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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997; OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO
Commission File Number 1-10315
HEALTHSOUTH CORPORATION
--------------------------------
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 63-0860407
- - --------------------------------------- ----------
(State or Other Jurisdiction (I.R.S. Employer Identification No.)
of Incorporation or Organization)
ONE HEALTHSOUTH PARKWAY
BIRMINGHAM, ALABAMA 35243
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(Address of Principal Executive (Zip Code)
Offices)
Registrant's Telephone Number, Including Area Code: (205) 967-7116
Securities Registered Pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on which Registered
- - --------------------------------------- ------------------------
COMMON STOCK, PAR VALUE NEW YORK STOCK EXCHANGE
$.01 per share
9.5% SENIOR SUBORDINATED NEW YORK STOCK EXCHANGE
NOTES DUE 2001
Securities Registered Pursuant to Section 12(g) of the Act: NONE
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 [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
State the aggregate market value of the voting stock held by non-affiliates
of the Registrant as of March 13, 1998:
Common Stock, par value $.01 per share -- $11,890,990,000
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of the latest practicable date.
Class Outstanding at March 13, 1998
- - ------------------------------------ ------------------------------
COMMON STOCK, PAR VALUE
$.01 PER SHARE 398,285,974 SHARES
DOCUMENTS INCORPORATED BY REFERENCE
No documents are incorporated by reference into this Annual Report on Form 10-K.
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PART I
ITEM 1. BUSINESS.
GENERAL
HEALTHSOUTH Corporation ("HEALTHSOUTH" or the "Company") is the nation's
largest provider of outpatient surgery and rehabilitative healthcare services.
The Company provides these services through its national network of outpatient
and inpatient rehabilitation facilities, outpatient surgery centers, diagnostic
centers, occupational medicine centers, medical centers and other healthcare
facilities. The Company believes that it provides patients, physicians and
payors with high-quality healthcare services at significantly lower costs than
traditional inpatient hospitals. Additionally, the Company's national network,
reputation for quality and focus on outcomes has enabled it to secure contracts
with national and regional managed care payors. At December 31, 1997, the
Company had over 1,750 patient care locations in 50 states, the United Kingdom
and Australia.
In its outpatient and inpatient rehabilitation facilities, the Company
provides interdisciplinary programs for the rehabilitation of patients
experiencing disability due to a wide variety of physical conditions, such as
stroke, head injury, orthopaedic problems, neuromuscular disease and
sports-related injuries. The Company's rehabilitation services include physical
therapy, sports medicine, work hardening, neurorehabilitation, occupational
therapy, respiratory therapy, speech-language pathology and rehabilitation
nursing. Independent studies have shown that rehabilitation services like those
provided by the Company can save money for payors and employers.
In addition to its rehabilitation facilities, the Company operates the
largest network of freestanding outpatient surgery centers in the United States.
The Company's outpatient surgery centers provide the facilities and medical
support staff necessary for physicians to perform non-emergency surgical
procedures. While outpatient surgery is widely recognized as generally less
expensive than surgery performed in a hospital, the Company believes that
outpatient surgery performed at a freestanding outpatient surgery center is
generally less expensive than hospital-based outpatient surgery. Over 80% of the
Company's surgery center facilities are located in markets served by its
rehabilitative service facilities, enabling the Company to pursue opportunities
for cross-referrals.
The Company is also among the largest operators of outpatient diagnostic
centers and occupational medicine centers in the United States. Most of the
Company's diagnostic centers and occupational medicine centers operate in
markets where the Company also provides rehabilitative healthcare and outpatient
surgery services. The Company believes that its ability to offer a comprehensive
range of its services in a particular geographic market makes the Company more
attractive to both patients and payors in such market.
Over the last three years, the Company has completed several significant
acquisitions in the rehabilitation business and has expanded into the surgery
center, diagnostic and occupational medicine businesses. The Company believes
that these acquisitions complement its historical operations and enhance its
market position. The Company further believes that its expansion into the
outpatient surgery, diagnostic and occupational medicine businesses provides it
with platforms for future growth. The Company is continually evaluating
potential acquisitions in the outpatient and rehabilitative healthcare services
industry.
The Company was organized as a Delaware corporation in February 1984. The
Company's principal executive offices are located at One HealthSouth Parkway,
Birmingham, Alabama 35243, and its telephone number is (205) 967-7116.
COMPANY STRATEGY
The Company's principal objective is to be the provider of choice for
patients, physicians and payors alike for outpatient surgery and rehabilitative
healthcare services throughout the United States. The Company's growth strategy
is based upon four primary elements: (i) the implementation of the
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Company's integrated service model in appropriate markets, (ii) successful
marketing to managed care organizations and other payors, (iii) the provision of
high-quality, cost-effective healthcare services, and (iv) the expansion of its
national network.
o Integrated Service Model. The Company seeks, where appropriate, to provide an
integrated system of healthcare services, including outpatient rehabilitation
services, inpatient rehabilitation services, ambulatory surgery services and
outpatient diagnostic services. The Company believes that its integrated
system offers payors the convenience of dealing with a single provider for
multiple services. Additionally, it believes that its facilities can provide
extensive cross-referral opportunities. For example, the Company estimates
that approximately one-third of its outpatient rehabilitation patients have
had outpatient surgery, virtually all inpatient rehabilitation patients will
require some form of outpatient rehabilitation, and virtually all inpatient
rehabilitation patients have had some type of diagnostic procedure. The
Company has implemented its Integrated Service Model in certain of its
markets, and intends to expand the model into other appropriate markets.
o Marketing to Managed Care Organizations and Other Payors. Since the late
1980s, the Company has focused on the development of contractual
relationships with managed care organizations, major insurance companies,
large regional and national employer groups and provider alliances and
networks. The Company's documented outcomes and experience with several
hundred thousand patients in delivering quality healthcare services at
reasonable prices has enhanced its attractiveness to such entities and has
given the Company a competitive advantage over smaller and regional
competitors. These relationships have increased patient flow to the Company's
facilities and contributed to the Company's same-store growth.
o Cost-Effective Services. The Company's goal is to provide high-quality
healthcare services in cost-effective settings. To that end, the Company has
developed standardized clinical protocols for the treatment of its patients.
This results in "best practices" techniques being utilized at all of the
Company's facilities, allowing the consistent achievement of demonstrable,
cost-effective clinical outcomes. The Company's reputation for its clinical
programs is enhanced through its relationships with major universities
throughout the nation, and its support of clinical research in its facilities.
Further, independent studies estimate that, for every dollar spent on
rehabilitation, $11 to $35 is saved. Finally, surgical procedures typically
are less expensive in outpatient surgery centers than in hospital settings.
The Company believes that outpatient and rehabilitative healthcare services
will assume increasing importance in the healthcare environment as payors
continue to seek to reduce overall costs by shifting patients to more
cost-effective treatment settings.
o Expansion of National Network. As the largest provider of outpatient surgery
and rehabilitative healthcare services in the United States, the Company is
able to realize economies of scale and compete successfully for national
contracts with large payors and employers while retaining the flexibility to
respond to particular needs of local markets. The national network affords
the Company the opportunity to offer large national and regional employers
and payors the convenience of dealing with a single provider, to utilize
greater buying power through centralized purchasing, to achieve more
efficient costs of capital and labor and to more effectively recruit and
retain clinicians. The Company believes that its recent acquisitions in the
outpatient surgery, diagnostic imaging and occupational medicine fields will
further enhance its national presence by broadening the scope of its existing
services and providing new opportunities for growth. These national benefits
are realized without sacrificing local market responsiveness. The Company's
objective is to provide those outpatient and rehabilitative healthcare
services needed within each local market by tailoring its services and
facilities to that market's needs, thus bringing the benefits of nationally
recognized expertise and quality into the local setting.
GROWTH THROUGH ACQUISITIONS
Beginning in 1994, the Company has consummated a series of significant
acquisitions. During 1995, the Company consummated pooling-of-interests mergers
with Surgical Health Corporation ("SHC"; 36 outpatient surgery centers in 11
states) and Sutter Surgery Centers, Inc. ("SSCI"; 12 outpatient surgery centers
in three states), as well as stock purchase acquisitions of the rehabilitation
hospitals division of
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NovaCare, Inc. ("NovaCare"; 11 inpatient rehabilitation facilities, 12 other
healthcare facilities and two Certificates of Need in eight states) and Caremark
Orthopedic Services Inc. ("Caremark"; 120 outpatient rehabilitation facilities
in 13 states). During 1996, the Company acquired Surgical Care Affiliates, Inc.
("SCA"; 67 outpatient surgery centers in 24 states), Advantage Health
Corporation ("Advantage Health"; approximately 136 inpatient and outpatient
rehabilitation facilities in 11 states), Professional Sports Care Management,
Inc. ("PSCM"; 36 outpatient rehabilitation facilities in New York, New Jersey
and Connecticut) and ReadiCare, Inc. ("ReadiCare"; 37 occupational medicine
centers in California and Washington) in pooling-of-interests transactions.
During 1997, the Company acquired Health Images, Inc. ("Health Images"; 55
diagnostic imaging centers in 13 states and the United Kingdom), ASC Network
Corporation ("ASC"; 29 surgery centers in eight states), Horizon/CMS Healthcare
Corporation ("Horizon/CMS"; 30 inpatient rehabilitation facilities and
approximately 275 outpatient rehabilitation centers in 24 states) and National
Imaging Affiliates, Inc. ("NIA"; eight diagnostic imaging centers in six
states). On December 31, 1997, the Company sold the long-term care assets of
Horizon/CMS, consisting of 139 long-term care facilities, 12 specialty
hospitals, 35 institutional pharmacy locations and over 1,000 rehabilitation
therapy contracts with long-term care facilities, to Integrated Health Services,
Inc. ("IHS"). The NovaCare, Caremark, Advantage Health, PSCM and Horizon/CMS
transactions have further enhanced the Company's position as the nation's
largest provider of inpatient and outpatient rehabilitative services, while the
SHC, SSCI, SCA and ASC transactions have made the Company the largest provider
of outpatient surgery services in freestanding centers in the nation and the
ReadiCare, Health Images and NIA transactions have broadened the Company's
services in occupational medicine and diagnostic imaging. The Company believes
that the geographic dispersion of the more than 1,750 locations now operated by
the Company makes it more attractive to managed care networks, major insurance
companies, regional and national employers and regional provider alliances and
enhances the Company's ability to implement its Integrated Service Model in
additional markets. See Item 7, "Management's Discussion and Analysis of
Financial Conditions and Results of Operations".
INDUSTRY BACKGROUND
In 1996, there were an estimated 3,500,000 inpatient hospital discharges in
the United States involving impairments requiring rehabilitative healthcare
services. "Rehabilitative healthcare services" refers to the range of skilled
services provided to individuals in order to minimize physical and cognitive
impairments, maximize functional ability and restore lost functional capacity.
The focus of rehabilitative healthcare is to ameliorate physical and cognitive
impairments resulting from illness or injury, and to restore or improve
functional ability so that individuals can return to work and lead independent
and fulfilling lives. Typically, rehabilitative healthcare services are provided
by a variety of healthcare professionals including physiatrists, rehabilitation
nurses, physical therapists, occupational therapists, speech- language
pathologists, respiratory therapists, recreation therapists, social workers,
psychologists, rehabilitation counselors and others. Over 80% of those receiving
rehabilitative healthcare services return to their homes, work, schools or
active retirement.
Demand for rehabilitative healthcare services continues to be driven by
advances in medical technologies, an aging population and the recognition on the
part of the payor community (insurers, self-insured companies, managed care
organizations and federal, state and local governments) that appropriately
administered rehabilitative services can improve quality of life as well as
lower overall healthcare costs. Studies conducted by insurance companies
demonstrate the ability of rehabilitation to significantly reduce the cost of
future care. Estimates of the savings range from $11 to $35 per dollar spent on
rehabilitation. Further, reimbursement changes have encouraged the rapid
discharge of patients from acute-care hospitals while they remain in need of
rehabilitative healthcare services.
The Company also believes that there is a growing trend toward the
provision of other healthcare services on an outpatient basis, fueled by
advances in technology, demands for cost-effective care and concerns for patient
comfort and convenience. An industry study indicates that there has been a 75%
increase in the number of treatments in all ambulatory settings from 1986 to
1996, with two-thirds of the total number of surgeries in the United States in
1996 being performed on an outpatient basis. The Company believes that these
trends will continue to foster demand for the delivery of healthcare services on
an outpatient basis.
3
PATIENT CARE SERVICES
The Company began its operations in 1984 with a focus on providing
comprehensive orthopaedic and musculoskeletal rehabilitation services on an
outpatient basis. Over the succeeding 14 years, the Company has consistently
sought and implemented opportunities to expand its services through acquisitions
and de novo development activities that complement its historic focus on
orthopaedic, sports medicine and occupational medicine services and that provide
independent platforms for growth. The Company's acquisitions and internal growth
have enabled it to become the largest provider of rehabilitative healthcare
services, both inpatient and outpatient, in the United States, as well as the
largest operator of freestanding outpatient surgery centers. In addition, the
Company has added diagnostic imaging services, occupational medicine services
and other outpatient services which provide natural enhancements to its
rehabilitative healthcare locations and facilitate the implementation of its
Integrated Service Model. The Company believes that these additional businesses
also provide opportunities for growth in other areas not directly related to the
rehabilitative business, and the Company intends to pursue further expansion in
those businesses.
Rehabilitative Services: General
When a patient is referred to one of the Company's rehabilitation
facilities, the patient undergoes an initial evaluation and assessment process
that results in the development of a rehabilitation care plan designed
specifically for that patient. Depending upon the patient's disability, this
evaluation process may involve the services of a single discipline, such as
physical therapy for a knee injury, or of multiple disciplines, as in the case
of a complicated stroke patient. HEALTHSOUTH has developed numerous
rehabilitation programs, which include stroke, head injury, spinal cord injury,
neuromuscular and work injury, that combine certain services to address the
needs of patients with similar disabilities. In this way, all of the facilities'
patients, regardless of the severity and complexity of their disabilities, can
receive the level and intensity of those services necessary for them to be
restored to as productive, active and independent a lifestyle as possible.
Outpatient Rehabilitation Services
The Company operates the largest group of affiliated proprietary outpatient
rehabilitation facilities in the United States. The Company's outpatient
rehabilitation centers offer a comprehensive range of rehabilitative healthcare
services, including physical therapy and occupational therapy, that are tailored
to the individual patient's needs, focusing predominantly on orthopaedic
injuries, sports injuries, work injuries, hand and upper extremity injuries,
back injuries, and various neurological/neuromuscular conditions. As of December
31, 1997, the Company provided outpatient rehabilitative healthcare services
through approximately 1,150 outpatient locations, including freestanding
outpatient centers and their satellites, outpatient satellites of inpatient
facilities and outpatient facilities managed under contract.
Continuing emphasis on containing increases in healthcare costs, as
evidenced by Medicare's prospective payment system, the growth in managed care
and the various alternative healthcare reform proposals, has resulted in earlier
discharge of patients from acute-care facilities. As a result, many hospital
patients do not receive the intensity of services that may be necessary for them
to achieve a full recovery from their diseases, disorders or traumatic
conditions. The Company's outpatient rehabilitation services play a significant
role in the continuum of care because they provide hospital-level services, in
terms of intensity, quality and frequency, in a more cost-efficient setting.
Patients treated at the Company's outpatient centers will undergo varying
courses of therapy depending upon their individual needs. Some patients may only
require a few hours of therapy per week for a few weeks, while others may spend
up to five hours per day in therapy for six months or more, depending on the
nature, severity and complexity of their injuries.
In general, the Company initially establishes an outpatient center in a
given market, either by acquiring an existing private therapy practice or
through de novo development, and institutes its clinical protocols and programs
in response to the community's general need for services. The Company will then
establish satellite clinics that are dependent upon the main facility for
management and adminis-
4
trative services. These satellite clinics generally provide a specific
evaluative or specialty service/program, such as hand therapy or foot and ankle
therapy, in response to specific market demands. The Company's outpatient
rehabilitation facilities range in size from 1,200 square feet for specialty
clinics to 20,000 square feet for large, full-service facilities. Currently, the
typical outpatient facility configuration ranges in size from 2,000 to 5,000
square feet and costs less than $500,000 to build out and equip.
Patient utilization of the Company's outpatient rehabilitation facilities
cannot be measured in the conventional manner applied to acute-care hospitals,
nursing homes and other healthcare providers which have a fixed number of
licensed beds and serve patients on a 24-hour basis. Utilization patterns in
outpatient rehabilitation facilities will be affected by the market to be
served, the types of injuries treated, the patient mix and the number of
available therapists, among other factors. Moreover, because of variations in
size, location, hours of operation, referring physician base and services
provided and other differences among each of the Company's outpatient
facilities, it is not possible to accurately assess patient utilization against
a norm.
Inpatient Services
INPATIENT REHABILITATION FACILITIES. At December 31, 1997, the Company
operated 132 inpatient rehabilitation facilities with 7,682 beds in the United
States, representing the largest group of affiliated proprietary inpatient
rehabilitation facilities in the nation, as well as a 71-bed rehabilitation
hospital in Australia. The Company's inpatient rehabilitation facilities provide
high-quality comprehensive services to patients who require intensive
institutional rehabilitation care.
