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Form 8-K HEALTHSOUTH CORP For: Aug 04

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August 4, 2015 7:50 AM EDT


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 8-K
CURRENT REPORT
Pursuant To Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report (date of earliest event reported): August 4, 2015 (December 31, 2014)

HealthSouth Corporation
(Exact name of Registrant as specified in its Charter)
Delaware
(State or Other Jurisdiction of Incorporation)
001-10315
63-0860407
(Commission File Number)
(IRS Employer Identification No.)
 
 
3660 Grandview Parkway, Suite 200, Birmingham, Alabama 35243
(Address of Principal Executive Offices, Including Zip Code)
(205) 967-7116
(Registrant’s Telephone Number, Including Area Code)
Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions:

¨
Written communication pursuant to Rule 425 under the Securities Act (17 CFR 230.425)
 
 
¨
Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)
 
 
¨
Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))
 
 
¨
Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))




Item 7.01. Regulation FD Disclosure
HealthSouth Corporation, a Delaware Corporation (“HealthSouth” or the “Company”), is filing this Current Report on Form 8-K to provide the following information:
•
Audited financial statements of Reliant Hospital Partners, LLC (“Reliant”) as of and for the year ended December 31, 2014
•
Unaudited pro forma condensed combined statement of operations for the year ended December 31, 2014 to include the Company's acquisition of EHHI Holdings, Inc. (“EHHI”) and its Encompass Home Health and Hospice business (“Encompass”)
The information contained herein is being furnished pursuant to Item 7.01 of Form 8-K, “Regulation FD Disclosure.” This information shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), or incorporated by reference in any filing under the Securities Act of 1933, as amended (the “Securities Act”), or the Exchange Act, except as shall be expressly set forth by specific reference in such a filing.
Audited Financial Statements of Reliant as of and for the Year Ended December 31, 2014
On June 10, 2015, HealthSouth entered into a definitive agreement to acquire the operations of Reliant for a cash purchase price of $730 million. Reliant operates a portfolio of 11 inpatient rehabilitation hospitals in Texas, Massachusetts, and Ohio for a total of 902 beds. This transaction, which is subject to customary closing conditions and regulatory approvals, including expiration or termination of all applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act, is expected to close in the fourth quarter of 2015. A copy of the acquisition agreement was filed as Exhibit 2.1 to the Current Report on Form 8-K filed by the Company on June 11, 2015.
The audited consolidated balance sheet of Reliant as of December 31, 2014 and the related audited consolidated statements of operations, members' deficit, and cash flows for the year ended December 31, 2014, together with the notes thereto and the auditor's report thereon, are filed as Exhibit 99.1 hereto and are incorporated by reference.
Unaudited Pro Forma Condensed Combined Statement of Operations for the Year Ended December 31, 2014
On December 31, 2014, the Company completed the acquisition of Encompass, the nation's fifth largest provider of Medicare-certified skilled home health services. The total cash consideration delivered at closing was $695.5 million. A copy of the acquisition agreement was filed as Exhibit 2.1 to the Company's Annual Report on Form 10-K (the “2014 Form 10-K”) filed on February 27, 2015.
On January 2, 2015, HealthSouth filed a Current Report on Form 8-K (the “Initial Filing”) to report the consummation of its acquisition of Encompass. On March 6, 2015, the Company filed a Current Report on Form 8-K/A (the “First Amendment”) to amend and supplement Item 9.01 of the Initial Filing to present certain financial statements of EHHI and to present certain unaudited pro forma condensed combined financial statements of the Company in connection with the acquisition of Encompass. The unaudited pro forma condensed combined financial statements of the Company filed in the First Amendment included a condensed combined balance sheet as of September 30, 2014 and condensed combined statements of operations for the year ended December 31, 2013 and the nine months ended September 30, 2014. This Current Report on Form 8-K further supplements Item 9.01 of the Initial Filing and First Amendment to present an unaudited pro forma condensed combined statement of operations of the Company for full-year 2014 in connection with the acquisition of Encompass. An unaudited pro forma condensed combined statement of operations for the year ended December 31, 2014, including the notes thereto, is included as Exhibit 99.2, which is incorporated herein by reference.




Item 9.01. Financial Statements and Exhibits
(a)    Financial Statements of Businesses Acquired
The audited consolidated balance sheet of Reliant as of December 31, 2014 and the related audited consolidated statements of operations, members' deficit, and cash flows for the year ended December 31, 2014, together with the notes thereto and the auditor's report thereon, are filed as Exhibit 99.1 hereto and is incorporated herein by reference.
(b)    Pro Forma Financial Information
The unaudited pro forma condensed combined statement of operations of HealthSouth for the year ended December 31, 2014 is filed as Exhibit 99.2 hereto and is incorporated herein by reference.
(d)
Exhibits
See Exhibit Index.




SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned hereunto duly authorized.
HEALTHSOUTH CORPORATION
 
 
 
By:
/S/   DOUGLAS E. COLTHARP
 
Name:
Douglas E. Coltharp
 
Title:
Executive Vice President and Chief Financial Officer
Dated: August 4, 2015




EXHIBIT INDEX

Exhibit Number
Description of Exhibit
99.1
Audited consolidated balance sheet of Reliant as of December 31, 2014 and the related audited consolidated statements of operations, members' deficit, and cash flows for the year ended December 31, 2014, together with the notes thereto and the auditor's report thereon.
99.2
Unaudited pro forma condensed combined statement of operations of HealthSouth for the year ended December 31, 2014.



Exhibit 99.1

Reliant Hospital Partners, LLC
Auditor’s Report and Consolidated Financial Statements
December 31, 2014





Reliant Hospital Partners, LLC
December 31, 2014



Contents
    
INDEPENDENT AUDITOR’S REPORT
1

 
 
CONSOLIDATED FINANCIAL STATEMENTS
 
Balance Sheet
3

Statement of Operations
5

Statement of Members’ Deficit
6

Statement of Cash Flows
7

Notes to Consolidated Financial Statements
8



















Independent Auditor’s Report



Board of Directors and Members of
Reliant Hospital Partners, LLC
Richardson, Texas


We have audited the accompanying consolidated financial statements of Reliant Hospital Partners, LLC and its subsidiaries (Company), which comprise the consolidated balance sheet as of December 31, 2014, and the related consolidated statement of operations, members’ deficit and cash flows for the year then ended, and the related notes to the consolidated financial statements.
Management’s Responsibility for the Financial Statements
Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.
Auditor’s Responsibility
Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.




Board of Directors and Members of
Reliant Hospital Partners, LLC
Page 2
Opinion
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Reliant Hospital Partners, LLC and its subsidiaries as of December 31, 2014, and the results of their operations and their cash flows for the year then ended in accordance with accounting principles generally accepted in the United States of America.

