 
29.5

Depreciation and amortization
2.2

 
15.9

 
5.0

 
—

 
23.1

Government, class action, and related settlements
(2.0
)
 
—

 
—

 
—

 
(2.0
)
Professional fees—accounting, tax, and legal
2.2

 
—

 
—

 
—

 
2.2

Total operating expenses
43.8

 
293.8

 
125.7

 
(17.4
)
 
445.9

Interest expense and amortization of debt discounts and fees
22.3

 
1.7

 
0.7

 
(0.3
)
 
24.4

Other income
—

 
(0.7
)
 
(1.5
)
 
0.3

 
(1.9
)
Equity in net income of nonconsolidated affiliates
(1.3
)
 
(2.0
)
 
—

 
—

 
(3.3
)
Equity in net income of consolidated affiliates
(113.7
)
 
(11.4
)
 
—

 
125.1

 
—

Management fees
(25.6
)
 
19.3

 
6.3

 
—

 
—

Income from continuing operations before income tax (benefit) expense
79.3

 
94.3

 
43.9

 
(125.1
)
 
92.4

Provision for income tax (benefit) expense
(85.6
)
 
(6.5
)
 
5.6

 
—

 
(86.5
)
Income from continuing operations
164.9

 
100.8

 
38.3

 
(125.1
)
 
178.9

Income (loss) from discontinued operations, net of tax
0.3

 
0.1

 
(0.3
)
 
—

 
0.1

Net Income
165.2

 
100.9

 
38.0

 
(125.1
)
 
179.0

Less: Net income attributable to noncontrolling interests
—

 
—

 
(13.8
)
 
—

 
(13.8
)
Net income attributable to HealthSouth
$
165.2

 
$
100.9

 
$
24.2

 
$
(125.1
)
 
$
165.2

Comprehensive income
$
163.4

 
$
100.9

 
$
38.0

 
$
(125.1
)
 
$
177.2

Comprehensive income attributable to HealthSouth
$
163.4

 
$
100.9

 
$
24.2

 
$
(125.1
)
 
$
163.4



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


 
Three Months Ended June 30, 2012
 
HealthSouth Corporation
 
Guarantor Subsidiaries
 
Nonguarantor Subsidiaries
 
Eliminating Entries
 
HealthSouth Consolidated
 
(In Millions)
Net operating revenues
$
3.2

 
$
384.4

 
$
159.9

 
$
(14.1
)
 
$
533.4

Less: Provision for doubtful accounts
0.2

 
(5.0
)
 
(1.7
)
 
—

 
(6.5
)
Net operating revenues less provision for doubtful accounts
3.4

 
379.4

 
158.2

 
(14.1
)
 
526.9

Operating expenses:
 

 
 

 
 

 
 

 
 
Salaries and benefits
5.8

 
180.4

 
74.6

 
(3.4
)
 
257.4

Other operating expenses
3.8

 
54.3

 
23.5

 
(6.6
)
 
75.0

Occupancy costs
1.1

 
11.0

 
4.3

 
(4.1
)
 
12.3

Supplies
—

 
18.7

 
7.2

 
—

 
25.9

General and administrative expenses
28.0

 
—

 
—

 
—

 
28.0

Depreciation and amortization
2.1

 
14.1

 
3.8

 
—

 
20.0

Professional fees—accounting, tax, and legal
5.5

 
—

 
—

 
—

 
5.5

Total operating expenses
46.3

 
278.5

 
113.4

 
(14.1
)
 
424.1

Interest expense and amortization of debt discounts and fees
20.8

 
1.9

 
0.6

 
(0.3
)
 
23.0

Other income
—

 
(0.1
)
 
(0.6
)
 
0.3

 
(0.4
)
Equity in net income of nonconsolidated affiliates
(0.8
)
 
(2.3
)
 
—

 
—

 
(3.1
)
Equity in net income of consolidated affiliates
(69.1
)
 
(5.1
)
 
—

 
74.2

 
—

Management fees
(24.2
)
 
18.6

 
5.6

 
—

 
—

Income from continuing operations before income tax (benefit) expense
30.4

 
87.9

 
39.2

 
(74.2
)
 
83.3

Provision for income tax (benefit) expense
(15.6
)
 
32.9

 
9.6

 
—

 
26.9

Income from continuing operations
46.0

 
55.0

 
29.6

 
(74.2
)
 
56.4

Income from discontinued operations, net of tax
0.7

 
0.8

 
2.0

 
—

 
3.5

Net Income
46.7

 
55.8

 
31.6

 
(74.2
)
 
59.9

Less: Net income attributable to noncontrolling interests
—

 
—

 
(13.2
)
 
—

 
(13.2
)
Net income attributable to HealthSouth
$
46.7

 
$
55.8

 
$
18.4

 
$
(74.2
)
 
$
46.7

Comprehensive income
$
46.9

 
$
55.8

 
$
31.6

 
$
(74.2
)
 
$
60.1

Comprehensive income attributable to HealthSouth
$
46.9

 
$
55.8

 
$
18.4

 
$
(74.2
)
 
$
46.9



23
HealthSouth Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements
Condensed Consolidating Statement of Operations