Inpatient rehabilitation patients are typically those who are experiencing
significant physical disabilities due to various conditions, such as head
injury, spinal cord injury, stroke, certain orthopaedic problems and
neuromuscular disease. The Company's inpatient rehabilitation facilities provide
the medical, nursing, therapy and ancillary services required to comply with
local, state and federal regulations as well as accreditation standards of the
Joint Commission on Accreditation of Healthcare Organizations (the "JCAHO") and
the Commission on Accreditation of Rehabilitation Facilities ("CARF").
All of the Company's inpatient rehabilitation facilities utilize an
interdisciplinary team approach to the rehabilitation process and involve the
patient and family, as well as the payor, in the determination of the goals for
the patient. Internal case managers monitor each patient's progress and provide
documentation of patient status, achievement of goals, functional outcomes and
efficiency.
In certain markets the Company's rehabilitation hospitals may provide
outpatient rehabilitation services as a complement to their inpatient services.
Typically, this opportunity arises when patients complete their inpatient course
of treatment but remain in need of additional therapy that can be accomplished
on an outpatient basis. Depending upon the demand for outpatient services and
physical space constraints, the rehabilitation hospital may establish the
services either within its building or in a satellite location. In either case,
the clinical protocols and programs developed for use in the freestanding
outpatient centers will be utilized by these facilities.
A number of the Company's rehabilitation hospitals, including its
Nashville, Tennessee (Vanderbilt University), Memphis, Tennessee (Methodist
Hospitals), Dothan, Alabama (Southeast Alabama Medical Center), Charleston,
South Carolina (North Trident Regional Medical Center) and Columbia, Missouri
(University of Missouri) hospital facilities, have been developed in conjunction
with local tertiary-care facilities. This strategy of developing effective
referral and service networks prior to opening results in improved operating
efficiencies for the new facilities. The Company is utilizing this same concept
in the rehabilitation hospital under development with the University of Virginia
and has entered into or is pursuing similar affiliations with a number of its
existing rehabilitation hospitals.
MEDICAL CENTERS. At December 31, 1997, the Company operated four medical
centers with 800 licensed beds in four distinct markets. These facilities
provide general and specialty medical and surgical healthcare services,
emphasizing orthopaedics, sports medicine and rehabilitation.
The Company acquired its medical centers as outgrowths of its
rehabilitative healthcare services. Often, patients require medical and surgical
interventions prior to the initiation of their rehabilitative care. In each of
the markets in which the Company has acquired a medical center, the Company had
5
well-established relationships with the medical communities serving each
facility. In addition, each of the facilities enjoyed well-established
reputations in orthopaedics and/or sports medicine prior to their acquisition by
the Company. Following the acquisition of each of its medical centers, the
Company has provided the resources to improve upon the physical plant and expand
services through the introduction of new technology. The Company has also
developed additional relationships between these facilities and certain
university facilities, including the University of Miami, Auburn University and
the University of Alabama at Birmingham. Through these relationships, the influx
of celebrity athletes and personalities and the acquisition of new technology,
all of the Company's medical centers have improved their operating efficiencies
and enhanced census.
Each of the Company's medical center facilities is licensed as an
acute-care hospital, is accredited by the JCAHO and participates in the Medicare
prospective payment system. See this Item, "Business -- Regulation".
INPATIENT FACILITY UTILIZATION. In measuring patient utilization of the
Company's inpatient facilities, various factors must be considered. Due to
market demand, demographics, start-up status, renovation, patient mix and other
factors, the Company may not treat all licensed beds in a particular facility as
available beds, which sometimes results in a material variance between licensed
beds and beds actually available for utilization at any specific time. The
Company is in a position to increase the number of available beds at such
facilities as market conditions dictate. During the year ended December 31,
1997, the Company's inpatient facilities achieved an overall utilization, based
on patient days and available beds, of 74.66%.
Surgery Centers
The Company is currently the largest operator of outpatient surgery centers
in the United States. At December 31, 1997, it operated 172 freestanding surgery
centers, including five mobile lithotripsy units, in 35 states. Over 80% of
these facilities are located in markets served by the Company's outpatient and
rehabilitative service facilities, enabling the Company to pursue opportunities
for cross-referrals between surgery and rehabilitative facilities as well as to
centralize administrative functions. The Company's surgery centers provide the
facilities and medical support staff necessary for physicians to perform
non-emergency surgical procedures. Its typical surgery center is a freestanding
facility with three to six fully equipped operating and procedure rooms and
ancillary areas for reception, preparation, recovery and administration. Each of
the Company's surgery centers is available for use only by licensed physicians,
oral surgeons and podiatrists, and the centers do not perform surgery on an
emergency basis.
Outpatient surgery centers, unlike hospitals, have not historically
provided overnight accommodations, food services or other ancillary services.
Over the past several years, states have increasingly permitted the use of
extended-stay recovery facilities by outpatient surgery centers. As a result,
many outpatient surgery centers are adding extended recovery care capabilities
where permitted. Most of the Company's surgery centers currently provide for
extended recovery stays. The Company's ability to develop such recovery care
facilities is dependent upon state regulatory environments in the particular
states where its centers are located.
The Company's outpatient surgery centers implement quality control
procedures to evaluate the level of care provided the centers. Each center has a
medical advisory committee of three to ten physicians which reviews the
professional credentials of physicians applying for medical staff privileges at
the center.
Diagnostic Centers
At December 31, 1997, the Company operated 101 diagnostic centers in 21
states and the United Kingdom. These centers provide outpatient diagnostic
imaging services, including magnetic resonance imaging ("MRI"), computerized
tomography ("CT") services, X-ray services, ultrasound services, mammography
services, nuclear medicine services and fluoroscopy. Not all services are
provided at all sites; however, most of the Company's diagnostic centers are
multi-modality centers.
6
The Company's diagnostic centers provide outpatient diagnostic procedures
performed by experienced radiological technicians. After the diagnostic
procedure is completed, the images are reviewed by radiologists who have
contracted with the Company. Such radiologists prepare a report of the test and
their findings, which are then delivered to the referring physician. The
Company's diagnostic centers are open at such hours as are appropriate for the
local medical community.
Because many patients at the Company's rehabilitative healthcare and
outpatient surgery facilities require diagnostic procedures of the type
performed at the Company's diagnostic centers, the Company believes that its
diagnostic operations are a natural complement to its other services and enhance
its ability to market those services to patients and payors.
Occupational Medicine Services
At December 31, 1997, the Company operated 93 occupational medicine centers
in 22 states. These centers provide cost-effective, outpatient primary medical
care and rehabilitation services to individuals for the treatment of
work-related medical problems.
The Company's occupational medicine centers market their services to large
and small employers, workers' compensation and health insurers and managed care
organizations. The services provided at the Company's occupational medicine
centers include outpatient primary medical care for work-related injuries and
illnesses, work-related physical examinations, physical therapy services and
workers' compensation medical services, as well as other services primarily
aimed at work-related injuries or illnesses. Medical services at the centers are
provided by licensed physicians who are employed by or under contract with the
Company or affiliated medical practices. These centers also employ nurses,
therapists and other licensed professional staff as necessary for the services
provided. The Company believes that occupational medicine primary care services
are a strategic component of its business, and that the physicians in its
occupational medicine centers can, in many cases, serve as "gatekeepers"
providing access to the other services offered by the Company.
Other Patient Care Services
In certain of its markets, the Company provides other patient care
services, including home healthcare, physician services and contract management
of hospital-based rehabilitative healthcare services. The Company evaluates
market opportunities on a case-by-case basis in determining whether to provide
additional services of these types, which may be complementary to facility-based
services provided by the Company or stand-alone businesses.
MARKETING OF FACILITIES AND SERVICES
The Company markets its facilities, and their services and programs, on
local, regional and national levels. Local and regional marketing activities are
typically coordinated by facility-based marketing personnel, whereas large-scale
regional and national efforts are coordinated by corporate-based personnel.
In general, the Company develops a marketing plan for each facility based
on a variety of factors, including population characteristics, physician
characteristics and incidence of disability statistics, in order to identify
specific service opportunities. Facility-oriented marketing programs are focused
on increasing the volume of patient referrals to the specific facility and
involve the development of ongoing relationships with area schools, businesses
and industries as well as physicians, health maintenance organizations and
preferred provider organizations.
The Company's larger-scale marketing activities are focused more broadly on
efforts to generate patient referrals to multiple facilities and the creation of
new business opportunities. Such activities include the development and
maintenance of contractual relationships or national pricing agreements with
large third-party payors, such as CIGNA, United Healthcare or other national
insurance companies, with national HMO/PPO companies, such as
Healthcare-COMPARE/AFFORDABLE, Hospital Network of America and Multiplan, with
national case management companies, such as INTRACORP
7
and Crawford & Co., and with national employers, such as Wal-Mart,
Georgia-Pacific Corporation, Dillard Department Stores, Goodyear Tire & Rubber
and Winn-Dixie. In addition, since many of the facilities acquired by the
Company during the past three years had very limited contractual relationships
with payors, managed care providers, employers and others, the Company is
expanding its existing payor relationships to include these facilities.
The Company carries out broader programs designed to further enhance its
public image. Among these is the HEALTHSOUTH Sports Medicine Council, headed by
Bo Jackson and involving other well-known professional and amateur athletes and
sports medicine specialists, which is dedicated to developing educational
programs focused on athletics for use in high schools. The Company has ongoing
relationships with the Ladies Professional Golf Association, the Southeastern
Conference, the U.S. Decathlon Team, USA Hockey, USA Wrestling, USA Volleyball
and more than 125 universities and colleges and 1,000 high schools to provide
sports medicine coverage of events and rehabilitative healthcare services for
injured athletes. In addition, the Company has established relationships with or
provided treatment services for athletes from some 40-50 professional sports
teams, as well as providing sports medicine services for Olympic and amateur
athletes. In 1996, the Company and the United States Olympic Committee
established the Richard M. Scrushy/HEALTHSOUTH Sports Medicine and Sport Science
Center at the USOC's Colorado Springs campus.
The Company is a national sponsor of the United Cerebral Palsy Association
and the National Arthritis Foundation and supports many other charitable
organizations on national and local levels. Through these endeavors, the Company
provides its employees with opportunities to support their communities.
SOURCES OF REVENUES
Private pay revenue sources represent the majority of the Company's
revenues. The following table sets forth the percentages of the Company's
revenues from various sources for the periods indicated:
YEAR ENDED YEAR ENDED
SOURCE DECEMBER 31, 1996 DECEMBER 31, 1997
- - -------------------------------------- ------------------- ------------------
Medicare ...................... 37.8% 36.9%
Commercial (1) ................ 34.9 35.1
Workers' Compensation ......... 11.3 11.1
All Other Payors (2) .......... 16.0 16.9
----- -----
100.0% 100.0%
- - ----------
(1) Includes commercial insurance, HMOs, PPOs and other managed care plans.
(2) Medicaid is included in this category, but is insignificant in amount.
The above table does not reflect the SCA, Advantage Health, PSCM, ReadiCare
or Health Images facilities for periods or portions thereof prior to the
effective date of the acquisitions. Comparable information for those facilities
is not available.
See this Item "Business -- Regulation -- Medicare Participation and
Reimbursement" for a description of certain of the reimbursement regulations
applicable to the Company's facilities.
COMPETITION
The Company competes in the geographic markets in which its facilities are
located. In addition, the Company's rehabilitation facilities compete on a
regional and national basis with other providers of specialized services such as
sports medicine and work hardening, and specific concentrations such as head
injury rehabilitation and orthopaedic surgery. The competition faced in each of
these markets is similar, with variations arising from the number of healthcare
providers in the given metropolitan area. The primary competitive factors in the
rehabilitation services business are quality of services, projected patient
outcomes, charges for services, responsiveness to the needs of the patients,
community and
8
physicians, and ability to tailor programs and services to meet specific needs
of the patients. Competitors and potential competitors include hospitals,
private practice therapists, rehabilitation agencies and others. Some of these
competitors may have greater patient referral support and financial and
personnel resources in particular markets than the Company. Management believes
that the Company competes successfully within the marketplace based upon its
reputation for quality, competitive prices, positive rehabilitation outcomes,
innovative programs, clean and bright facilities and responsiveness to needs.
The Company's surgery centers compete primarily with hospitals and other
operators of freestanding surgery centers in attracting physicians and patients,
and in developing new centers and in acquiring existing centers. The primary
competitive factors in the outpatient surgery business are convenience, cost,
quality of service, physician loyalty and reputation. Hospitals have many
competitive advantages in attracting physicians and patients, including
established standing in a community, historical physician loyalty and
convenience for physicians making rounds or performing inpatient surgery in the
hospital. However, the Company believes that its national market system and its
historical presence in certain of the markets where its surgery centers are
located will enhance the Company's ability to operate these facilities
successfully.
The Company's diagnostic centers compete with local hospitals, other
multi-center imaging companies, local independent diagnostic centers and imaging
centers owned by local physician groups. The Company believes that the principal
competitive factors in the diagnostic services are price, quality of service,
ability to establish and maintain relationships with managed care payors and
referring physicians, reputation of interpreting physicians, facility location
and convenience of scheduling. Management believes that the Company's diagnostic
facilities compete successfully within their respective markets, taking into
account these factors.
The Company's medical centers are located in four urban areas of the
country, all with well established healthcare services provided by a number of
proprietary, not-for-profit, and municipal hospital facilities. The Company's
facilities compete directly with these local hospitals as well as various
nationally recognized centers of excellence in orthopaedics, sports medicine and
other specialties. Because the Company's facilities enjoy a national and
international reputation for orthopaedic surgery and sports medicine, the
Company believes that its medical centers' level of service and continuum of
care enable them to compete successfully, both locally and nationally.
The Company potentially faces competition any time it initiates a
Certificate of Need ("CON") project or seeks to acquire an existing facility or
CON. See this Item, "Business -- Regulation". This competition may arise either
from competing companies, national or regional, or from local hospitals which
file competing applications or oppose the proposed CON project. The necessity
for these approvals serves as a barrier to entry and has the potential to limit
competition by creating a franchise to provide services to a given area. The
Company has generally been successful in obtaining CONs or similar approvals
when required, although there can be no assurance that it will achieve similar
success in the future.
REGULATION
The healthcare industry is subject to regulation by federal, state and
local governments. The various levels of regulatory activity affect the
Company's business activities by controlling its growth, requiring licensure or
certification of its facilities, regulating the use of its properties and
controlling the reimbursement to the Company for services provided.
Licensure, Certification and Certificate of Need Regulations
Capital expenditures for the construction of new facilities, the addition
of beds or the acquisition of existing facilities may be reviewable by state
regulators under a statutory scheme which is sometimes referred to as a CON
program. States with CON programs place limits on the construction and
acquisition of healthcare facilities and the expansion of existing facilities
and services. In such states, approvals are required for capital expenditures
exceeding certain amounts which involve inpatient rehabilitation facilities or
services. Outpatient rehabilitation facilities and services do not require such
approvals in a majority of states.
9
State CON statutes generally provide that, prior to the addition of new
beds, the construction of new facilities or the introduction of new services, a
state health planning designated agency (a "SHPDA") must determine that a need
exists for those beds, facilities or services. The CON process is intended to
promote comprehensive healthcare planning, assist in providing high quality
healthcare at the lowest possible cost and avoid unnecessary duplication by
ensuring that only those healthcare facilities that are needed will be built.
Typically, the provider of services submits an application to the
appropriate SHPDA with information concerning the area and population to be
served, the anticipated demand for the facility or service to be provided, the
amount of capital expenditure, the estimated annual operating costs, the
relationship of the proposed facility or service to the overall state health
plan and the cost per patient day for the type of care contemplated. Whether the
CON is granted is based upon a finding of need by the SHPDA in accordance with
criteria set forth in CON statutes and state and regional health facilities
plans. If the proposed facility or service is found to be necessary and the
applicant to be the appropriate provider, the SHPDA will issue a CON containing
a maximum amount of expenditure and a specific time period for the holder of the
CON to implement the approved project.
Licensure and certification are separate, but related, regulatory
activities. The former is usually a state or local requirement and the latter is
a federal requirement. In almost all instances, licensure and certification will
follow specific standards and requirements that are set forth in readily
available public documents. Compliance with the requirements is monitored by
annual on-site inspections by representatives of various government agencies.
All of the Company's inpatient rehabilitation facilities and medical centers and
substantially all of the Company's surgery centers are currently required to be
licensed, but only the outpatient rehabilitation facilities located in Alabama,
Arizona, Kentucky, Maryland, Massachusetts, New Hampshire, New Mexico and Rhode
Island currently must satisfy such a licensing requirement.
Medicare Participation and Reimbursement
In order to participate in the Medicare program and receive Medicare
reimbursement, each facility must comply with the applicable regulations of the
United States Department of Health and Human Services relating to, among other
things, the type of facility, its equipment, its personnel and its standards of
medical care, as well as compliance with all state and local laws and
regulations. All of the Company's inpatient facilities, except for the St. Louis
head injury center, participate in the Medicare program. Approximately 444 of
the Company's outpatient rehabilitation facilities currently participate in, or
are awaiting the assignment of a provider number to participate in, the Medicare
program. All of the Company's surgery centers and diagnostic centers are
certified (or awaiting certification) under the Medicare program. Its
Medicare-certified facilities, inpatient and outpatient, undergo annual on-site
Medicare certification surveys in order to maintain their certification status.