/s/ BKD, LLP
Dallas, Texas
March 31, 2015




Reliant Hospital Partners, LLC
Consolidated Balance Sheet
December 31, 2014

ASSETS
 
 
 
Currents assets
 
Cash
$
29,314,883

Patient accounts receivable, net of allowance;
    2014 - $3,755,046
29,985,411

Estimated amounts due from third-party payers
972,145

Prepaid expenses
3,715,579

Supply inventory and other
1,036,469

 
 
Total current assets
65,024,487

 
 
Property and Equipment, At cost
 
Buildings and land recorded under capital leases
194,142,528

Facility equipment and furniture
22,609,351

Construction in progress
39,994

 
216,791,873

Less accumulated depreciation and amortization
38,639,126

 
 
 
178,152,747

 
 
Other Assets
 
Deferred financing costs, net
3,356,709

Goodwill
60,223,270

Intangible assets, net
7,067,000

Due from affiliates
868,003

Other long-term assets
1,078,096

 
 
 
72,593,078

 
 
Total assets
$
315,770,312




(Continued)
3

Reliant Hospital Partners, LLC
Consolidated Balance Sheet (Continued)
December 31, 2014


Liabilities And Members’ Deficit
 
 
 
Current liabilities
 
Current maturities of long-term debt
$
3,862,500

Current maturities of capital lease obligations
2,363,175

Accounts payable
2,401,627

Accrued bonuses
1,298,316

Accrued benefits
2,985,431

Accrued property taxes
3,213,956

Other accrued expenses
4,962,167

Estimated amounts due to third-party payors
979,017

 
 
Total current liabilities
22,066,189

 
 
Long-term Debt, Less Current Maturities
150,637,500

 
 
Capital Lease Obligations, Less Current Maturities
186,238,796

 
 
Other Long-term Liabilities
6,981,679

 
 
 
365,924,164

 
 
Commitments and Contingencies
 
Members’ Deficit
 
Reliant Hospital Partners, LLC’s deficit
(53,416,858
)
Noncontrolling interests
3,263,006

 
 
Total members’ deficit
(50,153,852
)
 
 
Total liabilities and members’ deficit
$
315,770,312




See Notes to Consolidated Financial Statements
4

Reliant Hospital Partners, LLC
Consolidated Statement of Operations
Year Ended December 31, 2014



Revenue
 
Net patient service revenue
$
247,676,520

Other
1,400,036

 
 
Total revenue
249,076,556

 
 
Expenses
 
Salaries, wages, and benefits
108,826,751

Purchased services and professional fees
16,160,077

Other operating expenses
27,005,812

Rent expense
11,812,386

Depreciation and amortization
13,066,173

Management fees to affiliates
1,000,000

Provision for doubtful accounts
3,437,563

 
 
Total expenses
181,308,762

 
 
Operating income
67,767,794

 
 
Interest expense
(22,605,000
)
 
 
Net income
$
45,162,794

 

Amounts Attributable to Noncontrolling Interests
 
Net Income
$
45,162,794

Less net income attributable to noncontrolling interests
4,184,072

 
 
Net income attributable to Reliant Hospital Partners, LLC
$
40,978,722




See Notes to Consolidated Financial Statements
5

Reliant Hospital Partners, LLC
Consolidated Statement of Members’ Deficit
Year Ended December 31, 2014




 
Reliant
Hospital Partners, LLC
 
Noncontrolling Interests
 
Total
Members’
 Equity
(Deficit)
 
 
 
 
 
 
Balance, January 1, 2014
$
33,807,301

 
$
6,976,493

 
$
40,783,794

 
 
 
 
 
 
Unit-based compensation
350,927

 
—

 
350,927

Member distributions
(127,824,491
)
 
(7,432,499
)
 
(135,256,990
)
Reliant Hospital Partners, LLC purchase
of noncontrolling interests and other
redemption of interests
(729,317
)
 
(465,060
)
 
(1,194,377
)
Net income
40,978,722

 
4,184,072

 
45,162,794

 
 
 
 
 
 
Balance, December 31, 2014
$
(53,416,858
)
 
$
3,263,006

 
$
(50,153,852
)



See Notes to Consolidated Financial Statements
6

Reliant Hospital Partners, LLC
Consolidated Statement of Cash Flows
Year Ended December 31, 2014



Operating activities
 
Net income
$
45,162,794

Items not requiring cash
 
Depreciation and amortization of property and equipment
12,581,598

Amortization of intangible assets
484,575

Amortization of deferred financing costs
1,747,670

Provision for doubtful accounts
3,437,563

Unit-based compensation
350,927

Changes in
 
Patient accounts receivable
(20,149,864
)
Estimated amounts due from third-party payers
1,425,222

Inventory, prepaid expenses and other
(1,111,568
)
Accounts payable
(2,162,387
)
Accrued expenses and other
223,847

 
 
Net cash provided by operating activities
41,990,377

 


Investing activities
 
Purchase of property and equipment
(1,228,990
)
 


Net cash used in investing activities
(1,228,990
)
 
 
Financing activities
 
Distributions to members
(135,256,990
)
Reliant Hospital Partners, LLC purchase of noncontrolling
    interests and other redemption of interests
(1,194,377
)
Proceeds from issuance of long-term debt
124,667,621

Payment of deferred financing costs
(3,533,321
)
Payments on line of credit
(11,000,000
)
Payments on long-term debt
(15,993,538
)
Payments on capital lease obligations
(2,504,192
)
 
 
Net cash used in financing activities
(44,814,797
)
 
 
Decrease in Cash
(4,053,410
)
 
 
Cash, Beginning of Year
33,368,293

 
 
Cash, End of Year
$
29,314,883

 
 
Supplemental Cash Flows Information
 
Interest paid
$
20,998,582

 
 
Supplemental Disclosures of Noncash Investing Activities


Payables incurred for property and equipment
$
29,028





See Notes to Consolidated Financial Statements
7

Reliant Hospital Partners, LLC
Notes to Consolidated Financial Statements
December 31, 2014



Note 1:
Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations and Principles of Consolidation
Reliant Hospital Partners, LLC (RHP) is a Texas limited liability company. RHP and its subsidiaries (Company) operate inpatient rehabilitation hospitals providing physical, occupational and speech therapy services on an inpatient and outpatient basis at eight hospitals in Texas, two hospitals in Massachusetts and one hospital in Ohio. The consolidated financial statements include the accounts of RHP and its subsidiaries. All significant intercompany transactions and balances have been eliminated.
The Company operates seven of its hospitals through multiple tier partnership arrangements in which the hospital operating entity is in a separate partnership and whose owners consist of physician limited partners with RHP controlling the general partnership of each entity and varying amounts of limited partner interests. The term of each partnership is 50 years, commencing on various dates. The partnership agreements contain provisions, which limit the sale, assignment or transfer of a partner’s interest in the partnerships.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Patient Accounts Receivable
The Company reports patient accounts receivable for services rendered at net realizable amounts from third-party payers, patients and others. The Company provides an allowance for doubtful accounts based upon a review of outstanding receivables, historical collection information and existing economic conditions. The Company bills third-party payers directly and bills the patient when the patient’s liability is determined. Patient accounts receivable are due in full when billed. Accounts are considered delinquent and subsequently written off as bad debts based on individual credit evaluation and specific circumstances of the account.
Supply Inventory
Supply inventories are stated at the lower of cost, determined using the first-in, first-out method, or market.