Failure to comply with the program's conditions of participation may result in
loss of program reimbursement or other governmental sanctions. All such
facilities have been deemed to be in satisfactory compliance on all applicable
surveys. The Company has developed its operational systems to assure compliance
with the various standards and requirements of the Medicare program and has
established ongoing quality assurance activities to monitor compliance. The
Company believes that all of such facilities currently meet all applicable
Medicare requirements.
As a result of the Social Security Act Amendments of 1983, Congress adopted
a prospective payment system ("PPS") to cover the routine and ancillary
operating costs of most Medicare inpatient hospital services. Under this system,
the Secretary of Health and Human Services has established fixed payment amounts
per discharge based on diagnosis-related groups ("DRGs"). With limited
exceptions, a hospital's payment for Medicare inpatients is limited to the DRG
rate, regardless of the number of services provided to the patient or the length
of the patient's hospital stay. Under PPS, a hospital may retain the difference,
if any, between its DRG rate and its operating costs incurred in furnishing
inpatient services, and is at risk for any operating costs that exceed its DRG
rate. The Company's medical center facilities are generally subject to PPS with
respect to Medicare inpatient services.
10
The PPS program has been beneficial for the rehabilitation segment of the
healthcare industry because of the economic pressure on acute-care hospitals to
discharge patients as soon as possible. The result has been increased demand for
rehabilitation services for those patients discharged early from acute-care
hospitals. Outpatient rehabilitation services and freestanding inpatient
rehabilitation facilities are currently exempt from PPS, and inpatient
rehabilitation units within acute-care hospitals are eligible to obtain an
exemption from PPS upon satisfaction of certain federal criteria.
Currently, 12 of the Company's outpatient centers are Medicare-certified
Comprehensive Outpatient Rehabilitation Facilities ("CORFs") and 432 are
Medicare-certified rehabilitation agencies. CORFs have been designated
cost-reimbursed Medicare providers since 1982. Under the regulations, CORFs are
reimbursed reasonable costs (subject to certain limits) for services provided to
Medicare beneficiaries. Outpatient rehabilitation facilities certified by
Medicare as rehabilitation agencies are reimbursed on the basis of the lower of
reasonable costs for services provided to Medicare beneficiaries or charges for
such services. Outpatient rehabilitation facilities which are physician-directed
clinics, as well as outpatient surgery centers, are reimbursed by Medicare on a
fee screen basis; that is, they receive a fixed fee, which is determined by the
geographical area in which the facility is located, for each procedure
performed. The Company's outpatient rehabilitation facilities submit monthly
bills to their fiscal intermediaries for services provided to Medicare
beneficiaries, and the Company files annual cost reports with the intermediaries
for each such facility. Adjustments are then made if costs have exceeded
payments from the fiscal intermediary or vice versa.
The Company's inpatient facilities (other than the medical center
facilities) either are not currently covered by PPS or are exempt from PPS, and
are also cost-reimbursed, receiving the lower of reasonable costs or charges.
Typically, the fiscal intermediary pays a set rate based on the prior year's
costs for each facility. As with outpatient facilities subject to cost-based
reimbursement, annual cost reports are filed with the Company's fiscal
intermediary and payment adjustments are made, if necessary.
As part of the Balanced Budget Act of 1997, Congress directed the United
States Department of Health and Human Services to develop regulations that would
subject inpatient rehabilitation hospital to a PPS. The prospective rates are to
be phased in beginning October 1, 2000, and are to be fully implemented on
October 1, 2002. The Act requires that the rates must equal 98% of the amount of
payments that would have been made if the PPS had not been adopted. In addition,
the Act requires the establishment of a PPS for hospital outpatient department
services, effective for services furnished beginning in 1999. Since the drafting
of the regulations covering these initiatives is in very early stages, the
Company cannot predict at this time the effect that any such changes may have on
its operations.
Over the past several years an increasing number of healthcare providers
have been accused of violating the federal False Claims Act. That Act prohibits
the knowing presentation of a false claim to the United States government.
Because the Company performs thousands of similar procedures a year for which it
is reimbursed by Medicare and there is a relatively long statute of limitations,
a billing error could result in significant civil penalties. The Company does
not believe that it is or has been in violation of the False Claims Act.
Relationships with Physicians and Other Providers
Various state and federal laws regulate relationships among providers of
healthcare services, including employment or service contracts and investment
relationships. These restrictions include a federal criminal law prohibiting (i)
the offer, payment, solicitation or receipt of remuneration by individuals or
entities, to induce referrals of patients for services reimbursed under the
Medicare or Medicaid programs or (ii) the leasing, purchasing, ordering,
arranging for or recommending the lease, purchase or order of any item, good,
facility or service covered by such programs (the "Fraud and Abuse Law"). In
addition to federal criminal sanctions, violators of the Fraud and Abuse Law may
be subject to significant civil sanctions, including fines and/or exclusion from
the Medicare and/or Medicaid programs.
In 1991, the Office of the Inspector General ("OIG") of the United States
Department of Health and Human Services promulgated regulations describing
compensation arrangements which are not viewed as illegal remuneration under
the Fraud and Abuse Law (the "Safe Harbor Rules"). The Safe
11
Harbor Rules create certain standards ("Safe Harbors") for identified types of
compensation arrangements which, if fully complied with, assure participants in
the particular arrangement that the OIG will not treat such participation as a
criminal offense under the Fraud and Abuse Law or as the basis for an exclusion
from the Medicare and Medicaid programs or an imposition of civil sanctions. The
OIG closely scrutinizes healthcare joint ventures involving physicians and other
referral sources. In 1989, the OIG published a Fraud Alert that outlined
questionable features of "suspect" joint ventures.
In 1992, regulations were published in the Federal Register implementing
the OIG sanction and civil money penalty provisions established in the Fraud and
Abuse Law. The regulations (the "Exclusion Regulations") provide that the OIG
may exclude a Medicare provider from participation in the Medicare Program for a
five-year period upon a finding that the Fraud and Abuse Law has been violated.
The regulations expressly incorporate a test adopted by three federal circuit
courts providing that if one purpose of remuneration that is offered, paid,
solicited or received is to induce referrals, then the statute is violated. The
regulations also provide that after the OIG establishes a factual basis for
excluding a provider from the program, the burden of proof shifts to the
provider to prove that the Fraud and Abuse Law has not been violated.
The Company currently operates 22 of its rehabilitation hospitals and many
of its outpatient rehabilitation facilities as limited partnerships or limited
liability companies (collectively, "partnerships") with third-party investors.
Seven of the rehabilitation hospital partnerships involve physician investors,
13 of the rehabilitation hospital partnerships involve other institutional
healthcare providers and two of the rehabilitation hospital partnerships involve
both institutional providers and other investors, some of whom are physicians.
Seven of the outpatient partnerships currently have a total of 20 physician
limited partners, some of whom refer patients to the partnerships. Those
partnerships which are providers of services under the Medicare program, and
their limited partners, are subject to the Fraud and Abuse Law. A number of the
relationships established by the Company with physicians and other healthcare
providers do not fit within any of the Safe Harbors. The Safe Harbor Rules do
not expand the scope of activities that the Fraud and Abuse Law prohibits, nor
do they provide that failure to fall within a Safe Harbor constitutes a
violation of the Fraud and Abuse Law; however, the OIG has informally indicated
that failure to fall within a Safe Harbor may subject an arrangement to
increased scrutiny.
Most of the Company's surgery centers are owned by partnerships, which
include as partners physicians who perform surgical procedures at such centers.
Subsequent to the promulgation of the Safe Harbor Rules in 1991, the Department
of Health and Human Services issued for public comment additional proposed Safe
Harbors, one of which specifically addresses surgeon ownership interests in
ambulatory surgery centers (the "Proposed ASC Safe Harbor"). As proposed, the
Proposed ASC Safe Harbor would protect payments to be made to surgeons as a
return on investment interest in a surgery center if, among other conditions,
all the investors are surgeons who are in a position to refer patients directly
to the center and perform surgery on such referred patients. Since a subsidiary
of the Company is an investor in each limited partnership which owns a surgery
center, the Company's arrangements with physician investors do not fit within
the Proposed ASC Safe Harbor as currently proposed. The Company is unable at
this time to predict whether the Proposed ASC Safe Harbor will become final, and
if so, whether the language and requirements will remain as currently proposed,
or whether changes will be made prior to becoming final. There can be no
assurance that the Company will ever meet the criteria under the Proposed ASC
Safe Harbor as proposed or as it may be adopted in final form. The Company
believes, however, that its arrangements with physicians with respect to its
surgery center facilities should not fall within the activities prohibited by
the Fraud and Abuse Law.
Certain of the Company's diagnostic centers are owned or operated by
partnerships which include radiologists as partners. While such ownership
interests are not directly covered by the Safe Harbor Rules, the Company does
not believe that such arrangements violate the Fraud and Abuse Law because
radiologists are typically not in a position to make or induce referrals to
diagnostic centers. In addition, the Company's mobile lithotripsy operations are
conducted by partnerships in which urologists are limited partners. Because such
urologists are in a position to, and do, perform lithotripsy procedures
utilizing the Company's lithotripsy equipment, the Company believes that the
same analysis underlying the Proposed ASC Safe Harbor should apply to ownership
interests in lithotripsy equipment held by
12
urologists. In addition, the Company believes that the nature of lithotripsy
services (i.e., lithotripsy is only prescribed and utilized when a condition for
which lithotripsy is the treatment of choice has been diagnosed) makes the risk
of overutilization unlikely. There can be no assurance, however, that the Fraud
and Abuse Law will not be interpreted in a manner contrary to the Company's
beliefs with respect to diagnostic and lithotripsy services.
While several federal court decisions have aggressively applied the
restrictions of the Fraud and Abuse Law, they provide little guidance as to the
application of the Fraud and Abuse Law to the Company's partnerships. The
Company believes that it is in compliance with the current requirements of
applicable federal and state law, but no assurances can be given that a federal
or state agency charged with enforcement of the Fraud and Abuse Law and similar
laws might not assert a contrary position or that new federal or state laws, or
new interpretations of existing laws, might not adversely affect relationships
established by the Company with physicians or other healthcare providers or
result in the imposition of penalties on the Company or certain of its
facilities. Even the assertion of a violation could have a material adverse
effect upon the Company.
The so-called "Stark II" provisions of the Omnibus Budget Reconciliation
Act of 1993 amend the federal Medicare statute to prohibit the making by a
physician of referrals for "designated health services" (including physical
therapy, occupational therapy, radiology services or radiation therapy) to an
entity in which the physician has an investment interest or other financial
relationship, subject to certain exceptions. Such prohibition took effect on
January 1, 1995 and applies to all of the Company's partnerships with physician
partners. On January 9, 1998, the Department of Health and Human Services
published proposed regulations (the "Proposed Stark Regulations") under the
Stark II statute and solicited comments thereon. In addition, a number of states
have passed or are considering statutes which prohibit or limit physician
referrals of patients to facilities in which they have an investment interest.
In response to these regulatory activities, the Company has restructured most of
its partnerships which involve physician investors to the extent required by
applicable law, in order to eliminate physician ownership interests not
permitted by applicable law. The Company intends to take such actions as may be
required to cause the remaining partnerships to be in compliance with applicable
laws and regulations, including, if necessary, the prohibition of physician
partners from referring patients. The Company believes that this restructuring
has not adversely affected and will not adversely affect the operations of its
facilities.
Ambulatory surgery is not identified as a "designated health service" under
Stark II, and the Company does not believe the statute is intended to cover
ambulatory surgery services. The Proposed Stark Regulations would expressly
clarify that the provision of designated health services in an ambulatory
surgery center would be excepted from the referral prohibition of Stark II if
payment for such designated health services is included in the ambulatory
surgery center payment rate.
Lithotripsy facilities operated by the Company frequently operate on
hospital campuses, and it is possible to conclude that such services are
"inpatient and outpatient hospital services" -- a category of designated health
services under Stark II. The legislative history of the Stark II statute
indicates that the statute was not intended to cover the provision of
lithotripsy services by physician-owned lithotripsy providers under contract
with a hospital. In the commentary to the Proposed Stark Regulations, the
Department of Health and Human Services specifically solicited comments as to
whether lithotripsy services should be excluded from the definition of
"inpatient and outpatient hospital services". In the event that lithotripsy
services are not so excluded, the Company believes that the operations of its
lithotripsy partnerships either comply with, or can be restructured to comply
with, certain other exceptions to the Stark II referral prohibitions, and the
Company intends to take such steps as may be required to cause those
partnerships to be in compliance with Stark II if the final regulations so
require. In addition, physicians frequently perform endoscopic procedures in the
procedure rooms of the Company's surgery centers, and it is possible to construe
such services to be "designated health services". While the Company does not
believe that Stark II was intended to apply to such services, if that were
determined to be the case, the Company intends to take steps necessary to cause
the operations of its facilities to comply with the law.
13
The Health Insurance Portability and Accountability Act of 1996
In an effort to combat healthcare fraud, Congress included several
anti-fraud measures in the Health Insurance Portability and Accountability Act
of 1996 ("HIPAA"). HIPAA, among other things, amends existing crimes and
criminal penalties for Medicare fraud and enacts new federal healthcare fraud
crimes. HIPAA also expands the Fraud and Abuse Law to apply to all federal
healthcare programs, defined to include any plan or program that provides health
benefits through insurance that is funded by the federal government. Under
HIPAA, the Secretary of the Department of Health and Human Services (the
"Secretary") may exclude from the Medicare program any individual who has a
direct or indirect ownership or control interest in a healthcare entity that has
been convicted of a healthcare fraud crime or that has been excluded from the
Medicare conviction or exclusion of the entity. HIPAA directs the Secretary to
establish a program to collect information on healthcare fraud and abuse to
encourage individuals to report information concerning fraud and abuse against
the Medicare program and provides for payment of a portion of amounts collected
to such individuals. HIPAA mandates the establishment of a Fraud and Abuse
Program, among other programs, to control fraud and abuse with respect to health
plans and to conduct investigations, audits, evaluations, and inspections
relating to the delivery of and payment for healthcare in the United States.
HIPAA prohibits any person or entity from knowingly and willfully
committing a federal healthcare offense relating to a healthcare benefit
program. Under HIPAA, a "health care benefit program" broadly includes any
private plan or contract affecting interstate commerce under which any medical
benefit, item, or service is provided to any individual. Among the "federal
health care offenses" prohibited by HIPAA are healthcare fraud and making false
statements relative to healthcare matters. Any person or entity that knowingly
and willfully defrauds or attempts to defraud a healthcare benefit program or
obtains by means of false or fraudulent pretenses, representations or promises,
any of the money or property of any healthcare benefit program in connection
with the delivery of healthcare services is subject to a fine and/or
imprisonment. In addition, HIPAA provides that any person or entity that
knowingly and willfully falsifies or conceals or covers up a material fact or
makes any materially false or fraudulent statements in connection with the
delivery of or payment of healthcare services by a healthcare benefit plan is
subject to a fine and/or imprisonment.
HIPAA further expands the list of acts which are subject to civil monetary
penalties under federal law and increases the amount of civil penalties which
may be imposed. HIPAA provides for civil fines for individuals who retain an
ownership or control interest in a Medicare or Medicaid participating entity
after such individuals have been excluded from participating in the Medicare or
Medicaid program. HIPAA further provides for civil fines for individuals who
offer inducements to Medicare or Medicaid eligible patients if the individuals
know or should know that their offers will influence the patients to order or
receive items or services from a particular provider, practitioner or supplier.
The Company cannot predict whether other regulatory or statutory provisions
will be enacted by federal or state authorities which would prohibit or
otherwise regulate relationships which the Company has established or may
establish with other healthcare providers or the possibility of materially
adverse effects on its business or revenues arising from such future actions.
Management of the Company believes, however, that the Company will be able to
adjust its operations so as to be in compliance with any regulatory or statutory
provision as may be applicable. See this Item, "Business -- Patient Care
Services" and "Business -- Sources of Revenues".
INSURANCE
Beginning December 1, 1993, the Company became self-insured for
professional liability and comprehensive general liability. The Company
purchased coverage for all claims incurred prior to December 1, 1993. In
addition, the Company purchased underlying insurance which would cover all
claims once established limits have been exceeded. It is the opinion of
management that as of December 31, 1997, the Company had adequate reserves to
cover losses on asserted and unasserted claims.
In connection with the Horizon/CMS acquisition, the Company assumed
Horizon/CMS's open professional and general liability claims. The Company has
entered into an agreement with an insurance
14
carrier to assume responsibility for the majority of open claims. Under this
agreement, a "risk transfer" is being conducted which will convert Horizon/CMS's
self-insured claims to insured liabilities consistent with the terms of the
underlying insurance policy.
EMPLOYEES
As of December 31, 1997, the Company employed 56,281 persons, of whom
36,873 were full-time employees and 19,408 were part-time employees. Of the
above employees, 1,070 were employed at the Company's headquarters in
Birmingham, Alabama. Except for approximately 80 employees at one rehabilitation
hospital (about 18% of that facility's workforce), none of the Company's
employees are represented by a labor union. The Company is not aware of any
current activities to organize its employees at other facilities. Management of
the Company considers the relationship between the Company and its employees to
be good.
ITEM 2. PROPERTIES.
The Company's executive offices currently occupy approximately 200,000
square feet in a newly-constructed headquarters building in Birmingham, Alabama.
The headquarters building, which was occupied by the Company in February 1997,
was constructed on a 73-acre parcel of land owned by the Company pursuant to a
tax retention operating lease structured through NationsBanc Leasing
Corporation. Substantially all of the Company's outpatient rehabilitation and
occupational medicine operations are carried out in leased facilities. The
Company owns 37 of its inpatient rehabilitation facilities and leases or
operates under management contracts the remainder of its inpatient
rehabilitation facilities. The Company also owns 48 of its surgery centers and
45 of its diagnostic centers and leases the remainder. The Company constructed
its rehabilitation hospitals in Florence and Columbia, South Carolina, Kingsport
and Nashville, Tennessee, Concord, New Hampshire, Dothan, Alabama, and Columbia,
Missouri and is constructing its Charlottesville, Virginia rehabilitation
hospital, on property leased under long-term ground leases. The property on
which the Company's Memphis, Tennessee rehabilitation hospital is located is
owned in partnership by the Company and Methodist Hospitals of Memphis. The
Company owns its four medical center facilities. The Company currently owns, and
from time to time may acquire, certain other improved and unimproved real
properties in connection with its business. See Notes 5 and 7 of "Notes to
Consolidated Financial Statements" for information with respect to the
properties owned by the Company and certain indebtedness related thereto.
In management's opinion, the Company's physical properties are adequate for
the Company's needs for the foreseeable future, and are consistent with its
expansion plans described elsewhere in this Annual Report on Form 10-K.
15
The following table sets forth a listing of the Company's patient care
services locations at December 31, 1997:
OUTPATIENT INPATIENT
REHABILITATION REHABILITATION MEDICAL SURGERY DIAGNOSTIC OTHER
STATE FACILITIES FACILITIES(BEDS)(2) CENTERS(BEDS)(2) CENTERS CENTERS SERVICES
- - --------------------------- --------------------- --------------------- ------------------ --------- ------------ ---------
Alabama ................... 26 7 (336) 1 (219) 5 6 11
Alaska .................... 7 1 1 4
Arizona ................... 24 4 (243) 2 1 6
Arkansas .................. 8 5 (278) 2 5
California ................ 57 1 (60) 35 1 31
Colorado .................. 45 1 (64) 5 7 1
Connecticut ............... 34 1 (30) 5 3
Delaware .................. 5 1
District of Columbia ...... 1 1
Florida ................... 80 12 (735) 1 (285) 18 7 27
Georgia ................... 30 1 (50) 3 10 4
Hawaii .................... 13 1
Idaho ..................... 5 1
Illinois .................. 49 5 3 1
Indiana ................... 18 4 (260) 5 3
Iowa ...................... 3 1
Kansas .................... 6 4 (231) 1
Kentucky .................. 5 2 (80) 3
Louisiana ................. 4 6 (367) 1 2 2
Maine ..................... 7 4 (155) 4
Maryland .................. 27 2 (66) 7 8 1
Massachusetts ............. 27 14 (806) 1 2 12
Michigan .................. 23 1 (30) 1 1
Minnesota ................. 14
Mississippi ............... 7
Missouri .................. 48 2 (86) 10 9
Montana ................... 3
Nebraska .................. 2
Nevada .................... 21 2 (126) 1 2
New Hampshire ............. 10 3 (99)
New Jersey ................ 71 1 (155) 1 2 1
New Mexico ................ 6 1 (61) 1 1
New York .................. 47 1 (27) 1 1
North Carolina ............ 17 3 1
North Dakota .............. 2
Ohio ...................... 38 1 (30) 7 4
Oklahoma .................. 17 3 (183) 1 1
Oregon .................... 29 1
Pennsylvania .............. 52 14 (1,085) 8 6 4
Rhode Island .............. 3
South Carolina ............ 9 4 (235) 2 6 2
South Dakota .............. 2
Tennessee ................. 34 6 (362) 6 5
Texas ..................... 103 19 (1,116) 1 (96) 21 20 41
Utah ...................... 1 1 (86) 1 1
Vermont ................... 1
Virginia .................. 21 1 (40) 1 (200) 3 9
Washington ................ 85 2 1 17
West Virginia ............. 2 4 (200) 1
Wisconsin ................. 3 4
Wyoming ................... 2
- - ----------
(1) Includes freestanding outpatient centers and their satellites, outpatient
satellites of inpatient rehabilitation facilities and outpatient facilities
managed under contract.
(2) "Beds" refers to the number of beds for which a license or certificate of
need has been granted, which may vary materially from beds available for
use.
16
In addition, at December 31, 1997, the Company operated six diagnostic
centers in the United Kingdom and one rehabilitation hospital in Australia.
ITEM 3. LEGAL PROCEEDINGS.
In the ordinary course of its business, the Company may be subject, from
time to time, to claims and legal actions by patients and others. The Company
does not believe that any such pending actions, if adversely decided, would have
a material adverse effect on its financial condition. See Item 1, "Business --
Insurance" and Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" for a description of the Company's
insurance coverage arrangements.
From time to time, the Company appeals decisions of various rate-making
authorities with respect to Medicare rates established for the Company's
facilities. These appeals are initiated in the ordinary course of business.
Management believes that adequate reserves have been established for possible
adverse decisions on any pending appeals and that the outcomes of currently
pending appeals, either individually or in the aggregate, will have no material
adverse effect on the Company's operations.
CERTAIN HORIZON/CMS LITIGATION
On October 29, 1997, HEALTHSOUTH acquired Horizon/CMS through the merger of
a wholly owned subsidiary of HEALTHSOUTH with and into Horizon/CMS. Horizon/CMS
is currently a party, or is subject, to certain material litigation matters and
disputes, which are described below, as well as various other litigation matters
and disputes arising in the ordinary course of its business. The Company is not
itself a party to the litigation described below.
SEC and NYSE Investigations
The Division of Enforcement of the SEC is conducting a private
investigation with respect to trading in the securities of Horizon/CMS and
Continental Medical Systems, Inc. ("CMS"), which was acquired by Horizon/CMS in
June 1995. In connection with that investigation, Horizon/CMS produced certain
documents, and Neal M. Elliott, then Chairman of the Board, President and Chief
Executive Officer of Horizon/CMS, and certain other former officers of
Horizon/CMS have given testimony to the SEC. Horizon/CMS has also been informed
that certain of its division office employees and an individual, affiliates of
whom had limited business relationships with Horizon/CMS, have responded to
subpoenas from the SEC. Mr. Elliott also produced certain documents in response
to a subpoena from the SEC. In addition, Horizon/CMS and Mr. Elliott have
responded to separate subpoenas from the SEC pertaining to trading in
Horizon/CMS's common stock and various material press releases issued in 1996 by
Horizon/CMS; Horizon/CMS's February 18, 1997 announcement that the Company would
acquire Horizon/CMS; and any discussions of proposed business combinations
between Horizon/CMS and Medical Innovations and Horizon/CMS and certain other
companies. The investigation is, to the knowledge of the Company and
Horizon/CMS, ongoing, and neither Horizon/CMS nor the Company possesses all the
facts with respect to the matters under investigation. Although neither
Horizon/CMS nor the Company has been advised by the SEC that the SEC has
concluded that any of Horizon/CMS, Mr. Elliott or any other current or former
officer of director of Horizon/CMS has been involved in any violation of the
federal securities laws, there can be no assurance as to the outcome of the
investigation or the time of its conclusion. Both Horizon/CMS and the Company
have, to the extent requested to date, cooperated fully with the SEC in
connection with the investigation.
In March 1995, the New York Stock Exchange informed Horizon/CMS that it had
initiated a review of trading in Hillhaven Corporation common stock prior to the
announcement of Horizon/CMS's proposed acquisition of Hillhaven. In April 1995,
the NYSE extended the review of trading to include all dealings with CMS. On
April 3, 1996, the NYSE notified Horizon/CMS that it had initiated a review of
trading in its common stock preceding Horizon/CMS's March 1, 1996 press release
announcing a revision in Horizon/CMS's third quarter earnings estimate. On
February 20, 1997, the NYSE notified Horizon/CMS that it was reviewing trading
in Horizon/CMS's securities prior to the February 18, 1997 announcement that the
Company would acquire Horizon/CMS. Horizon/CMS has cooperated with the NYSE in
its reviews and, to Horizon/CMS's knowledge, the reviews are ongoing.
17
In February 1997, the Company received a subpoena from the SEC with respect
to its investigation concerning trading in Horizon/CMS common stock prior to the
February 18, 1997 announcement that the Company would acquire Horizon/CMS and a
request for information from the NYSE in connection with its review of such
trading. The Company responded to such subpoena and request for information and
advised both the SEC and the NYSE that it intended to cooperate fully in any
investigations or reviews relating to such trading. The Company provided certain
additional information to the SEC in April 1997. Since that time, the Company
has had no further inquiries from either the SEC or the NYSE with respect to
such matters, and is unaware of the current status of such investigations or
reviews.
Michigan Attorney General Investigation Into Long-Term Care Facility In
Michigan
Horizon/CMS learned in September 1996 that the Attorney General of the
State of Michigan was investigating one of its skilled nursing facilities. The
facility, in Howell, Michigan, was owned and operated by Horizon/CMS from
February 1994 until December 31, 1997. As widely reported in the press, the
Attorney General seized a number of patient, financial and accounting records
that were located at this facility. By order of a circuit judge in the county in
which the facility is located, the Attorney General was ordered to return
patient records to the facility for copying. Horizon/CMS advised the Michigan
Attorney General that it was willing to cooperate fully in the investigation.
The facility in question was sold by Horizon/CMS to IHS on December 31, 1997.
On February 19, 1998, the State of Michigan filed a criminal complaint
against Horizon/CMS, four former employees of the facility and one former
Horizon/CMS regional manager, alleging various violations in 1995 and 1996 of
certain statutes relating to patient care, patient medical records and the
making of false statements with respect to the condition or operations of the
facility (State of Michigan v. Horizon/CMS Healthcare Corp., et al., Case No.
98-630-FY, State of Michigan District Court 54B). The maximum fines chargeable
against Horizon/CMS under the counts alleged in the complaint (exclusive of
charges against the individual defendants, some of which charges may result in
indemnification obligations for Horizon/CMS) aggregate $69,000. Horizon/CMS
denies the allegations made in the complaint and expects to vigorously defend
against the charges. Because such charges have just been filed, it is not
possible to predict at this time the outcome or effect of this litigation or the
length of time it will take to resolve this litigation.
Stockholder Derivative Actions
Commencing in April and continuing into May 1996, Horizon/CMS was served
with nine complaints alleging a class action derivative action brought by
stockholders of Horizon/CMS for and on behalf of Horizon/CMS in the Court of
Chancery of New Castle County, Delaware, against certain then-current and former
directors of Horizon/CMS. The nine lawsuits have been consolidated into one
action styled In re Horizon/CMS Healthcare Corporation Shareholders Litigation.
The plaintiffs alleged, among other things, that Horizon/CMS's then-current and
former directors breached their fiduciary duties to Horizon/CMS and the
stockholders as a result of (i) the purported failure to supervise adequately
and the purported knowing mismanagement of the operations of Horizon/CMS, and
(ii) the purported misuse of inside information in connection with the sale of
Horizon/CMS's Common Stock by certain of the current and former directors in
January and February 1996. To that end, the plaintiffs sought an accounting from
the directors for profits to themselves and damages suffered by Horizon/CMS as a
result of the transaction complained of in the complaint and attorneys' fees and
costs. On June 21, 1996, the individual defendants filed a motion with the
Chancery Court seeking to dismiss this matter because, among other things, the
plaintiffs failed to make a demand on the board of directors prior to commencing
this litigation.
In April 1996, Horizon/CMS was served with complaint in a stockholder's
derivative lawsuit styled Lind v. Rocco A. Ortenzio, Neal M. Elliott, Klemett L.
Belt, Jr., Robert A. Ortenzio, Russell L. Carson, Bryan C. Cressey, Charles H.
Gonzales, Michael A. Jeffries, Gerard M. Martin, Frank M. McCord, Raymond N.
Noveck, Barry M. Portnoy, LeRoy S. Zimmerman and Horizon/CMS Healthcare
Corporation, No. CIV 96-0538-BB, pending in the United States District Court for
the District of New Mexico.
18
The claims alleged by the plaintiff, and the relief sought, were substantially
identical to those in the Delaware litigation. Horizon/CMS filed a motion
seeking a stay of this case pending the outcome of the motion to dismiss in the
Delaware derivative lawsuits or, in the alternative, to dismiss this case for
those same reasons.
On February 24, 1998, the plaintiffs in the consolidated Delaware case
voluntarily dismissed their action without prejudice. Horizon/CMS expects that
the plaintiff in the New Mexico case will likewise dismiss his action. If that
does not occur, Horizon/CMS will renew and vigorously prosecute its motion to
dismiss the New Mexico action. If such dismissal does not occur, the Company
cannot currently predict the outcome or the effect of the New Mexico litigation
or the length of time it will take to resolve such litigation.
Lawsuit by Former Shareholders of Communi-Care, Inc. and Pro Rehab, Inc.
On May 28, 1997, CMS was served with a lawsuit styled Kenneth Hubbard and
Lynn Hubbard v. Rocco Ortenzio, Robert A. Ortenzio and Continental Medical
Systems, Inc., No. 3:97 CV294MCK, filed in the United States District Court for
the Western District of North Carolina, Charlotte Division, by the former
shareholders of Communi-Care, Inc. and Pro Rehab, Inc. seeking damages arising
out of certain "earnout" provisions of the definitive purchase agreements under
which CMS purchased the outstanding stock of Communi-Care, Inc. and Pro Rehab,
Inc. from such shareholders. The plaintiffs allege that the manner in which CMS
and the other defendants operated the companies after their acquisition breached
its fiduciary duties to the plaintiffs, constituted fraud, gross negligence and
bad faith and a breach of their employment agreements with the companies. As a
result of such alleged conduct, the plaintiffs assert that they are entitled to
damages in an amount in excess of $27,000,000 from CMS and the other defendants.
Horizon/CMS believes, based upon its evaluation of the legal and factual matters
relating to the plaintiffs' assertions, that it has valid defenses to the
plaintiffs' claims and, as a result, intends to vigorously contest such claims.
Because this litigation remains at an early stage, the Company cannot now
predict the outcome or effect of such litigation or the length of time it will
take to resolve such litigation.
RehabOne Litigation
In March 1997, Horizon/CMS was served with a lawsuit filed in the United
States District Court for the Middle District of Pennsylvania, styled RehabOne,
Inc. v. Horizon/CMS Healthcare Corporation, Continental Medical Systems, Inc.
David Nation and Robert Ortenzio, No. CV-97-0292. In this lawsuit the plaintiff
alleges violations of federal and state securities laws, fraud and negligent
misrepresentation by Horizon/CMS and certain former officers of CMS in
connection with the issuance of a warrant to purchase 500,000 shares of
Horizon/CMS Common Stock (the "Warrant"). The Warrant was issued to the
plaintiff in connection with the settlement of certain prior litigation between
the plaintiff and CMS. The plaintiff's complaint does not state the amount of
damages sought. Horizon/CMS disputes the factual and legal assertions of the
plaintiff in this litigation and intends to vigorously contest the plaintiff's
claims. Because this litigation is at an early stage, the Company cannot predict
the length of time it will take to resolve the litigation or the outcome or
effect of the litigation.
EEOC Litigation
In March 1997, the Equal Employment Opportunity Commission (the "EEOC")
filed a complaint against Horizon/CMS alleging that Horizon/CMS had engaged in
unlawful employment practices in respect of Horizon/CMS's employment policies
related to pregnancies. Specifically, the EEOC asserts that Horizon/CMS's
alleged refusal to provide pregnant employees with light-duty assignments to
accommodate their temporary disabilities caused by pregnancy violates Sections
701(k) and 703(a) of Title VII, 42 U.S.C. (section)(section) 2000e-(k) and
2000e-2(a). In this lawsuit, the EEOC seeks, among other things, to permanently
enjoin Horizon/CMS's employment practices in this regard. Horizon/CMS disputes
the factual and legal assertions of the EEOC in this litigation and intends to
vigorously contest the EEOC's claims. Because this litigation has just
commenced, the Company cannot predict the length of time it will take to resolve
the litigation or the outcome of the litigation.
19
North Louisiana Rehabilitation Hospital Medicare Billing Investigation
In August 1996, the United States Attorney for the Western District of
Louisiana, without actually initiating litigation, apprised Horizon/CMS of
alleged civil liability under the federal False Claims Act for what the
government believes were false or fraudulent Medicare and other federal program
claims submitted by Horizon/CMS's North Louisiana Rehabilitation Hospital
("NLRH") during the period from 1989 through 1992, including certain claims
submitted by a physician who was a member of the medical staff and under
contract to NLRH during the period. Specifically, the government alleges that
NLRH facilitated the submission of false claims under Part B of the Medicare
program by the physician and that NLRH itself submitted false claims under Part
A of the Medicare program for services that were not medically necessary. In
August 1996, the U.S. Attorney identified allegedly improper Part A and Part B
billings, together with penalty provisions under the False Claims Act, ranging
in the aggregate from approximately $1,700,000 to $2,200,000. The government
does not dispute that the Medicare Part A services were rendered, but only
whether they were medically necessary. Horizon/CMS has vigorously contested the
allegation that any cases of disputed medical necessity in this matter
constitute false or fraudulent claims under the civil False Claims Act.