8

Reliant Hospital Partners, LLC
Notes to Consolidated Financial Statements
December 31, 2014




Property and Equipment
Property and equipment acquisitions are recorded at cost and are depreciated using the straight-line method over the estimated useful life of each asset. Assets under capital lease obligations, including both land and buildings, are amortized over the shorter of the lease term or their respective estimated useful lives.
At December 31, 2014, fully depreciated assets included in property and equipment was approximately $387,000.
The estimated useful lives for each major depreciable class of property and equipment are as follows:
Buildings and land recorded under capital leases
20 - 25 years
Facility equipment and furniture
3 - 20 years
Deferred Financing Costs
Deferred financing costs represent costs incurred in connection with the issuance or modification of long-term debt. Such costs are being amortized to interest expense over the term of the respective debt using the straight-line method, which approximates the effective interest method. During the year ended December 31, 2014, interest expense of $1,335,399 was recognized due to refinancing the long-term debt. Total interest expense related to debt issuance costs was $1,747,670 in 2014.
Goodwill and Indefinite-lived Intangible Assets
Goodwill and indefinite-lived intangibles are evaluated annually for impairment or more frequently if impairment indicators are present. A qualitative assessment is performed to determine whether the existence of events or circumstances leads to a determination that it is more-likely-than-not the fair value of the reporting unit or indefinite-lived intangible asset is less than its carrying amount. If, based on the evaluation, it is determined to be more-likely-than-not that the fair value is less than the carrying value, then the goodwill or indefinite-lived intangible is tested further for impairment. If the implied fair value of goodwill or the fair value of the indefinite-lived intangible is lower than their carrying amounts, an impairment loss is recognized in an amount equal to the difference. Any subsequent increases in the value of goodwill and indefinite-lived intangibles are not recognized in the financial statements. There was no impairment of goodwill or indefinite-lived intangible assets recognized during the year ended December 31, 2014.
Intangible Assets
The Company’s intangible assets with finite lives are trade names. The trade names are being amortized on a straight-line basis over periods ranging from 5 – 20 years. These assets are periodically evaluated as to the recoverability of their carrying values and more frequently if there are impairment indicators.


9

Reliant Hospital Partners, LLC
Notes to Consolidated Financial Statements
December 31, 2014




Long-lived Asset Impairment
The Company evaluates the recoverability of the carrying value of long-lived assets whenever events or circumstances indicate the carrying amount may not be recoverable. If a long-lived asset is tested for recoverability and the undiscounted estimated future cash flows expected to result from the use and eventual disposition of the asset are less than the carrying amount of the asset, the asset is written down to fair value and an impairment loss is recognized for the amount by which the carrying amount of the long-lived asset exceeds its fair value.
No asset impairment was recognized during the year ended December 31, 2014.
Net Patient Service Revenue
The Company has agreements with third-party payers that provide for payments to the Company at amounts different from its established rates. Net patient service revenue is reported at the estimated net realizable amounts from patients, third-party payers and others for services rendered and includes estimated retroactive revenue adjustments. Retroactive adjustments are considered in the recognition of revenue on an estimated basis in the period the related services are rendered and such estimated amounts are revised in future periods as adjustments become known.
Income Taxes
The Company is not directly subject to income taxes under the provisions of the Internal Revenue Code and applicable state laws. Therefore, taxable income or loss is reported to the individual members for inclusion in their respective tax returns and no provision for federal income taxes are included in the accompanying consolidated statements of operations.
The Company is subject to state income taxes, including the Texas margin tax. These taxes are not significant for the year ended December 31, 2014.
Professional Liability Claims
The Company recognizes an accrual for claim liabilities based on estimated ultimate losses and costs associated with settling claims and a receivable to reflect the estimated insurance recoveries, if any. Professional liability claims are described more fully in Note 5.
Unit-based Compensation
Awards of unit-based compensation are measured at their grant date fair value. Compensation expense is recognized in the accompanying consolidated statement of operations over the vesting period of the respective award. See Note 14 for additional information.


10

Reliant Hospital Partners, LLC
Notes to Consolidated Financial Statements
December 31, 2014




Note 2:
Net Patient Service Revenue
Revenues consist primarily of net patient service revenue that is recorded based on established billing rates less contractual adjustments.
Inpatient and outpatient rehabilitation services rendered to Medicare and Medicaid program beneficiaries are paid at prospectively determined rates. These rates vary according to a patient classification system that is based on clinical and diagnostic factors. The Company is reimbursed for certain services at tentative rates with final settlement determined after submission of annual cost reports and audits thereof by the Medicare and Medicaid administrative contractors.
Approximately 75% of net patient service revenue is from participation in the Medicare program during the year ended December 31, 2014. Net patient service revenue from participation in the Medicaid program has not been a significant source of revenue for the Company.
Laws and regulations governing the Medicare and Medicaid programs are complex and subject to interpretation and change. As a result, it is reasonably possible that recorded estimates will change materially in the near term.
The Company has also entered into payment agreements with certain commercial insurance carriers, health maintenance organizations and preferred provider organizations. The basis for payment to the Company under these agreements includes prospectively determined rates per discharge, discounts from established charges and prospectively determined daily rates.

Note 3:
Concentration of Credit Risk
The Company grants credit without collateral to its patients, most of who reside in areas near the Company’s hospitals and are insured under third-party payer agreements. Substantially all of the Company’s net receivables are due from third-party payers. The mix of net receivables from third-party payers at December 31, 2014 is:
Medicare
76
%
Medicaid
7
%
Blue Cross Blue Shield
10
%
Other third-party payers
7
%
 
100
%



11

Reliant Hospital Partners, LLC
Notes to Consolidated Financial Statements
December 31, 2014




Note 4:
Acquired Intangible Assets and Goodwill
At December 31, 2014, the carrying amount of goodwill was $60,223,270. The goodwill was recorded as the excess of the purchase price over the fair value of the identifiable assets acquired, net of liabilities assumed, from a 2011 acquisition of all of the assets of Reliant Hospital Partners, LLC. This acquisition included varying interests in multiple tier partnerships. The goodwill has been assigned to the Company’s sole reporting unit and includes goodwill attributable to both the Company and noncontrolling interests.
The carrying amount and accumulated amortization of the Company’s identifiable intangible assets were as follows at December 31, 2014:

 
Gross Carrying Amount
 
Accumulated Amortization
 
Net
2014
 
 
 
 
 
Trade names
$
5,881,500

 
$
(1,124,500
)
 
$
4,757,000

Certificates of need
2,310,000

 
—

 
2,310,000

 
$
8,191,500

 
$
(1,124,500
)
 
$
7,067,000

The trade names are being amortized over periods ranging from 5 – 20 years. The certificates of need have indefinite lives.
Amortization expense related to the identifiable intangible assets was $484,575 for the year ended December 31, 2014. Estimated future intangible asset amortization expense at December 31, 2014 is as follows:
2015
$
484,575

2016
484,575

2017
484,575

2018
484,575

2019
230,575

Thereafter
2,588,125

 
$
4,757,000

Note 5:
Professional Liability Claims
The Company purchases professional liability insurance under a claims-made policy. Under such a policy, only claims made and reported to the insurer during the policy term, regardless of when the incidents giving rise to the claims occurred, are covered. The Company also purchases excess umbrella liability coverage, which provides additional coverage above the basic policy limits up to the amount specified in the umbrella policy.


12

Reliant Hospital Partners, LLC
Notes to Consolidated Financial Statements
December 31, 2014




The Company recognizes an accrual for claim liabilities based on estimated ultimate losses and costs associated with litigating and settling claims and a receivable to reflect estimated insurance recoveries, if any. Based upon the Company’s claims experience, no accrual has been made for the Company’s estimated professional liability costs as the amount is not expected to be material. It is reasonably possible that this estimate could change materially in the near term.

Note 6:
Lines of Credit
On May 2, 2012, the Company entered into a revolving credit facility agreement with two lenders that provided for cash borrowings under revolving lines of credit or issuances of letters of credit up to $9,000,000 and was to expire on May 2, 2017. On December 31, 2013, the Company amended the credit facility to, among other things, increase the revolving credit borrowings to $22,000,000 for the 180 day period following the effective date and $12,000,000 thereafter. On September 30, 2014, the Company amended the credit facility to, among other things, increase the revolving credit borrowings to $15,000,000. Borrowings and letters of credit are limited to amounts calculated using adjusted EBITDA, the leverage multiple in effect and funded indebtedness. Cash borrowings under the revolving line of credit at December 31, 2014 totaled $0. At December 31, 2014, there were no amounts outstanding under letters of credit. Interest on borrowings under the credit agreement is computed based on the Company’s outstanding balance at the LIBOR rate plus 4.75% with a floor of 5.75%. The interest rate was 5.75% at December 31, 2014.
The Company also pays an annual unused commitment fee of 0.5%. The credit agreement is secured by substantially all assets of the Company and is guaranteed by the parents of the Company. The credit agreement contains limitations customarily found in such agreements on the incurrence of additional debt, investments, dividends and sale or merger of the Company and contains certain financial covenants. The credit agreement matures on December 31, 2018.

Note 7:
Long-term Debt

Prior to the credit facility entered into on May 2, 2012, described below, the Company utilized long-term notes to finance equipment and initial startup needs including supply inventory and operating expenses. The obligor on each note was the operating partnership who utilized the funds. Payment of outstanding balances was guaranteed by RHP and each operating partnership’s limited partners. The working capital and equipment notes were paid off and replaced by the credit facility entered into during May 2012 discussed below. At December 31, 2014, long-term debt includes the following:

Credit facility
$
154,500,000

Less current maturities
(3,862,500
)
 
$
150,637,500



13

Reliant Hospital Partners, LLC
Notes to Consolidated Financial Statements
December 31, 2014




On May 2, 2012, the Company entered into a $45,000,000 credit facility with a group of institutional lenders, which included a $36,000,000 term loan and was to expire May 2, 2017. The facility was entered into in order to: (1) purchase additional noncontrolling interests, (2) refinance the lines of credit and other long-term indebtedness, (3) provide working capital and (4) fund certain fees associated with the facility funding and the purchase of the limited partner ownership interests. On December 31, 2013, the Company amended the credit facility agreement to increase the credit facility to $70,375,000, which included Term Loan A for $36,000,000 and Term Loan B for $12,375,000 in order to purchase two additional hospitals and to provide working capital. On September 30, 2014, the Company amended the credit facility agreement to increase the credit facility to $169,500,000, in order to fund distributions of accumulated earnings to members. The credit facility matures October 1, 2019, and requires quarterly payments ranging from $965,625 to $1,931,250 plus interest beginning on January 1, 2015, with a final payment at maturity of $125,531,250. Interest on borrowings under the credit agreement is computed based on the Company’s outstanding balance (at the lower of the bank’s prime rate plus 3.75% or the LIBOR rate plus 4.75%). The interest rate was 5.75% at December 31, 2014. The credit agreement is secured by substantially all assets of the Company and is guaranteed by the parent of the Company. The credit agreement contains limitations customarily found in such agreements on the incurrence of additional debt, investments, dividends and sale or merger of the Company and contains certain financial covenants.
In November 2011, RHP purchased additional ownership interests of its subsidiaries from certain limited partners for $3,716,619. $2,477,745 of the purchase was funded through notes payable to the limited partners at 5% interest, payable in three annual installments with the final payment on November 14, 2014. These notes were not collateralized.
Aggregate annual maturities of long-term debt at December 31, 2014 were:
2015
$
3,862,500

2016
3,862,500

2017
7,725,000

2018
7,725,000

2019
131,325,000

 
$
154,500,000



14

Reliant Hospital Partners, LLC
Notes to Consolidated Financial Statements
December 31, 2014




Note 8:
Capital Lease Obligations
The Company is obligated under long-term noncancellable leases for certain buildings and land, which for accounting purposes, qualify as capital leases. The leases have minimum lease terms expiring through 2036 and have imputed interest rates recorded ranging from 7.5% to 8.895%. The lease payments are guaranteed by RHP and each respective operating partnership limited partner for its related lease. Future annual payments on capital lease obligations at December 31, 2014, are shown below:
2015
$
16,879,767

2016
18,478,579

2017
18,770,450

2018
19,083,339

2019
19,240,915

Thereafter
299,219,818

 
391,672,868

Less amount representing interest
(203,070,897
)
Present value of future minimum lease payments
188,601,971

Less current maturities
(2,363,175
)
 
 
Long-term portion
$
186,238,796

At December 31, 2014, property and equipment include the following property under capital leases:
Buildings and land
$
194,142,528

Less accumulated depreciation
(29,936,057
)
 
$
164,206,471



15

Reliant Hospital Partners, LLC
Notes to Consolidated Financial Statements
December 31, 2014