Moreover, Horizon/CMS denies that NLRH facilitated the submission of false
claims under Medicare Part B.
In late April 1997, Horizon/CMS received administrative subpoenas relating
to the matter and has since then produced extensive materials with respect
thereto. Without conceding liability for either the Medicare Part A or Part B
claims, in May 1997, Horizon commenced preliminary settlement discussions with
the government. In preparation for settlement meetings held in late June and
mid-July 1997, Horizon/CMS and the government developed and then refined their
respective analyses of any losses the government may have incurred in this
regard. Following the July 1997 meetings, the government proposed to Horizon/CMS
that the matter be settled by Horizon/CMS's paying the government $4,900,000
with respect to alleged Medicare Part A overpayments and that Horizon/CMS and
certain individual physicians pay the government $820,000 with respect to
Medicare Part B claims for physician services. In late July, Horizon/CMS
responded by offering to settle the matter for $3,700,000 for alleged Medicare
Part A overpayments and $445,000 for alleged Medicare Part B claims for which
Horizon/CMS potentially could bear any responsibility. The government recently
advised Horizon/CMS that it has accepted the latter's settlement offer in this
regard, and the parties are currently in the process of negotiating and
implementing definitive settlement documentation.
Heritage Western Hills Litigation
Since July 1996, Horizon/CMS has been a defendant in a lawsuit styled Lexa
A. Auld, Administratrix of Martha Hary, Deceased v. Horizon/CMS Healthcare
Corporation and Charles T. Maxvill, D.O., No. 48-165121, 48th Judicial District
Court, Tarrant County, Texas. The case involved injuries allegedly suffered by a
resident of the Heritage Western Hills nursing facility in Fort Worth, Texas.
Horizon/CMS tendered the claim to its insurance carrier, which accepted coverage
with a reservation of rights and provided a defense through the carrier's
selected counsel in Dallas, Texas. The case went to trial on October 29, 1997,
and on November 7, 1997, the jury rendered a verdict in favor of the plaintiff
in the amount of $2,370,000 in compensatory damages and $90,000,000 in punitive
damages. Counsel has advised Horizon/CMS that, under applicable Texas law, the
punitive damages award is, at worst, limited to four times the amount of the
compensatory damages (the "Punitive Damages Cap"), and thus that the maximum
amount of an enforceable judgment in favor of the plaintiff is approximately
$12,000,000. Counsel has also advised Horizon/CMS that there are, potentially,
other and further caps on both the amount of compensatory damages available to
the plaintiff and the amount of punitive damages. Horizon/CMS filed the required
motions with the court to impose the Punitive Damages Cap. On February 20, 1998,
the court reduced the jury's verdict and entered a judgment in the amount of
approximately $11,237,000. Horizon/CMS also vigorously disputes the efficacy of
the jury's verdict and has appealed the judgment.
Horizon/CMS's insurance carrier continues to defend the matter subject to a
reservation of rights. Horizon/CMS based upon an evaluation by its then-current
internal counsel, after reviewing the findings contained in the jury verdict,
the insurance policy at issue and the carrier's handling of the case, believes
20
that the entirety of any judgment ultimately entered is covered by and payable
from such insurance policy, less Horizon/CMS's self-insured retention of
$250,000. On November 19, 1997, the insurance carrier sent Horizon/CMS a letter
indicating its belief that certain policy exclusions might apply and requesting
additional information which might affect its coverage determination.
Horizon/CMS has retained separate counsel to analyze the coverage issues and
advise Horizon/CMS on its position, and Horizon/CMS expects to continue to
negotiate any coverage issues with its carrier. Settlement negotiations by
Horizon/CMS's insurance carrier, in conjunction with the Company's retained
counsel, continue with the plaintiff. It is not possible at this time to predict
the outcome of any post-trial motions or appeals, the resolution of any coverage
issues, the outcome of any settlement negotiations or the ultimate amount of any
liability which will be borne by Horizon/CMS.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
21
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock is listed for trading on the New York Stock
Exchange (Symbol: HRC). The following table sets forth for the fiscal periods
indicated the high and low reported sale prices for the Company's Common Stock
as reported on the NYSE Composite Transactions Tape. All prices shown have been
adjusted for a two-for-one stock split effected in the form of a 100% stock
dividend paid on March 17, 1997.
REPORTED
SALE PRICE
-------------------------
HIGH LOW
----------- -----------
1996
First Quarter .......... $ 19.07 $ 13.50
Second Quarter ......... 19.32 16.16
Third Quarter .......... 19.32 14.25
Fourth Quarter ......... 19.88 17.57
1997
First Quarter .......... $ 22.38 $ 17.94
Second Quarter ......... 27.12 17.75
Third Quarter .......... 28.94 23.12
Fourth Quarter ......... 28.31 22.00
- - ----------
The closing price for the Common Stock on the New York Stock Exchange on March
27, 1998, was $27.875.
There were approximately 5,977 holders of record of the Common Stock as of
March 13, 1998, excluding those shares held by depository companies for certain
beneficial owners.
The Company has never paid cash dividends on its Common Stock (although
certain of the companies acquired by the Company in poolings-of-interests
transactions had paid dividends prior to such acquisitions) and does not
anticipate the payment of cash dividends in the foreseeable future. The Company
currently anticipates that any future earnings will be retained to finance the
Company's operations.
RECENT SALES OF UNREGISTERED SECURITIES
On October 23, 1997, the Company issued an aggregate of 984,189 shares of
its Common Stock in connection with its acquisition of National Imaging
Affiliates, Inc. ("NIA"). The shares were issued to 100 persons and entities who
were, immediately prior to such acquisition, stockholders of NIA and were issued
pursuant to the exemptions provided in Section 4(2) of the Securities Act of
1933, as amended, and Rule 506 of Regulation D promulgated thereunder. The
Company believes that such exemptions are available because (a) the transaction
did not involve a public offering, (b) no more than 35 of the former NIA
stockholders were not "accredited investors", as such term is defined in
Regulation D, and (c) the Company otherwise complied with the requirements of
Rule 506. All such shares were registered for resale pursuant to a Registration
Statement on Form S-3 declared effective by the SEC on December 5, 1997.
22
ITEM 6. SELECTED FINANCIAL DATA.
Set forth below is a summary of selected consolidated financial data for
the Company for the years indicated. All amounts have been restated to reflect
the effects of the 1994 acquisition of ReLife, Inc. ("ReLife"), the 1995 SHC and
SSCI acquisitions, the 1996 SCA and Advantage Health acquisitions, and the 1997
Health Images acquisition, each of which was accounted for as a pooling of
interests.
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------
1993 1994 1995 1996 1997
------------- ------------- ------------- ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
INCOME STATEMENT DATA:
Revenues ......................................... $1,055,295 $1,726,321 $2,118,681 $2,568,155 $3,017,269
Operating unit expenses .......................... 715,189 1,207,707 1,441,059 1,667,248 1,888,435
Corporate general and administrative expenses..... 43,378 67,798 65,424 79,354 82,757
Provision for doubtful accounts .................. 22,677 35,740 42,305 58,637 71,468
Depreciation and amortization .................... 75,425 126,148 160,901 207,132 250,010
Merger and acquisition related expenses (1) ...... 333 6,520 19,553 41,515 15,875
Loss on impairment of assets (2) ................. -- 10,500 53,549 37,390 --
Loss on abandonment of computer project .......... -- 4,500 -- -- --
Loss on disposal of surgery centers .............. -- 13,197 -- -- --
NME Selected Hospitals Acquisition
related expense .................................. 49,742 -- -- -- --
Interest expense ................................. 25,884 74,895 105,517 98,751 111,504
Interest income .................................. (6,179) (6,658) (8,009) (6,034) (4,414)
Gain on sale of partnership interest ............. (1,400) -- -- -- --
Gain on sale of MCA Stock ........................ -- (7,727) -- -- --
---------- ---------- ---------- ---------- ----------
925,049 1,532,620 1,880,299 2,183,993 2,415,635
---------- ---------- ---------- ---------- ----------
Income from continuing operations before
income taxes, minority interests and
extraordinary item .............................. 130,246 193,701 238,382 384,162 601,634
Provision for income taxes ....................... 40,450 68,560 86,161 143,929 206,153
---------- ---------- ---------- ---------- ----------
89,796 125,141 152,221 240,233 395,481
Minority interests ............................... 29,549 31,665 43,753 50,369 64,873
---------- ---------- ---------- ---------- ----------
Income from continuing operations before
extraordinary item .............................. 60,247 93,476 108,468 189,864 330,608
Income from discontinued operations .............. 3,986 (6,528) (1,162) -- --
Extraordinary item (2) ........................... -- -- (9,056) -- --
---------- ---------- ---------- ---------- ----------
Net income ...................................... $ 64,233 $ 86,948 $ 98,250 $ 189,864 $ 330,608
========== ========== ========== ========== ==========
Weighted average common shares outstanding
(3)(6) .......................................... 265,502 273,480 289,594 321,367 346,872
========== ========== ========== ========== ==========
Net income per common share: (3)(6)
Continuing operations ........................... $ 0.23 $ 0.34 $ 0.37 $ 0.59 $ 0.95
Discontinued operations ......................... 0.01 (0.02) 0.00 -- --
Extraordinary item .............................. -- -- (0.03) -- --
---------- ---------- ---------- ---------- ----------
$ 0.24 $ 0.32 $ 0.34 $ 0.59 $ 0.95
========== ========== ========== ========== ==========
Weighted average common share outstanding --
assuming dilution(3)(4)(6) ..................... 275,366 300,758 320,018 349,033 365,546
========== ========== ========== ========== ==========
Net income per common share -- assuming
dilution: (3)(4)(6)
Continuing operations ........................... $ 0.22 $ 0.32 $ 0.35 $ 0.55 $ 0.91
Discontinued operations ......................... 0.01 (0.02) 0.00 -- --
Extraordinary item .............................. -- -- (0.03) -- --
---------- ---------- ---------- ---------- ----------
$ 0.23 $ 0.30 $ 0.32 $ 0.55 $ 0.91
========== ========== ========== ========== ==========
23
DECEMBER 31,
-------------------------------------------------------------------------
1993 1994 1995 1996 1997
------------- ------------ ------------ ------------ ------------
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash and marketable securities ......... $ 153,011 $ 134,040 $ 159,793 $ 153,831 $ 152,399
Working capital ........................ 300,876 308,770 406,601 564,529 566,751
Total assets ........................... 2,000,566 2,355,920 3,107,808 3,529,706 5,401,053
Long-term debt (5) ..................... 1,028,610 1,164,135 1,453,018 1,560,143 1,601,824
Stockholders' equity ................... 727,737 837,160 1,269,686 1,569,101 3,157,428
- - ----------
(1) Expenses related to SHC's Ballas Merger in 1993, the ReLife and Heritage
Acquisitions in 1994, the SHC, SSCI and NovaCare Rehabilitation Hospitals
Acquisitions in 1995, the SCA, Advantage Health, PSCM and ReadiCare
Acquisitions in 1996, and the Health Images Acquisition in 1997.
(2) See "Notes to Consolidated Financial Statements".
(3) Adjusted to reflect a two-for-one stock split effected in the form of a 100%
stock dividend paid on April 17, 1995 and a two-for-one stock split effected
in the form of a 100% stock dividend paid on March 17, 1997.
(4) Diluted earnings per share in 1994, 1995, 1996 and 1997 reflect shares
reserved for issuance upon conversion of the Company's 5% Convertible
Subordinated Debentures due 2001. Substantially all of such Debentures were
converted into shares of the Company's Common Stock in 1997.
(5) Includes current portion of long-term debt.
(6) Earnings per share amounts prior to 1997 have been restated as required to
comply with Statement of Financial Accounting Standards No. 128, "Earnings
Per Share". For further discussion, see Note 1 of "Notes to Consolidated
Financial Statements".
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
GENERAL
The following discussion is intended to facilitate the understanding and
assessment of significant changes and trends related to the consolidated results
of operations and financial condition of the Company, including certain factors
related to recent acquisitions by the Company, the timing and nature of which
have significantly affected the Company's consolidated results of operations.
This discussion and analysis should be read in conjunction with the Company's
consolidated financial statements and notes thereto included elsewhere in this
Annual Report on Form 10-K.
The Company completed the following major acquisitions over the last three
years (common share amounts have been adjusted to reflect stock splits effected
in the form of 100% stock dividends paid on April 17, 1995 and March 17, 1997):
o On April 1, 1995, the Company purchased the operations of the
rehabilitation hospital division of NovaCare, Inc. (the "NovaCare
Rehabilitation Hospitals Acquisition"). The purchase price was
approximately $235,000,000. The NovaCare Rehabilitation Hospitals consisted
of 11 rehabilitation hospitals in seven states, 12 other facilities and two
Certificates of Need.
o On June 13, 1995, the Company acquired Surgical Health Corporation (the
"SHC Acquisition"). A total of 17,062,960 shares of the Company's Common
Stock were issued in the transaction, representing a value of $155,000,000
at the time of the acquisition. The Company also purchased SHC's
$75,000,000 aggregate principal amount of 11.5% Senior Subordinated Notes
due 2004 for an aggregate consideration of approximately $86,000,000. At
that time, SHC operated a network of 36 free-standing surgery centers in 11
states, and five mobile lithotripsy units.
o On October 26, 1995, the Company acquired Sutter Surgery Centers, Inc. (the
"SSCI Acquisition"). A total of 3,552,002 shares of the Company's Common
Stock were issued in the transaction, representing a value of $44,444,000
at the time of the acquisition. At that time, SSCI operated a network of 12
freestanding surgery centers in three states.
24
o On December 1, 1995, the Company acquired Caremark Orthopedic Services Inc.
(the "Caremark Acquisition"). The purchase price was approximately
$127,500,000. At that time, Caremark owned and operated approximately 120
outpatient rehabilitation centers in 13 states.
o On January 17, 1996, the Company acquired Surgical Care Affiliates, Inc.
(the "SCA Acquisition"). A total of 91,856,678 shares of the Company's
Common Stock were issued in the transaction, representing a value of
approximately $1,400,000,000 at the time of the acquisition. At that time,
SCA operated a network of 67 freestanding surgery centers in 24 states.
o On March 14, 1996, the Company acquired Advantage Health Corporation (the
"Advantage Health Acquisition"). A total of 18,203,978 shares of the
Company's Common Stock were issued in the transaction, representing a value
of approximately $315,000,000 at the time of the acquisition. At that time,
Advantage Health operated a network of 136 sites of service, including four
freestanding rehabilitation hospitals, one freestanding multi-use hospital,
one nursing home, 68 outpatient rehabilitation facilities, 14 inpatient
managed rehabilitation units, 24 rehabilitation services management
contracts and six managed subacute rehabilitation units, primarily located
in the northern United States.
o On August 20, 1996, the Company acquired Professional Sports Care
Management, Inc. (the "PSCM Acquisition"). A total of 3,622,888 shares of
the Company's Common Stock were issued in the transaction, representing a
value of approximately $59,000,000 at the time of the acquisition. At that
time, PSCM operated a network of 36 outpatient rehabilitation centers in
three states.
o On December 2, 1996, the Company acquired ReadiCare, Inc. (the "ReadiCare
Acquisition"). A total of 4,007,954 shares of the Company's Common Stock
were issued in the transaction, representing a value of approximately
$76,000,000 at the time of the acquisition. At that time, ReadiCare
operated a network of 37 occupational medicine and rehabilitation centers
in two states.
o On March 3, 1997, the Company acquired Health Images, Inc. ("Health
Images"). A total of 10,343,470 shares of the Company's Common Stock were
issued in the transaction, representing a value of approximately
$208,162,000 at the time of the acquisition. At that time, Health Images
operated 49 freestanding diagnostic centers in 13 states and six in the
United Kingdom.
o On September 30, 1997 the Company acquired ASC Network Corporation (the
"ASC Acquisition"). The Company paid approximately $130,827,000 in cash for
all of the issued and outstanding capital stock of ASC and assumed
approximately $61,000,000 in debt. At that time, ASC operated 29 outpatient
surgery centers in eight states.
o On October 23, 1997 the Company acquired National Imaging Affiliates, Inc.
("NIA"). A total of 984,189 shares of the Company's Common Stock were
issued in the transaction, representing a value of approximately
$20,706,000 at the time of the acquisition. At that time, NIA operated
eight diagnostic imaging centers in six states.
o On October 29, 1997, the Company acquired Horizon/CMS Healthcare
Corporation (the "Horizon/CMS Acquisition"). A total of 45,261,000 shares
of the Company's Common Stock were issued in the transaction, representing
a value of approximately $975,824,000 at the time of the acquisition, and
the Company assumed approximately $740,000,000 in debt. At that time,
Horizon/CMS operated 30 inpatient rehabilitation facilities and
approximately 275 outpatient rehabilitation centers, among other strategic
businesses, as well as certain long-term care businesses. On December 31,
1997, the Company sold the long-term care assets of Horizon/CMS, including
139 long-term care facilities, 12 specialty hospitals, 35 institutional
pharmacy locations and over 1,000 rehabilitation therapy contracts with
long-term care facilities, to Integrated Health Services, Inc. ("IHS"). IHS
paid approximately $1,130,000,000 in cash (net of certain adjustments) and
assumed approximately $94,000,000 in debt in the transaction.