Note 9:
Sale-leaseback Transaction and Operating Leases
At the close of business on December 31, 2013, RHP purchased certain personal property and operations of two hospitals in the Boston area from FS Commonwealth LLC (FSC) and FS Patriot LLC (FSP). Concurrently, an unrelated third-party, HRSE-TST III, LLC (TST) purchased the land and buildings associated with FSP and FSC from HRSE 1 Properties Trust (HRSE1) for $88,000,000. It was determined that the substance of the transaction was that the Company acquired all of the assets of the hospitals, and simultaneously sold the real property to TST in a sale-leaseback transaction. The Company has entered into lease agreements to lease the property from TST for a period of 15 years beginning January 1, 2014. The real estate was valued at $82,000,000 in the business combination. A gain of $6,000,000 realized in this transaction was deferred and is being amortized to income in proportion to rent charged over the term of the lease. At December 31, 2014, the remaining deferred gain of $5,600,000 is included in other long-term liabilities on the accompanying consolidated balance sheet.
The Company leases four facilities and the home office under noncancellable facility lease agreements with terms ranging from 5 – 15 years along with renewal options for periods ranging from 15 – 25 years. The leases also require additional payments for operating expenses, real estate taxes and insurance. The facility lease agreements contain escalation clauses based on fixed terms and changes in the Consumer Price Index. The excess of cumulative rent expense, recognized on a straight-line basis, over cumulative rent payments is recorded as a long-term liability in the accompanying consolidated balance sheet and was approximately $1,382,000 as of December 31, 2014.
Future minimum lease payments at December 31, 2014 were:
2015
$
7,966,033

2016
8,698,913

2017
8,860,513

2018
8,921,531

2019
9,077,241

Thereafter
83,369,837

Future minimum lease payments
$
126,894,068

The lease payments are guaranteed by RHP and each operating partnership limited partner for its related lease. Total rent expense under these lease agreements was approximately $11,909,000 for the year ended December 31, 2014.


16

Reliant Hospital Partners, LLC
Notes to Consolidated Financial Statements
December 31, 2014




Note 10:
Retirement Plan
The Company has a defined contribution pension plan covering substantially all employees. The Board of Directors annually determines the amount, if any, of the Company’s contributions to the plan. The Board of Directors approved a discretionary contribution for the year ended December 31, 2014 of $150,000 which is included in accounts payable and accrued expenses in the accompanying 2014 consolidated balance sheet.

Note 11:
Related Party Transactions
RHP has an agreement with Nautic Partners VI, L.P. (Nautic), which is a member of RHP’s ultimate parent, Reliant Holding Company, LLC (Holding), to pay management fees of $500,000 annually, until actual annualized or budgeted EBITDA equals or exceeds $20,000,000, when the management fee increases to $1,000,000 annually. The Company’s EBITDA exceeded $20,000,000 during 2014. Nautic received $900,000 of the management fee in 2014, and $100,000 was paid to board consultants in 2014. Additionally, the Company reimburses certain travel costs of Nautic. RHP paid travel costs totaling $47,632 to Nautic for the year ended December 31, 2014, under this agreement.
Nautic is also named in the lawsuit discussed in Note 13.  The Company and Nautic have agreed to share in certain legal costs related to the lawsuit.  Based on the allocation proposed by Nautic’s insurer, the Company has paid and accrued obligations to various firms that include amounts to be reimbursed by Nautic. At December 31, 2014, approximately $868,000, is recorded as a receivable from Nautic included in due from affiliates in the accompanying consolidated balance sheet and as an offset to legal expense.

Note 12:
Fair Value of Financial Instruments
The following methods were used to estimate the fair value of financial instruments recognized in the accompanying balance sheets at amounts other than fair value.
Cash
The carrying amount approximates fair value.
Long-term Debt
Fair value is estimated based on the borrowing rates currently available to the Company for bank loans with similar terms and maturities and determined through the use of a discounted cash flow model. Substantially all long-term debt was modified during 2014 and, therefore, their carrying amount approximates fair value.


17

Reliant Hospital Partners, LLC
Notes to Consolidated Financial Statements
December 31, 2014




Note 13:
Significant Estimates and Concentrations
Accounting principles generally accepted in the United States of America require disclosure of certain significant estimates and current vulnerabilities due to certain concentrations. Those matters include the following:
Cash
At December 31, 2014, the Company’s cash accounts exceeded federally insured limits by approximately $28,522,000.
Allowance for Net Patient Service Revenue Adjustments
Estimates of allowances for adjustments included in net patient service revenue are described in Notes 1 and 2.
Professional Liability Claims
Estimates related to the accrual for professional liability claims are described in Note 5.
Litigation
A lawsuit has been brought against RHP, Old RHP, other parties and selected current and former executives of RHP in Dallas County, Texas, District Court. The plaintiff alleges a number of causes of actions and seeks, among other things, monetary damages and an injunction prohibiting RHP from pursuing any expansion of services in certain markets. RHP has denied any wrongdoing and is defending the case vigorously. On November 18, 2011, the court awarded monetary sanctions against certain former executives of RHP. The Court has not awarded any sanctions against RHP. No potential range of loss, if any, can be estimated. Accordingly, an estimated liability has not been recorded in the accompanying consolidated financial statements. A portion of the Company’s legal expenses were recoverable based on the Company’s insurance policies in effect. As of December 31, 2014, the insurance coverage related to this case and any additional legal expenses or settlements will not be recovered as the maximum insurance payment was fully recovered.
In the normal course of business, the Company is, from time to time, subject to allegations that may or do result in litigation. Some of these allegations are in areas not covered by commercial insurance; for example, allegations regarding employment practices or performance of contracts. The Company evaluates such allegations by conducting investigations to determine the validity of each potential claim. Based upon the advice of counsel, management records an estimate of the amount of ultimate expected loss, if any, for each of these matters. No provisions for potential losses were accrued at December 31, 2014. Events could occur that would cause the estimate of ultimate loss to differ materially in the near term.