Each of the NovaCare Rehabilitation Hospitals Acquisition, the Caremark
Acquisition, the ASC Acquisition, the Horizon/CMS Acquisition and the NIA
Acquisition was accounted for under the purchase method of accounting and,
accordingly, the acquired operations are included in the Company's consolidated
financial information from their respective dates of acquisition. Each of the
SHC Acquisi-
25
tion, the SSCI Acquisition, the SCA Acquisition, the Advantage Health
Acquisition and the Health Images Acquisition was accounted for as a pooling of
interests and, with the exception of data set forth relating to revenues derived
from Medicare and Medicaid, all amounts shown in the following discussion have
been restated to reflect such acquisitions. SHC, SSCI, SCA, Advantage Health and
Health Images did not separately track such revenues. The PSCM Acquisition and
the ReadiCare Acquisition were also accounted for as poolings of interests.
However, due to the immateriality of PSCM and ReadiCare, the Company's
historical financial statements for all periods prior to the quarters in which
the respective mergers took place have not been restated. Instead, stockholders'
equity has been increased during 1996 to reflect the effects of the PSCM
Acquisition and the ReadiCare Acquisition. The results of operations of PSCM and
ReadiCare are included in the accompanying financial statements and the
following discussion from the date of acquisition forward (see Note 2 of "Notes
to Consolidated Financial Statements" for further discussion).
The Company determines the amortization period of the cost in excess of net
asset value of purchased facilities based on an evaluation of the facts and
circumstances of each individual purchase transaction. The evaluation includes
an analysis of historic and projected financial performance, an evaluation of
the estimated useful life of the buildings and fixed assets acquired, the
indefinite useful life of certificates of need and licenses acquired, the
competition within local markets, lease terms where applicable, and the legal
terms of partnerships where applicable. The Company utilizes independent
appraisers and relies on its own management expertise in evaluating each of the
factors noted above. With respect to the carrying value of the excess of cost
over net asset value of purchased facilities and other intangible assets, the
Company determines on a quarterly basis whether an impairment event has occurred
by considering factors such as the market value of the asset, a significant
adverse change in legal factors or in the business climate, adverse action by
regulators, a history of operating losses or cash flow losses, or a projection
of continuing losses associated with an operating entity. The carrying value of
excess cost over net asset value of purchased facilities and other intangible
assets will be evaluated if the facts and circumstances suggest that it has been
impaired. If this evaluation indicates that the value of the asset will not be
recoverable, as determined based on the undiscounted cash flows of the entity
acquired over the remaining amortization period, the Company's carrying value of
the asset will be reduced by the estimated shortfall of cash flows to the
estimated fair market value.
Governmental, commercial and private payors have increasingly recognized
the need to contain their costs for healthcare services. These payors,
accordingly, are turning to closer monitoring of services, prior authorization
requirements, utilization review and increased utilization of outpatient
services. During the periods discussed below, the Company has experienced an
increased effort by these payors to contain costs through negotiated discount
pricing. The Company views these efforts as an opportunity to demonstrate the
effectiveness of its clinical programs and its ability to provide its
rehabilitative healthcare services efficiently. The Company has entered into a
number of contracts with payors to provide services and has realized an
increased volume of patients as a result.
The Company's revenues include net patient service revenues and other
operating revenues. Net patient service revenues are reported at estimated net
realizable amounts from patients, insurance companies, third-party payors
(primarily Medicare and Medicaid) and others for services rendered. Revenues
from third-party payors also include estimated retroactive adjustments under
reimbursement agreements which are subject to final review and settlement by
appropriate authorities. Management determines allowances for doubtful accounts
and contractual adjustments based on historical experience and the terms of
payor contracts. Net accounts receivable include only those amounts estimated by
management to be collectible.
The Company, in many cases, operates more than one site within a market. In
such markets, there is customarily an outpatient center or inpatient facility
with associated satellite outpatient locations. For purposes of the following
discussion and analysis, same store operations are measured on locations within
markets in which similar operations existed at the end of the period and include
the operations of additional locations opened within the same market. New store
operations are measured on locations within new markets.
26
RESULTS OF OPERATIONS OF THE COMPANY
Twelve-Month Periods Ended December 31, 1995 and 1996
The Company operated 739 outpatient rehabilitation locations at December
31, 1996, compared to 537 outpatient rehabilitation locations at December 31,
1995. In addition, the Company operated 96 inpatient rehabilitation facilities,
135 surgery centers, 72 diagnostic centers and five medical centers at December
31, 1996, compared to 95 inpatient rehabilitation facilities, 122 surgery
centers, 69 diagnostic centers and five medical centers at December 31, 1995.
The Company's operations generated revenues of $2,568,155,000 in 1996, an
increase of $449,474,000, or 21.2%, as compared to 1995 revenues. Same store
revenues for the twelve months ended December 31, 1996 were $2,408,294,000, an
increase of $289,613,000, or 13.7%, as compared to the same period in 1995. New
store revenues for 1996 were $159,861,000. New store revenues reflect the
acquisition of one inpatient rehabilitation hospital, the addition of eight new
outpatient surgery centers, and the acquisition of outpatient rehabilitation
operations in 57 new markets (see Note 9 of "Notes to Consolidated Financial
Statements"). The increase in revenues is primarily attributable to the addition
of these operations and increases in patient volume. Revenues generated from
patients under the Medicare and Medicaid programs respectively accounted for
37.8% and 2.9% of total revenues for 1996, compared to 40.0% and 2.5% of total
revenues for 1995. Revenues from any other single third-party payor were not
significant in relation to the Company's total revenues. During 1996, same store
outpatient visits, inpatient days and surgical cases increased 19.9%, 10.8% and
7.3%, respectively. Revenue per outpatient visit, inpatient day and surgical
case for same store operations increased (decreased) by (0.8)%, 3.8% and 1.1%,
respectively.
Operating expenses, at the operating unit level, were $1,667,248,000, or
64.9% of revenues, for 1996, compared to 68.0% of revenues for 1995. The
decrease in operating expenses as a percentage of revenues is primarily
attributable to the 13.7% increase in same store revenues noted above. Same
store operating expenses for 1996 were $1,567,820,000, or 65.1% of related
revenues. New store operating expenses were $99,428,000, or 62.2% of related
revenues. Corporate general and administrative expenses increased from
$65,424,000 in 1995 to $79,354,000 in 1996. As a percentage of revenues,
corporate general and administrative expenses were 3.1% in both 1995 and 1996.
Total operating expenses were $1,746,602,000, or 68.0% of revenues, for 1996,
compared to $1,506,483,000, or 71.1% of revenues, for 1995. The provision for
doubtful accounts was $58,637,000, or 2.3% of revenues, for 1996, compared to
$42,305,000, or 2.0% of revenues, for 1995.
Depreciation and amortization expense was $207,132,000 for 1996, compared
to $160,901,000 for 1995. The increase resulted from the investment in
additional assets by the Company. Interest expense decreased to $98,751,000 in
1996, compared to $105,517,000 for 1995, primarily because of the favorable
interest rates on the Company's revolving credit facility (see "Liquidity and
Capital Resources"). For 1996, interest income was $6,034,000, compared to
$8,009,000 for 1995. The decrease in interest income resulted primarily from a
decrease in the average amount outstanding in interest-bearing investments.
Merger expenses in 1996 of $41,515,000 represent costs incurred or accrued
in connection with completing the SCA Acquisition ($19,727,000), the Advantage
Health Acquisition ($9,212,000), the PSCM Acquisition ($5,513,000) and the
ReadiCare Acquisition ($7,063,000). For further discussion, see Note 2 of "Notes
to Consolidated Financial Statements".
Income before minority interests and income taxes for 1996 was
$384,162,000, compared to $238,382,000 for 1995. Minority interests reduced
income before income taxes by $50,369,000 in 1996, compared to $43,753,000 for
1995. The provision for income taxes for 1996 was $143,929,000, compared to
$86,161,000 for 1995, resulting in effective tax rates of 43.1% for 1996 and
44.3% for 1995. Net income for 1996 was $189,864,000.
Twelve-Month Periods Ended December 31, 1996 and 1997
The Company operated approximately 1,150 outpatient rehabilitation
locations at December 31, 1997, compared to 739 outpatient rehabilitation
locations at December 31, 1996. In addition, the Com-
27
pany operated 138 inpatient rehabilitation facilities, 172 surgery centers, 101
diagnostic centers and four medical centers at December 31, 1997, compared to 96
inpatient rehabilitation facilities, 135 surgery centers, 72 diagnostic centers
and five medical centers at December 31, 1996.
The Company's operations generated revenues of $3,017,269,000 in 1997, an
increase of $449,114,000, or 17.5%, as compared to 1996 revenues. Same store
revenues for the twelve months ended December 31, 1997 were $2,834,528,000, an
increase of $266,373,000, or 10.4%, as compared to the same period in 1996. New
store revenues for 1997 were $182,741,000. New store revenues reflect primarily
the addition of 30 inpatient rehabilitation hospitals and 275 outpatient centers
from the Horizon/CMS Acquisition, the addition of 29 outpatient surgery centers
from the ASC Acquisition, and the acquisition of outpatient rehabilitation
operations in 28 new markets (see Note 9 of "Notes to Consolidated Financial
Statements"). The increase in revenues is primarily attributable to the addition
of these operations and increases in patient volume. Revenues generated from
patients under the Medicare and Medicaid programs respectively accounted for
36.9% and 2.3% of total revenues for 1997, compared to 37.8% and 2.9% of total
revenues for 1996. Revenues from any other single third-party payor were not
significant in relation to the Company's total revenues. During 1997, same store
outpatient visits, inpatient days, surgical cases and diagnostic cases increased
20.6%, 10.8%, 8.8% and 12.3%, respectively. Revenue per outpatient visit,
inpatient day, surgical case and diagnostic case for same store operations
increased (decreased) by 2.6%, 1.6%, (0.4)% and (0.3) %, respectively.
Operating expenses, at the operating unit level, were $1,888,435,000, or
62.6% of revenues, for 1997, compared to 64.9% of revenues for 1996. The
decrease in operating expenses as a percentage of revenues is primarily
attributable to the 10.4% increase in same store revenues noted above. In same
store operations, the incremental costs associated with increased revenues are
significantly lower as a percentage of those increased revenues. Same store
operating expenses for 1997 were $1,752,208,000, or 61.8% of related revenues.
New store operating expenses were $136,227,000, or 74.5% of related revenues.
New store revenues and operating expenses for 1997 include two months of
operations of the facilities acquired from Horizon/CMS, in which aggregate
operating expenses are significantly higher as a percentage of related revenues
than the Company's other facilities. Corporate general and administrative
expenses increased from $79,354,000 in 1996 to $82,757,000 in 1997. As a
percentage of revenues, corporate general and administrative expenses decreased
from 3.1% in 1996 to 2.7% in 1997. Total operating expenses were $1,971,192,000,
or 65.3% of revenues, for 1997, compared to $1,746,602,000, or 68.0% of
revenues, for 1996. The provision for doubtful accounts was $71,468,000, or 2.4%
of revenues, for 1997, compared to $58,637,000, or 2.3% of revenues, for 1996.
Depreciation and amortization expense was $250,010,000 for 1997, compared
to $207,132,000 for 1996. The increase resulted from the investment in
additional assets by the Company. Interest expense increased to $111,504,000 in
1997, compared to $98,751,000 for 1996, primarily because of the increased
amount outstanding under the Company's revolving credit facility (see "Liquidity
and Capital Resources"). For 1997, interest income was $4,414,000, compared to
$6,034,000 for 1996. The decrease in interest income resulted primarily from a
decrease in the average amount outstanding in interest-bearing investments.
Merger expenses in 1997 of $15,875,000 represent costs incurred or accrued
in connection with completing the Health Images Acquisition. For further
discussion, see Note 2 of "Notes to Consolidated Financial Statements".
Income before minority interests and income taxes for 1997 was
$601,634,000, compared to $384,162,000 for 1996. Minority interests reduced
income before income taxes by $64,873,000 in 1997, compared to $50,369,000 for
1996. The provision for income taxes for 1997 was $206,153,000, compared to
$143,929,000 for 1996, resulting in effective tax rates of 38.4% for 1997 and
43.1% for 1996. Net income for 1997 was $330,608,000.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company had working capital of $566,751,000,
including cash and marketable securities of $152,399,000. Working capital at
December 31, 1996 was $564,529,000, including cash and marketable securities of
$153,831,000. For 1997, cash provided by operations was $415,848,000,
28
compared to $388,345,000 for 1996. For 1997, investing activities provided
$366,514,000, compared to using $485,193,000 for 1996. The change is primarily
due to the proceeds from the sale of the long-term care assets of Horizon/CMS to
IHS in 1997. Additions to property, plant and equipment and acquisitions
accounted for $346,141,000 and $270,218,000, respectively, during 1997. Those
same investing activities accounted for $204,792,000 and $91,391,000,
respectively, in 1996. Financing activities used $784,360,000 and provided
$95,107,000 during 1997 and 1996, respectively. The change is primarily due to
the Company's use of proceeds from the IHS sale to pay down outstanding
indebtedness. Net borrowing (reductions) proceeds for 1997 and 1996 were
$(771,570,000) and $101,366,000, respectively.
Net accounts receivable were $745,994,000 at December 31, 1997, compared to
$540,389,000 at December 31, 1996. The number of days of average annual revenues
in ending receivables was 75.8 at December 31, 1997, compared to 76.8 at
December 31, 1996. The concentration of net accounts receivable from patients,
third-party payors, insurance companies and others at December 31, 1997 was
consistent with the related concentration of revenues for the period then ended.
The Company has a $1,250,000,000 revolving credit facility with
NationsBank, N.A. ("NationsBank") and other participating banks (the "1996
Credit Agreement"). The 1996 Credit Agreement replaced a previous $1,000,000,000
revolving credit agreement, also with NationsBank. Interest is paid based on
LIBOR plus a predetermined margin, a base rate or competitively bid rates from
the participating banks. This credit facility has a maturity date of March 31,
2001. The Company provided a negative pledge on all assets for the 1996 Credit
Agreement. Pursuant to the terms of the 1996 Credit Agreement, the Company has
elected to convert $350,000,000 of the $1,250,000,000 1996 Credit Agreement into
a two-year amortizing term note maturing on December 31, 1999. The Company has
received a $350,000,000 commitment from NationsBank for an additional 364-day
facility (the "Interim Revolving Credit Facility") which is on substantially the
same terms as the 1996 Credit Agreement. The effective interest rate on the
average outstanding balance under the 1996 Credit Agreement was 5.87% for the
twelve months ended December 31, 1997, compared to the average prime rate of
8.44% during the same period. At December 31, 1997, the Company had drawn
$1,175,000,000 under the 1996 Credit Agreement. For further discussion, see Note
7 of "Notes to Consolidated Financial Statements".
In connection with the Horizon/CMS Acquisition, the Company obtained a
$1,250,000,000 Senior Bridge Credit Facility from NationsBank, N.A. and nine
other banks on substantially the same terms as the 1996 Credit Agreement. At the
time of the closing of the Horizon/CMS Acquisition, approximately $1,000,000,000
was drawn under the Senior Bridge Credit Facility, primarily to repay certain
existing indebtedness of Horizon/CMS. The Company repaid all amounts drawn as of
December 31, 1997 under the Senior Bridge Credit Facility upon the closing of
the sale of the Horizon/CMS long-term care assets to IHS, thereby permanently
reducing the amount available thereunder to $500,000,000. The effective interest
rate on the average outstanding balance under the Senior Bridge Credit Facility
was 6.52% for the twelve months ended December 31, 1997 (see Note 7 of "Notes to
Consolidated Financial Statements").
In 1994, the Company issued $115,000,000 principal amount of 5% Convertible
Subordinated Debentures due 2001 (the "2001 Debentures"). The Company called the
2001 Debentures for redemption on April 1, 1997. Prior to the redemption date,
the holders of the 2001 Debentures surrendered substantially all of the 2001
Debentures for conversion into approximately 12,226,000 shares of the Company's
Common Stock.
On March 20, 1998, the Company issued $500,000,000 principal amount of
3.25% Convertible Subordinated Debentures due 2003 (the "2003 Debentures").
Proceeds from the sale of the 2003 Debentures were used to pay off all amounts
under the Senior Bridge Credit Facility and reduce outstanding amounts under the
1996 Credit Agreement. Effective with the sale of the Debentures, the Senior
Bridge Credit Facility was terminated.