18

Reliant Hospital Partners, LLC
Notes to Consolidated Financial Statements
December 31, 2014




Note 14:
Incentive Units
Holding, parent of RHP, issued incentive units in the form of Class B, Class C-1, Class C-2 and Class C-3 units during 2011, 2012 and 2014 to key employees and directors of the Company. The units are considered profits interests, so no capital contributions are required by the holders of the units. The incentive unit holders participate in distributions made by the Company, subject to achievement of certain distribution targets and an order of priority as defined by Holding. The incentive units are accounted for as compensatory awards. The Class B and Class C-1 units granted in 2011 and 2012 vest in five equal annual installments on each anniversary of the grant date, provided that they vest in their entirety upon consummation of a sale of the Company. The Class C-1 units granted in 2014 vested 40% at the time of issuance and the remaining units issued vest in three equal annual installments beginning on January 31, 2015, provided that they vest in their entirety upon consummation of a sale of the Company. The Class C-2 and Class C-3 units vest in their entirety upon the consummation of a sale of the Company, if in connection with the sale of the Company the aggregate consideration payable will result in a target distribution as specified by Holding having been satisfied. In the case of employee termination, only unvested incentive units are returned to the Company. The Company believes that such awards better align the interests of its employees with those of its members.
The Company used an option pricing method to value the incentive units. Under this method, all classes of membership units are modeled as call options on the Company’s underlying equity value, and the rights and preferences of each class of membership are considered in order to allocate a fair value to each class. A significant input of the option pricing method is the enterprise value of the Company, which was estimated utilizing a combination of the income and market approach. The fair value of the incentive units were estimated on the date of grant using a Black-Scholes option valuation model with the assumptions noted in the following table. As the Company does not have a history of market prices for units, expected volatility is based on observable data for a group of peer companies and other factors. The expected term represents the estimated time until a liquidity event. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant. The fair value of the incentive units also includes a nonmarketability discount of 25%.
Expected volatility
42.16
%
Expected dividend yield
0
%
Expected term (in years)
5

Risk-free rate
1.68
%


19

Reliant Hospital Partners, LLC
Notes to Consolidated Financial Statements
December 31, 2014




Information regarding the amount and grant-date fair value of the vested and nonvested Class B and Class C-1 incentive units is as follows for 2014:
 
Units
 
Weighted-Average Grant-Date Fair Value
Outstanding, beginning of year
3,313,419

 
$
0.45

Granted
 
 
 
Class C-1
94,694

 
$
1.11

Forfeited
—

 
$
—

 
 
 
 
Outstanding, end of year
3,408,113

 
$
0.47

 
 
 
 
Vested, beginning of year
1,573,298

 
$
0.44

Class B
20,000

 
$
0.42

Class C-1
672,322

 
$
0.51

Forfeited
—

 
$
—

 
 
 
 
Vested, end of year
2,265,620

 
$
0.46

 
 
 
 
Nonvested, end of year
1,142,493

 
$
0.50

The Company recognized compensation expense related to the Class B and Class C-1 incentive units of $350,927 during the year ended December 31, 2014. At December 31, 2014, there was $571,981 of total unrecognized compensation expense related to nonvested incentive units that is expected to be recognized over a weighted-average period of 1.8 years.
Information regarding the amount and grant-date fair value of the Class C-2 and Class C-3 incentive units is as follows for 2014:
 
Units
 
Weighted-Average Grant-Date Fair Value
Outstanding, beginning of year
6,344,442

 
$
0.21

Granted
 
 
 
Class C-2
94,694

 
$
0.68

Class C-3
94,694

 
$
0.44

Forfeited
 
 
 
Class C-2
—

 
$
—

Class C-3
—

 
$
—

 
 
 
 
Outstanding, end of year
6,533,830

 
$
0.22



20

Reliant Hospital Partners, LLC
Notes to Consolidated Financial Statements
December 31, 2014




Unrecognized compensation expense of $1,470,006 related to the Class C-2 and Class C-3 incentive units will be recognized when they vest, which will occur upon sale of the Company.

Note 15:
Subsequent Event (Unaudited)
On June 10, 2015, HealthSouth Corporation, a Delaware corporation, and it’s newly formed subsidiary, HealthSouth Acquisition Holdings, LLC, a Delaware limited liability company, entered into an acquisition agreement with the Company, Holding, Nautic and additional related parties. The acquisition is expected to close in 2015.


21

Exhibit 99.2

HealthSouth and EHHI Unaudited Pro Forma Condensed Combined Financial Information

On December 31, 2014, HealthSouth Corporation (the “Company” or “HealthSouth”) completed its acquisition of EHHI Holdings, Inc. (“EHHI”) and its Encompass Home Health and Hospice business (“Encompass”). In the acquisition, HealthSouth acquired, for cash, all of the issued and outstanding equity interests of EHHI, other than equity interests contributed to HealthSouth Home Health Holdings, Inc. (“Holdings”), a subsidiary of HealthSouth and now indirect parent of EHHI, by certain sellers in exchange for shares of common stock of Holdings. These certain sellers were members of Encompass management, including April Anthony, the Chief Executive Officer of Encompass. These sellers contributed a portion of their shares of common stock of EHHI, valued at approximately $64.5 million, in exchange for shares of common stock of Holdings. As a result of that contribution, they hold approximately 16.7% of the outstanding common stock of Holdings, while HealthSouth owns the remainder. In addition, Ms. Anthony and certain other employees of Encompass entered into amended and restated employment agreements, each agreement having an initial term of three years.
Initially, HealthSouth drew $375 million under its term loan facilities and $325 million under its revolving credit facility to fund the cash purchase price in the acquisition. The total cash consideration delivered at closing was $695.5 million. In January 2015, the Company issued an additional $400 million of its existing 5.75% Senior Notes due 2024 at a price of 102% of the principal amount and used $250 million of the net proceeds to repay borrowings under its term loan facilities, with the remaining net proceeds used to repay borrowings under its revolving credit facility.
The unaudited pro forma condensed combined financial information presented below is derived from the historical financial statements of HealthSouth and EHHI, adjusted to give effect to the acquisition and its funding. The unaudited pro forma condensed combined financial information should be read in conjunction with the accompanying notes and the respective historical financial information from which it was derived, which includes the Company’s Form 10-K for the year ended December 31, 2014 (the “2014 Form 10-K”).
The unaudited pro forma condensed combined statement of operations for the year ended December 31, 2014 gives effect to the acquisition and its funding as if they had occurred on January 1, 2014. The pro forma adjustments have been made solely for informational purposes. The actual results reported by the combined company in periods following the acquisition may differ significantly from that reflected in this unaudited pro forma condensed combined statement of operations for a number of reasons, including but not limited to cost savings from operating efficiencies, synergies, and the impact of the incremental costs incurred in integrating the two companies. As a result, the pro forma condensed combined financial information is not intended to represent and does not purport to be indicative of what the combined company’s results of operations would have been had the acquisition and its funding been completed on January 1, 2014. In addition, the pro forma condensed combined financial information does not purport to project the future results of operations of the combined company. In the opinion of management, all necessary adjustments to the unaudited pro forma financial information have been made.
The pro forma condensed combined financial information is based on various assumptions, which are described in the accompanying notes presented on the following pages. Pro forma adjustments are those that are directly attributable to the acquisition, are factually supportable, and are expected to have a continuing impact on the consolidated results. The unaudited pro forma condensed combined financial information does not reflect any cost savings from operating efficiencies or synergies that could result from the acquisition.
Because the acquisition of Encompass was completed on December 31, 2014, Encompass is included in the historical balance sheet of HealthSouth as of December 31, 2014. Therefore, a pro forma balance sheet as of December 31, 2014 is not included.

1

Unaudited Pro Forma Condensed Combined Statement of Operations



 
For the Year Ended December 31, 2014
 
Historical
 
 
 
Pro Forma Adjustments
 
 
 
HealthSouth
 
EHHI
 
Adjustments for Consistent Presentation
 
Acquisition Related Debt Transactions
 
Allocation of Acquisition Consideration
 
Pro Forma Combined
 
(In Millions, Except Per Share Data)
Net operating revenues
$
2,405.9

 
$
368.9

 
$
—

 
$
—

 
$
—

 
$
2,774.8

Less: Provision for doubtful accounts
(31.6
)
 
—

 
(1.6
)
 
—

 
—

 
(33.2
)
Net operating revenues less provision for doubtful accounts
2,374.3

 
368.9

 
(1.6
)
 
—

 
—

 
2,741.6

Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
Salaries and benefits
1,161.7

 
—

 
272.6

 
—

 
(14.3
)
 
1,420.0

General and administrative salaries
—

 
81.3

 
(81.3
)
 
—

 
—

 
—

Cost of sales
—

 
175.0

 
(175.0
)
 
—

 
—

 
—

Other operating expenses
351.6

 
73.0

 
(29.4
)
 
—

 
(11.7
)
 
383.5

Occupancy costs
41.6

 
—

 
6.1

 
—

 
—

 
47.7

Supplies
111.9

 
—

 
5.7

 
—

 
—

 
117.6

General and administrative expenses
124.8

 
—

 
0.2

 
—

 
(2.9
)
 
122.1

Depreciation and amortization
107.7

 
5.4

 
1.8

 
—

 
5.4

 
120.3

Government, class action, and related settlements
(1.7
)
 
—

 
—

 
—

 
—

 
(1.7
)
Professional fees - accounting, tax, and legal
9.3

 
—

 
—

 
—

 
—

 
9.3

Total operating expenses
1,906.9

 
334.7

 
0.7

 
—

 
(23.5
)
 
2,218.8

Loss on early extinguishment of debt
13.2

 
2.8

 
—

 
(2.8
)
 
—

 
13.2

Interest expense and amortization of debt discounts and fees
109.2

 
8.7

 
—

 
17.6

 
—

 
135.5

Other income
(31.2
)
 
0.5

 
(0.5
)
 
—

 
—

 
(31.2
)
Equity in net income of nonconsolidated affiliates
(10.7
)
 
—

 
—

 
—

 
—

 
(10.7
)
Income from continuing operations before income tax expense
386.9

 
22.2

 
(1.8
)
 
(14.8
)
 
23.5

 
416.0

Provision for income tax expense
110.7

 
9.2

 
(0.7
)
 
(5.9
)
 
9.4

 
122.7

Income from continuing operations
276.2

 
13.0

 
(1.1
)
 
(8.9
)
 
14.1

 
293.3

Less: Net income attributable to noncontrolling interest
(59.7
)
 
—

 
—

 
—

 
(4.7
)
 
(64.4
)
Net income from continuing operations attributable to HealthSouth
216.5

 
13.0

 
(1.1
)
 
(8.9
)
 
9.4

 
228.9

Less: Convertible perpetual preferred stock dividends
(6.3
)
 
—

 
—

 
—

 
—

 
(6.3
)
Net income from continuing operations attributable to HealthSouth common shareholders
$
210.2

 
$
13.0

 
$
(1.1
)
 
(8.9
)
 
9.4

 
$
222.6

 
 
 
 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding:
 
 
 
 
 
 
 
 
 
 
 
Basic
86.8

 
 
 
 
 
 
 
 
 
86.8

Diluted
100.7

 
 
 
 
 
 
 
 
 
100.7

 
 
 
 
 
 
 
 
 
 
 
 
Earnings per common share from continuing operations attributable to HealthSouth common shareholders:
 
 
 
 
 
 
 
 
 
 
Basic
$
2.40

 
 
 
 
 
 
 
 
 
$
2.53

Diluted
$
2.24

 
 
 
 
 
 
 
 
 
$
2.37



The accompanying notes are an integral part of this unaudited condensed combined financial information.
2

Notes to Unaudited Condensed Combined Pro Forma Financial Information


Note 1 - Basis of Presentation
The unaudited pro forma condensed combined financial information was prepared using the acquisition method of accounting and presents the pro forma combined financial information based upon the historical audited financial statements for the year ended December 31, 2014. Certain adjustments have been made to the historical financial statements of EHHI to conform to the presentation and accounting policies of HealthSouth. See Note 2, Unaudited Pro Forma Adjustments.
The accompanying unaudited pro forma condensed combined statement of operations gives effect to HealthSouth’s acquisition of Encompass as if it had been consummated on January 1, 2014. The unaudited pro forma condensed combined financial information has been prepared for illustrative purposes only and does not purport to represent what the actual consolidated results of operations of the combined entity would have been had the acquisition and its funding occurred on the date assumed, nor are they indicative of the combined entity’s future consolidated results of operations. In addition, the unaudited condensed combined pro forma financial information does not reflect any cost savings from operating efficiencies or synergies that could result from the acquisition.
Note 2 - Unaudited Pro Forma Adjustments
Adjustments for Consistent Presentation
Adjustments for consistent presentation for the year ended December 31, 2014 are as follows (in millions):
 
Cost of Sales
 
General and Administrative Salaries
 
Other Operating Expenses
 
Other
 
Total Adjustments for Consistent Presentation
Net operating revenues
$
—

 
$
—

 
$
—

 
$
—

 
$
—

Less: Provision for doubtful accounts
—

 
—

 
—

 
(1.6
)
 
(1.6
)
Net operating revenues less provision for doubtful accounts
—

 
—

 
—

 
(1.6
)
 
(1.6
)
Operating expenses:
 
 
 
 
 
 
 
 
 
Salaries and benefits
158.7

 
79.9

 
34.0

 
—

 
272.6

General and administrative salaries
—

 
(81.3
)
 
—

 
—

 
(81.3
)
Cost of sales
(175.0
)
 
—

 
—

 
—

 
(175.0
)
Other operating expenses
10.6

 
1.2

 
(40.1
)
 
(1.1
)
 
(29.4
)
Occupancy costs
—

 
—

 
6.1

 
—

 
6.1

Supplies
5.7

 
—

 
—

 
—

 
5.7

General and administrative expenses
—

 
0.2

 
—

 
—

 
0.2

Depreciation and amortization
—

 
—

 
—

 
1.8

 
1.8

Total operating expenses
—

 
—

 
—

 
0.7

 
0.7

Other income
—

 
—

 
—

 
(0.5
)
 
(0.5
)
Income from continuing operations before income tax expense
—

 
—

 
—

 
(1.8
)
 