The Company intends to pursue the acquisition or development of additional
healthcare operations, including outpatient rehabilitation facilities, inpatient
rehabilitation facilities, ambulatory surgery centers, outpatient diagnostic
centers and companies engaged in the provision of rehabilitation-related
services, and to expand certain of its existing facilities. While it is not
possible to estimate precisely the amounts which will actually be expended in
the foregoing areas, the Company anticipates that over the
29
next twelve months, it will spend approximately $100,000,000 on maintenance and
expansion of its existing facilities and approximately $300,000,000 on
development of the Integrated Service Model. See Item 1, "Business -- Company
Strategy".
Although the Company is continually considering and evaluating acquisitions
and opportunities for future growth, the Company has not entered into any
agreements with respect to material future acquisitions. The Company believes
that existing cash, cash flow from operations and borrowings under the revolving
line of credit and the interim revolving credit facility will be sufficient to
satisfy the Company's estimated cash requirements for the next twelve months,
and for the reasonably foreseeable future. In addition, the Company expects to
explore other opportunities within the capital markets as a result of its
reduced leverage and investment grade rating.
Inflation in recent years has not had a significant effect on the Company's
business, and is not expected to adversely affect the Company in the future
unless it increases significantly.
EXPOSURES TO MARKET RISK
The Company is exposed to market risk related to changes in interest rates.
Because of its favorable borrowing arrangements and current market conditions,
the Company currently does not use derivatives, such as swaps or caps, to alter
the interest characteristics of its debt instruments and investment securities.
The impact on earnings and value of market risk-sensitive financial instruments
(principally marketable security investments and long-term debt) is subject to
change as a result of movements in market rates and prices. The Company uses
sensitivity analysis models to evaluate these impacts.
The Company's investment in marketable securities was $4,326,000 at
December 31, 1997, which represents less than 0.1% of total assets at that date.
These securities are generally short-term, highly-liquid instruments and,
accordingly, their fair value approximates cost. Earnings on investments in
marketable securities are not significant to the Company's results of
operations, and therefore any changes in interest rates would have a minimal
impact on future pre-tax earnings.
With respect to the Company's interest-bearing liabilities, approximately
$1,175,000,000 in long-term debt at December 31, 1997 is subject to variable
rates of interest, while the remaining balance in long-term debt of $426,824,000
is subject to fixed rates of interest (see Note 7 of "Notes to Consolidated
Financial Statements for further description). The fair value of the Company's
total long-term debt, based on discounted cash flow analyses, approximates its
carrying value at December 31, 1997. Based on a hypothetical 1% increase in
interest rates, the potential losses in future pre-tax earnings would be
approximately $11,175,000. The impact of such a change on the carrying value of
long-term debt would not be significant. These amounts are determined
considering the impact of the hypothetical interest rates on the Company's
borrowing cost and long-term debt balances. These analyses do not consider the
effects, if any, of the potential changes in the overall level of economic
activity that could exist in such an environment. Further, in the event of a
change of significant magnitude, management would expect to take actions
intended to further mitigate its exposure to such change. Subsequent to December
31, the Company issued $500,000,000 in principal amount of the 2003 Debentures
(see Note 14 of "Notes to Consolidated Financial Statements"). The proceeds were
used to pay down existing variable-rate indebtedness, which will in effect
further reduce the Company's exposure to market risk related to interest rate
fluctuations.
Foreign operations, and the related market risks associated with foreign
currency, are currently insignificant to the Company's results of operations and
financial position.
COMPUTER TECHNOLOGIES AND YEAR 2000 COMPLIANCE
The Company is aware of the issues associated with the programming code in
existing computer systems as the year 2000 approaches. Many existing computer
programs use only two digits to identify a year in the date field. The issue is
whether such code exists in the Company's mission-critical applications and if
that code will produce accurate information with relation to date-sensitive
calculations after the turn of the century.
30
The Company has completed a thorough review of its material computer
applications and determined that such applications contain very few
date-sensitive calculations. The Company's computer applications are divided
into two categories, those maintained internally by the Company's Information
Technology Group and those maintained externally by the applications' vendors.
For internally maintained applications, revisions are currently being made and
are expected to be implemented by the first quarter of 1999. The Company expects
that the total cost associated with these revisions will be less than
$1,000,000. These costs will be primarily incurred during 1998 and be charged to
expense as incurred. For externally maintained systems, the Company has received
written confirmation from the vendors that each system is currently year 2000
compliant or will be made year 2000 compliant during 1998. The cost to be
incurred by the Company related to externally maintained systems is expected to
be minimal.
The Company has initiated a program to determine whether the computer
applications of its significant payors and suppliers will be upgraded in a
timely manner. The Company has not completed this review; however, initial
responses indicate that no significant problems are currently expected to arise.
The Company has also initiated a program to determine whether embedded
applications which control certain medical and other equipment will be affected.
The nature of the Company's business is such that any failure of these type
applications is not expected to have a material adverse effect on its business.
Because of the many uncertainties associated with year 2000 compliance
issues, and because the Company's assessment is necessarily based on information
from third party-vendors, payors and suppliers, there can be no assurance that
the Company's assessment is correct or as to the materiality or effect of any
failure of such assessment to be correct.
FORWARD-LOOKING STATEMENTS
Statements contained in this Annual Report on Form 10-K which are not
historical facts are forward-looking statements. In addition, the Company,
through its senior management, from time to time makes forward-looking public
statements concerning its expected future operations and performance and other
developments. Such forward-looking statements are necessarily estimates
reflecting the Company's best judgment based upon current information and
involve a number of risks and uncertainties, and there can be no assurance that
other factors will not affect the accuracy of such forward-looking statements.
While is impossible to identify all such factors, factors which could cause
actual results to differ materially from those estimated by the Company include,
but are not limited to, changes in the regulation of the healthcare industry at
either or both of the federal and state levels, changes in reimbursement for the
Company's services by governmental or private payors, competitive pressures in
the healthcare industry and the Company's response thereto, the Company's
ability to obtain and retain favorable arrangements with third-party payors,
unanticipated delays in the Company's implementation of its Integrated Service
Model, general conditions in the economy and capital markets, and other factors
which may be identified from time to time in the Company's Securities and
Exchange Commission filings and other public announcements.
31
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Consolidated financial statements of the Company meeting the requirements
of Regulation S-X are filed on the succeeding pages of this Item 8 of this
Annual Report on Form 10-K, as listed below:
PAGE
-----
Report of Independent Auditors ................................................. 33
Consolidated Balance Sheets as of December 31, 1996 and 1997 ................... 34
Consolidated Statements of Income for the Years Ended December 31, 1995, 1996
and 1997 ..................................................................... 35
Consolidated Statements of Stockholders' Equity for the Years Ended December
31, 1995, 1996 and 1997 ...................................................... 36
Consolidated Statements of Cash Flows for the Years Ended December 31, 1995,
1996 and 1997 ................................................................ 37
Notes to Consolidated Financial Statements ..................................... 38
Other financial statements and schedules required under Regulation S-X are
listed in Item 14(a)2, and filed under Item 14(d), of this Annual Report on Form
10-K.
QUARTERLY RESULTS (UNAUDITED)
Set forth below is certain summary information with respect to the
Company's operations for the last eight fiscal quarters. All amounts have been
restated to reflect the effects of the 1996 acquisitions of SCA and Advantage
Health and the 1997 acquisition of Health Images, all of which were accounted
for as poolings of interests. All per share amounts have been adjusted to
reflect a two-for-one stock split effected in the form of a 100% stock dividend
paid on March 17, 1997. Earnings per share amounts for 1996 and the first three
quarters of 1997 have been restated to comply with Statement of Financial
Accounting Standards No. 128, "Earnings Per Share".
1996
-------------------------------------------------------------
1ST 2ND 3RD 4TH
QUARTER QUARTER QUARTER QUARTER
------------- ------------- ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenues ....................... $ 612,149 $ 628,854 $ 651,742 $ 675,410
Net income ..................... 39,681 61,985 63,481 24,717
Net income per common share..... 0.12 0.19 0.20 0.08
Net income per common share
-- assuming dilution .......... 0.12 0.18 0.18 0.07
1997
-------------------------------------------------------------
1ST 2ND 3RD 4TH
QUARTER QUARTER QUARTER QUARTER
------------- ------------- ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenues ....................... $ 691,631 $ 723,017 $ 748,370 $ 854,251
Net income ..................... 64,580 81,319 85,919 98,790
Net income per common share..... 0.20 0.24 0.25 0.26
Net income per common share
-- assuming dilution .......... 0.19 0.23 0.24 0.25
32
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors
HEALTHSOUTH Corporation
We have audited the accompanying consolidated balance sheets of HEALTHSOUTH
Corporation and Subsidiaries as of December 31, 1996 and 1997, and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the three years in the period ended December 31, 1997. Our audits also
included the financial statement schedule listed in the Index at Item 14(a).
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
HEALTHSOUTH Corporation and Subsidiaries at December 31, 1996 and 1997, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997, in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
ERNST & YOUNG LLP
Birmingham, Alabama
February 25, 1998, except for Note 14,
as to which the date is March 20, 1998
33
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
------------------------------
1996 1997
-------------- -------------
(IN THOUSANDS)
ASSETS
Current assets:
Cash and cash equivalents (Note 3) ........................................ $ 150,071 $ 148,073
Other marketable securities (Note 3) ...................................... 3,760 4,326
Accounts receivable, net of allowances for doubtful
accounts of $75,360,000 in 1996 and $123,545,000 in 1997.................. 540,389 745,994
Inventories ............................................................... 47,408 64,029
Prepaid expenses and other current assets ................................. 128,174 120,776
Deferred income taxes (Note 10) ........................................... 15,238 --
---------- ----------
Total current assets ....................................................... 885,040 1,083,198
Other assets:
Loans to officers ......................................................... 1,396 1,007
Assets held for sale (Note 9) ............................................. -- 60,400
Other (Note 4) ............................................................ 84,016 162,311
---------- ----------
85,412 223,718
Property, plant and equipment, net (Note 5) ................................ 1,464,833 1,850,765
Intangible assets, net (Note 6) ............................................ 1,094,421 2,243,372
---------- ----------
Total assets ............................................................... $3,529,706 $5,401,053
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable .......................................................... $ 116,451 $ 124,058
Salaries and wages payable ................................................ 67,793 121,768
Accrued interest payable and other liabilities ............................ 75,936 97,506
Income taxes payable ...................................................... 13,242 92,507
Deferred income taxes (Note 10) ........................................... -- 34,119
Current portion of long-term debt (Note 7) ................................ 47,089 46,489
---------- ----------
Total current liabilities .................................................. 320,511 516,447
Long-term debt (Note 7) .................................................... 1,513,054 1,555,335
Deferred income taxes (Note 10) ............................................ 51,790 76,613
Deferred revenue and other long-term liabilities ........................... 3,964 1,538
Minority interests-limited partnerships (Note 1) ........................... 71,286 93,692
Commitments and contingencies (Note 11)
Stockholders' equity (Notes 8 and 12):
Preferred stock, $.10 par value--1,500,000 shares authorized;
issued and outstanding- none ............................................. -- --
Common stock, $.01 par value--500,000,000 shares authorized;
issued--326,493,000 in 1996 and 395,233,000 in 1997 .................... 3,265 3,952
Additional paid-in capital ................................................ 1,060,012 2,317,821
Retained earnings ......................................................... 525,718 853,641
Treasury stock, at cost (182,000 shares in 1996 and 1997) ................. (323) (323)
Receivable from Employee Stock Ownership Plan ............................. (14,148) (12,247)
Notes receivable from stockholders ........................................ (5,423) (5,416)
---------- ----------
Total stockholders' equity ................................................. 1,569,101 3,157,428
---------- ----------
Total liabilities and stockholders' equity ................................. $3,529,706 $5,401,053
========== ==========
See accompanying notes.
34
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31,
---------------------------------------------
1995 1996 1997
------------- ------------- -------------
(IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
Revenues ............................................... $2,118,681 $2,568,155 $3,017,269
Operating unit expenses ................................ 1,441,059 1,667,248 1,888,435
Corporate general and administrative expenses .......... 65,424 79,354 82,757
Provision for doubtful accounts ........................ 42,305 58,637 71,468
Depreciation and amortization .......................... 160,901 207,132 250,010
Merger and acquisition related expenses (Notes 2 and 9). 19,553 41,515 15,875
Loss on impairment of assets (Note 13) ................. 53,549 37,390 --
Interest expense ....................................... 105,517 98,751 111,504
Interest income ........................................ (8,009) (6,034) (4,414)
---------- ---------- ----------
1,880,299 2,183,993 2,415,635
---------- ---------- ----------
Income from continuing operations before income taxes,
minority interests and extraordinary item ............. 238,382 384,162 601,634
Provision for income taxes (Note 10) ................... 86,161 143,929 206,153
---------- ---------- ----------
152,221 240,233 395,481
Minority interests ..................................... 43,753 50,369 64,873
---------- ---------- ----------
Income from continuing operations before extraordinary
item .................................................. 108,468 189,864 330,608
Loss from discontinued operations ...................... (1,162) -- --
Extraordinary item ( Note 2) ........................... (9,056) -- --
---------- ---------- ----------
Net income ............................................. $ 98,250 $ 189,864 $ 330,608
========== ========== ==========
Weighted average common shares outstanding ............. 289,594 321,367 346,872
========== ========== ==========
Net income per common share: ...........................
Continuing operations ................................. $ 0.37 $ 0.59 $ 0.95
Discontinued operations ............................... 0.00 -- --
Extraordinary item .................................... ( 0.03) -- --
---------- ---------- ----------
$ 0.34 $ 0.59 $ 0.95
========== ========== ==========
Weighted average common shares outstanding -
assuming dilution .................................... 320,018 349,033 365,546
========== ========== ==========
Net income per common share - assuming dilution:
Continuing operations ................................. $ 0.35 $ 0.55 $ 0.91
Discontinued operations ............................... 0.00 -- --
Extraordinary item .................................... ( 0.03) -- --
---------- ---------- ----------
$ 0.32 $ 0.55 $ 0.91
========== ========== ==========
See accompanying notes.