(1.8
)
Provision for income tax expense
—

 
—

 
—

 
(0.7
)
 
(0.7
)
Income from continuing operations
$
—

 
$
—

 
$
—

 
$
(1.1
)
 
$
(1.1
)
The unaudited pro forma condensed combined statement of operations includes the above reclassification adjustments to conform the EHHI statement of operations to HealthSouth’s presentation. Amounts in the “other” column represent adjustments to:
•
reclassify the provision for doubtful accounts from other operating expenses to a reduction from net operating revenues;

3

Notes to Unaudited Condensed Combined Pro Forma Financial Information


•
adjust the historical amortization of EHHI’s licenses; EHHI did not amortize these intangible assets while HealthSouth has assigned a 10-year life to them;
•
reclassify management fees associated with EHHI’s former equity holders and non-income related tax amounts from other income to other operating expenses; and
•
provide for income taxes on these adjustments using HealthSouth’s historical effective income tax rate of 40%.
Adjustments for Acquisition Related Debt Transactions
Adjustments for acquisition related debt transactions for the year ended December 31, 2014 are as follows (in millions):
 
Term Loan Facilities
 
Revolving Credit Facility
 
5.75% Senior Notes due 2024
 
Encompass Debt
 
Total Adjustments for Acquisition Related Debt
Interest expense and amortization of debt discounts and fees
$
3.5

 
$
2.8

 
$
19.7

 
$
(8.4
)
 
$
17.6

The unaudited pro forma condensed combined statement of operations includes the above adjustments for interest expense related to HealthSouth’s funding of the Encompass acquisition. As discussed above, in December 2014, HealthSouth drew $375 million under its term loan facilities and $325 million under its revolving credit facility to fund the acquisition of Encompass. In January 2015, HealthSouth issued an additional $400 million of its 5.75% Senior Notes due 2024 at a price of 102% of the principal amount and used $250 million of the net proceeds to repay borrowings under its term loan facilities, with the remaining net proceeds used to repay borrowings under its revolving credit facility.
Interest rates used in these adjustments represent HealthSouth’s current effective interest rates on the above borrowings as follows:
•
term loan facilities - 2.7%
•
revolving credit facility - 2.0%
•
senior notes - 5.8%, inclusive of financing costs
Each 0.125% variance in the assumed interest rate of the term loan facilities and revolving credit facility would change pro forma interest expense by (in millions):
 
Year Ended
December 31, 2014
Term loan facilities
$
0.2

Revolving credit facility
0.2

 
$
0.4

At closing, HealthSouth repaid all outstanding debt, excluding capital lease obligations, of Encompass. Therefore, interest expense and any losses on early extinguishment of debt associated with the historical borrowings of EHHI were eliminated for purposes of this pro forma presentation.
The income tax impact of these interest expense adjustments was estimated using an income tax rate of 40% and resulted in a reduction to income tax expense of $5.9 million for the year ended December 31, 2014 for the combined entity.
See Note 8, Long-term Debt, to the financial statements accompanying the 2014 Form 10‑K.

4

Notes to Unaudited Condensed Combined Pro Forma Financial Information


Adjustments for Allocation of Acquisition Consideration
Adjustments for the allocation of acquisition consideration for the year ended December 31, 2014 are as follows (in millions):
 
Stock Compensation
 
Depreciation and Amortization
 
Transaction Costs
 
Other
 
Total Adjustments for Allocation of Acquisition Consideration
Operating expenses:
 
 
 
 
 
 
 
 
 
Salaries and benefits
$
—

 
$
—

 
$
—

 
$
(14.3
)
 
$
(14.3
)
Other operating expenses
—

 
—

 
(11.3
)
 
(0.4
)
 
(11.7
)
General and administrative expenses
6.4

 
—

 
(9.3
)
 
—

 
(2.9
)
Depreciation and amortization
—

 
5.4

 
 
 
—

 
5.4

Total operating expenses
6.4

 
5.4

 
(20.6
)
 
(14.7
)
 
(23.5
)
Other income
—

 
—

 
—

 
—

 
—

Income from continuing operations before income tax expense
(6.4
)
 
(5.4
)
 
20.6

 
14.7

 
23.5

Provision for income tax expense
(2.5
)
 
(2.2
)
 
8.2

 
5.9

 
9.4

Income from continuing operations
(3.9
)
 
(3.2
)
 
12.4

 
8.8

 
14.1

Less: Net income attributable to noncontrolling interest
—

 
—

 
—

 
(4.7
)
 
(4.7
)
Net income from continuing operations attributable to HealthSouth
$
(3.9
)
 
$
(3.2
)
 
$
12.4

 
$
4.1

 
$
9.4

Amounts in the above table are preliminary estimates for the following:
•
Stock compensation - In conjunction with this acquisition, HealthSouth granted stock appreciation rights (“SARs”) based on Holdings’ common stock to certain members of Encompass management at closing on December 31, 2014. HealthSouth granted 122,976 SARs that vest based on continued employment and an additional 129,124 SARs that vest based on continued employment and the extent of Encompass’ attainment of a target 2017 specified performance measure. In general terms, half of the SARs of each type will vest on December 31, 2018 with the remainder vesting on December 31, 2019. The SARs that ultimately vest will expire on the tenth anniversary of the grant date or within a specified period following any earlier termination of employment. Upon exercise, each SAR must be settled for cash in the amount by which the per share fair value of Holdings’ common stock on the exercise date exceeds the agreed upon per share fair value on the acquisition date. The fair value of Holdings’ common stock is determined using the product of the trailing 12-month specified performance measure for Holdings and a specified median market price multiple based on a basket of public home health companies. Amounts in the above table include HealthSouth’s estimate of expense expected to be recorded for these awards. This estimate includes many assumptions related to pricing and volume, operating expenses, discount factors, tax rates, etc. Changes in economic and operating conditions impacting these assumptions could result in a different amount recorded in the future, and such differences could be material.
Amounts in the above table also include restricted stock awards assumed to have been granted to members of Encompass management during the periods presented. For information regarding HealthSouth’s share-based payments, see Note 13, Share-Based Payments, to the financial statements accompanying the 2014 Form 10‑K.
•
Depreciation and amortization - Amounts included in the above table represent adjustments to depreciation and amortization expense based upon the estimated fair values of the property and equipment and definite-lived intangible assets acquired in the acquisition using their estimated remaining useful lives.

5

Notes to Unaudited Condensed Combined Pro Forma Financial Information


•
Transaction costs - Amounts included in the above table represent the direct incremental costs of the acquisition that are reported in the historical statements of operations of HealthSouth and EHHI and must be eliminated from the pro forma statement of operations of the combined entity.
•
Other - Amounts included in the above table primarily include the elimination of management fees paid to EHHI’s former equity holders, transaction bonuses paid to Encompass employees, and the impact of noncontrolling interests.


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