35
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
COMMON STOCK ADDITIONAL
---------------------- PAID-IN
SHARES AMOUNT CAPITAL
----------- ---------- --------------
(IN THOUSANDS)
Balance at December 31, 1994 ......................................... 145,029 $1,451 $ 607,024
Adjustment for ReLife Merger (Note 2) ................................ 2,732 27 7,114
Proceeds from exercise of options (Note 8) ........................... 1,136 11 10,218
Proceeds from issuance of common shares .............................. 15,232 152 334,896
Income tax benefits related to incentive stock options (Note 8) ...... -- -- 6,653
Reduction in receivable from ESOP .................................... -- -- --
Loans made to stockholders ........................................... -- -- --
Purchase of limited partnership units ................................ -- -- --
Purchases of treasury stock .......................................... -- -- --
Net income ........................................................... -- -- --
Translation adjustment ............................................... -- -- --
Dividends paid ....................................................... -- -- --
------- ------ ----------
Balance at December 31, 1995 ......................................... 164,129 1,641 965,905
Adjustment for Advantage Health Merger (Note 2) ...................... -- -- --
Adjustment for 1996 mergers (Note 2) ................................. 4,047 40 68,785
Proceeds from exercise of options (Note 8) ........................... 3,514 36 34,380
Income tax benefits related to incentive stock options (Note 8) ...... -- -- 23,767
Reduction in receivable from ESOP .................................... -- -- --
Payments received on stockholders' notes receivable .................. -- -- --
Purchase of limited partnership units ................................ -- -- --
Purchase of treasury stock ........................................... -- -- --
Retirement of treasury stock ......................................... (1,835) (18) (31,259)
Net income ........................................................... -- -- --
Translation adjustment ............................................... -- -- --
Dividends paid ....................................................... -- -- --
Stock split .......................................................... 156,638 1,566 (1,566)
------- ------ ----------
Balance at December 31, 1996 ......................................... 326,493 3,265 1,060,012
Common shares issued in connection with acquisitions (Note 9) ........ 46,245 462 996,068
Value of options exchanged in connection with the
Horizon/CMS acquisition (Note 9) ..................................... -- -- 23,191
Common shares issued upon conversion of 5% Convertible Subordi-
nated Debentures due 2001 (Note 7) .................................. 12,226 122 113,050
Proceeds from exercise of options (Note 8) ........................... 10,269 103 58,921
Income tax benefits related to incentive stock options (Note 8) ...... -- -- 66,579
Reduction in receivable from ESOP .................................... -- -- --
Payments received on stockholders' notes receivable .................. -- -- --
Purchase of limited partnership units ................................ -- -- --
Net income ........................................................... -- -- --
Translation adjustment ............................................... -- -- --
------- ------ ----------
Balance at December 31, 1997 ......................................... 395,233 $3,952 $2,317,821
======= ====== ==========
TREASURY STOCK
RETAINED ------------------------- RECEIVABLE
EARNINGS SHARES AMOUNT FROM ESOP
------------ ----------- ------------- ------------
(IN THOUSANDS)
Balance at December 31, 1994 ......................................... $ 273,768 2,482 $ (22,367) $ (17,477)
Adjustment for ReLife Merger (Note 2) ................................ (3,734) -- -- --
Proceeds from exercise of options (Note 8) ........................... -- -- -- --
Proceeds from issuance of common shares .............................. -- -- -- --
Income tax benefits related to incentive stock options (Note 8) ...... -- -- -- --
Reduction in receivable from ESOP .................................... -- -- -- 1,591
Loans made to stockholders ........................................... -- -- -- --
Purchase of limited partnership units ................................ (4,767) -- -- --
Purchases of treasury stock .......................................... -- 588 (8,497) --
Net income ........................................................... 98,250 -- -- --
Translation adjustment ............................................... 247 -- -- --
Dividends paid ....................................................... (8,403) -- -- --
--------- ----- --------- ---------
Balance at December 31, 1995 ......................................... 355,361 3,070 (30,864) (15,886)
Adjustment for Advantage Health Merger (Note 2) ...................... (17,638) -- -- --
Adjustment for 1996 mergers (Note 2) ................................. (1,256) -- -- --
Proceeds from exercise of options (Note 8) ........................... -- -- -- --
Income tax benefits related to incentive stock options (Note 8) ...... -- -- -- --
Reduction in receivable from ESOP .................................... -- -- -- 1,738
Payments received on stockholders' notes receivable .................. -- -- -- --
Purchase of limited partnership units ................................ (83) -- -- --
Purchase of treasury stock ........................................... -- 89 (736) --
Retirement of treasury stock ......................................... -- (3,068) 31,277 --
Net income ........................................................... 189,864 -- -- --
Translation adjustment ............................................... 692 -- -- --
Dividends paid ....................................................... (1,222) -- -- --
Stock split .......................................................... -- 91 -- --
--------- ------ --------- ---------
Balance at December 31, 1996 ......................................... 525,718 182 (323) (14,148)
Common shares issued in connection with acquisitions (Note 9) ........ -- -- -- --
Value of options exchanged in connection with the
Horizon/CMS acquisition (Note 9) ..................................... -- -- -- --
Common shares issued upon conversion of 5% Convertible Subordi-
nated Debentures due 2001 (Note 7) .................................. -- -- -- --
Proceeds from exercise of options (Note 8) ........................... -- -- -- --
Income tax benefits related to incentive stock options (Note 8) ...... -- -- -- --
Reduction in receivable from ESOP .................................... -- -- -- 1,901
Payments received on stockholders' notes receivable .................. -- -- -- --
Purchase of limited partnership units ................................ (2,465) -- -- --
Net income ........................................................... 330,608 -- -- --
Translation adjustment ............................................... (220) -- -- --
--------- ------ --------- ---------
Balance at December 31, 1997 ......................................... $ 853,641 182 $ (323) $ (12,247)
========= ====== ========= =========
NOTES
RECEIVABLE TOTAL
FROM STOCKHOLDERS'
STOCKHOLDERS EQUITY
------------- --------------
(IN THOUSANDS)
Balance at December 31, 1994 ......................................... $ (5,240) $ 837,159
Adjustment for ReLife Merger (Note 2) ................................ -- 3,407
Proceeds from exercise of options (Note 8) ........................... -- 10,229
Proceeds from issuance of common shares .............................. -- 335,048
Income tax benefits related to incentive stock options (Note 8) ...... -- 6,653
Reduction in receivable from ESOP .................................... -- 1,591
Loans made to stockholders ........................................... (1,231) (1,231)
Purchase of limited partnership units ................................ -- (4,767)
Purchases of treasury stock .......................................... -- (8,497)
Net income ........................................................... -- 98,250
Translation adjustment ............................................... -- 247
Dividends paid ....................................................... -- (8,403)
-------- ----------
Balance at December 31, 1995 ......................................... (6,471) 1,269,686
Adjustment for Advantage Health Merger (Note 2) ...................... -- (17,638)
Adjustment for 1996 mergers (Note 2) ................................. -- 67,569
Proceeds from exercise of options (Note 8) ........................... -- 34,416
Income tax benefits related to incentive stock options (Note 8) ...... -- 23,767
Reduction in receivable from ESOP .................................... -- 1,738
Payments received on stockholders' notes receivable .................. 1,048 1,048
Purchase of limited partnership units ................................ -- (83)
Purchase of treasury stock ........................................... -- (736)
Retirement of treasury stock ......................................... -- --
Net income ........................................................... -- 189,864
Translation adjustment ............................................... -- 692
Dividends paid ....................................................... -- (1,222)
Stock split .......................................................... -- --
-------- ----------
Balance at December 31, 1996 ......................................... (5,423) 1,569,101
Common shares issued in connection with acquisitions (Note 9) ........ -- 996,530
Value of options exchanged in connection with the
Horizon/CMS acquisition (Note 9) ..................................... -- 23,191
Common shares issued upon conversion of 5% Convertible Subordi-
nated Debentures due 2001 (Note 7) .................................. -- 113,172
Proceeds from exercise of options (Note 8) ........................... -- 59,024
Income tax benefits related to incentive stock options (Note 8) ...... -- 66,579
Reduction in receivable from ESOP .................................... -- 1,901
Payments received on stockholders' notes receivable .................. 7 7
Purchase of limited partnership units ................................ -- (2,465)
Net income ........................................................... -- 330,608
Translation adjustment ............................................... -- (220)
-------- ----------
Balance at December 31, 1997 ......................................... $ (5,416) $3,157,428
======== ==========
See accompanying notes.
36
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
------------------------------------------
1995 1996 1997
------------ ------------- ---------------
(IN THOUSANDS)
OPERATING ACTIVITIES
Net income ...................................................................... $ 98,250 $ 189,864 $ 330,608
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization .................................................. 160,901 207,132 250,010
Provision for doubtful accounts ................................................ 42,305 58,637 71,468
Provision for losses on impairment of assets ................................... 53,549 37,390 --
Merger and acquisition related expenses ........................................ 19,553 41,515 15,875
Loss on extinguishment of debt ................................................. 14,606 -- --
Income applicable to minority interests of limited partnerships ................ 43,753 50,369 64,873
Provision for deferred income taxes ............................................ 396 14,308 12,520
Provision for deferred revenue ................................................. (1,990) (1,255) (406)
Changes in operating assets and liabilities, net of effects of acquisitions:
Accounts receivable ........................................................... (69,754) (141,323) (196,623)
Inventories, prepaid expenses and other current assets ........................ 1,370 (35,084) 20,092
Accounts payable and accrued expenses ......................................... (12,880) (33,208) (152,569)
---------- ---------- ------------
Net cash provided by operating activities ....................................... 350,059 388,345 415,848
INVESTING ACTIVITIES
Purchases of property, plant and equipment ...................................... (183,867) (204,792) (346,141)
Proceeds from sale of property, plant and equipment ............................. 16,026 -- --
Proceeds from sale of non-strategic assets ...................................... -- -- 1,136,571
Additions to intangible assets, net of effects of acquisitions .................. (117,900) (175,380) (61,887)
Assets obtained through acquisitions, net of liabilities assumed ................ (517,773) (91,391) (270,218)
Changes in other assets ......................................................... (6,963) (14,214) (91,245)
Proceeds received on sale of other marketable securities ........................ 22,513 584 773
Investments in other marketable securities ...................................... (11,304) -- (1,339)
---------- ---------- ------------
Net cash (used in) provided by investing activities ............................. (799,268) (485,193) 366,514
FINANCING ACTIVITIES
Proceeds from borrowings ........................................................ 721,973 205,873 1,763,243
Principal payments on long-term debt ............................................ (502,152) (104,507) (2,534,813)
Early retirement of debt ........................................................ (14,606) -- --
Proceeds from exercise of options ............................................... 10,083 34,415 59,024
Proceeds from issuance of common stock .......................................... 330,954 -- --
Purchase of treasury stock ...................................................... (8,497) (736) --
Reduction in receivable from ESOP ............................................... 1,591 1,738 1,901
(Loans made to) payments received from stockholders ............................. (1,231) 1,048 7
Dividends paid .................................................................. (8,403) (1,222) --
Proceeds from investment by minority interests .................................. 1,103 510 2,572
Purchase of limited partnership units ........................................... (10,076) (3,064) (2,685)
Payment of cash distributions to limited partners ............................... (36,697) (38,948) (73,609)
---------- ---------- ------------
Net cash provided by (used in) financing activities ............................. 484,042 95,107 (784,360)
---------- ---------- ------------
Increase (decrease) in cash and cash equivalents ................................ 34,833 (1,741) (1,998)
Cash and cash equivalents at beginning of year (Note 2) ......................... 116,121 155,449 150,071
---------- ---------- ------------
Cash flows related to mergers (Note 2) .......................................... 4,495 (3,637) --
---------- ---------- ------------
Cash and cash equivalents at end of year ........................................ $ 155,449 $ 150,071 $ 148,073
========== ========== ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the year for:
Interest ....................................................................... $ 103,973 $ 97,024 $ 112,223
Income taxes ................................................................... 85,714 67,975 137,778
Non-cash investing activities:
The Company assumed liabilities of $84,820,000, $19,197,000 and $
1,153,825,000 during the years ended December 31, 1995, 1996 and 1997,
respectively, in connection with its acquisitions.
During the year ended December 31, 1996, the Company issued approximately
8,095,000 common shares as consideration for mergers (see Note 2).
During the year ended December 31, 1997, the Company issued 46,245,000 common
shares with a market value of $996,530,000 as consideration for acquisitions
accounted for as purchases.
Non-cash financing activities:
During 1995 and 1997, the Company effected two-for-one stock splits of its
common stock which were effected in the form of 100% stock dividends.
The Company received a tax benefit from the disqualifying disposition of
incentive stock options of $6,653,000, $23,767,000 and $66,579,000 for the
years ended December 31, 1995, 1996 and 1997, respectively.
During 1997, the holders of the Company's $115,000,000 in aggregate principal
amount of 5% Convertible Subordinated Debentures due 2001 surrendered the
Debentures for conversion into approximately 12,226,000 shares of the
Company's Common Stock.
See accompanying notes.
37
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
1. SIGNIFICANT ACCOUNTING POLICIES
The significant accounting policies followed by HEALTHSOUTH Corporation and
its subsidiaries ("the Company") are presented as an integral part of the
consolidated financial statements.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of HEALTHSOUTH
Corporation ("HEALTHSOUTH") and its wholly-owned subsidiaries, as well as its
majority ownership or controlling interest in limited partnerships and limited
liability companies. All significant intercompany accounts and transactions have
been eliminated in consolidation.
HEALTHSOUTH is engaged in the business of providing comprehensive
rehabilitative, clinical, diagnostic and surgical healthcare services on an
inpatient and outpatient basis, primarily in the United States.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the accompanying consolidated
financial statements and notes. Actual results could differ from those
estimates.
MARKETABLE SECURITIES
Marketable securities and debt securities are classified as
available-for-sale. Available-for-sale securities are carried at fair value,
with the unrealized gains and losses, if material, reported as a separate
component of stockholders' equity, net of tax. The cost of the specific security
sold method is used to compute gain or loss on the sale of securities. Interest
and dividends on securities classified as available-for-sale are included in
interest income. Marketable securities and debt securities held by the Company
have maturities of less than one year.
ACCOUNTS RECEIVABLE AND THIRD-PARTY REIMBURSEMENT ACTIVITIES
Receivables from patients, insurance companies and third-party contractual
insured accounts (Medicare and Medicaid) are based on payment agreements which
generally result in the Company's collecting an amount different from the
established rates. Net third-party settlement receivables included in accounts
receivable were $21,138,000 and $36,759,000 at December 31, 1996 and 1997,
respectively. Final determination of the settlement is subject to review by
appropriate authorities. The differences between original estimates made by the
Company and subsequent revisions (including final settlement) were not material
to the operations of the Company. Adequate allowances are provided for doubtful
accounts and contractual adjustments. Uncollectible accounts are written off
against the allowance for doubtful accounts after adequate collection efforts
are made. Net accounts receivable include only those amounts estimated by
management to be collectible.
The concentration of net accounts receivable from third-party contractual
payors and others, as a percentage of total net accounts receivable, was as
follows:
DECEMBER 31,
-------------------
1996 1997
-------- --------
Medicare ......... 26% 25%
Medicaid ......... 5 4
Other ............ 69 71
-- --
100% 100%
=== ===
38
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
INVENTORIES
Inventories are stated at the lower of cost or market using the specific
identification method.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost. Upon sale or retirement
of property, plant or equipment, the cost and related accumulated depreciation
are eliminated from the respective account and the resulting gain or loss is
included in the results of operations.
Interest cost incurred during the construction of a facility is
capitalized. The Company incurred interest of $108,382,000, $102,694,000 and
$113,995,000, of which $2,865,000, $3,943,000 and $2,491,000 was capitalized,
during 1995, 1996 and 1997, respectively.
Depreciation and amortization is computed using the straight-line method
over the estimated useful lives of the assets or the term of the lease, as
appropriate. The estimated useful life of buildings is 30-40 years and the
general range of useful lives for leasehold improvements, furniture, fixtures
and equipment is 10-15 years.
INTANGIBLE ASSETS
Cost in excess of net asset value of purchased facilities is amortized over
20 to 40 years using the straight-line method. Organization and partnership
formation costs are deferred and amortized on a straight-line basis over a
period of 36 months. Organization, partnership formation and start-up costs for
a project that is subsequently abandoned are charged to operations in that
period. Debt issue costs are amortized over the term of the debt. Noncompete
agreements are amortized using the straight-line method over the term of the
agreements.
Effective July 1, 1997, the Company began expensing amounts reflecting the
costs of implementing its clinical and administrative programs and protocols at
acquired facilities in the period in which such costs are incurred. Previously,
the Company had capitalized such costs and amortized them over 36 months. Such
costs at June 30, 1997 aggregated $64,643,000, net of accumulated amortization.
These capitalized costs will be amortized in accordance with the Company's
existing policy and will be fully amortized by June 2000.
Through June 30, 1997, the Company has assigned value to and capitalized
organization and partnership formation costs which have been incurred by the
Company or obtained by the Company in acquisitions accounted for as purchases.
Effective July 1, 1997, the Company no longer assigned value to organization and
partnership formation costs obtained in acquisitions accounted for as purchases
except to the extent that objective evidence exists that such costs will provide
future economic benefits to the Company after the acquisition. Such organization
and partnership formation costs at June 30, 1997 which were obtained by the
Company in purchase transactions aggregated $8,380,000, net of accumulated
amortization. Such costs at June 30 will be amortized in accordance with the
Company's existing policy and will be fully amortized by June 2000.
MINORITY INTERESTS
The equity of minority investors in limited partnerships and limited
liability companies of the Company is reported on the consolidated balance
sheets as minority interests. Minority interests reported in the consolidated
income statements reflect the respective interests in the income or loss of the
limited partnerships or limited liability companies attributable to the minority
investors (ranging from 1% to 50% at December 31, 1997), the effect of which is
removed from the results of operations of the Company.
39
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
REVENUES
Revenues include net patient service revenues and other operating revenues.
Other operating revenues include cafeteria revenue, gift shop revenue, rental
income, trainer/contract revenue, management and administrative fee revenue
(related to non-consolidated subsidiaries and affiliates) and transcriptionist
fees which are insignificant to total revenues. Net patient service revenues are
reported at the estimated net realizable amounts from patients, third-party
payors and others for services rendered, including estimated retroactive
adjustments under reimbursement agreements with third-party payors.
INCOME PER COMMON SHARE
In 1997, the Financial Accounting Standards Board issued Statement No. 128,
"Earnings per Share". Statement 128 replaced the calculation of primary and
diluted earnings per share with basic and diluted earnings per share. Unlike
primary earnings per share, basic earnings per share excludes any dilutive
effects of options, warrants and convertible securities. Diluted earnings per
share is similar to the previously reported fully diluted earnings per share.
All earnings per share amounts for all periods have been presented, and where
appropriate, restated to conform to the Statement 128 requirements.
The following table sets forth the computation of basic and diluted
earnings per share:
YEAR ENDED DECEMBER 31,
--------------------------------------------
1995 1996 1997
-------------- -------------- --------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Numerator:
Income from continuing operations before extraordinary item....... $ 108,468 $ 189,864 $ 330,608
---------- ---------- ----------
Numerator for basic earnings per share--income available to
common stockholders ............................................ 108,468 189,864 330,608
Effect of dilutive securities:
Elimination of interest and amortization on 5% Convertible
Subordinated Debentures due 2001, less the related effect of
the provision for income taxes ................................. 3,826 3,839 968
---------- ---------- ----------
Numerator for diluted earnings per share-income available to
common stockholders after assumed conversion ................... $ 112,294 $ 193,703 $ 331,576
========== ========== ==========
Denominator:
Denominator for basic earnings per share - weighted-average
shares ......................................................... 289,594 321,367 346,872
Effect of dilutive securities:
Net effect of dilutive stock options ........................... 18,198 15,440 15,617
Assumed conversion of 5% Convertible Subordinated De-
bentures due 2001 ............................................. 12,226 12,226 3,057
---------- ---------- ----------
Dilutive potential common shares ............................... 30,424 27,666 18,674
---------- ---------- ----------
Denominator of diluted earnings per share - adjusted
weighted-average shares and assumed conversions ............... 320,018 349,033 365,546
========== ========== ==========
Basic earnings per share .......................................... $ 0.37 $ 0.59 $ 0.95
========== ========== ==========
Diluted earnings per share ........................................ $ 0.35 $ 0.55 $ 0.91
========== ========== ==========
40
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
IMPAIRMENT OF ASSETS
The Company records impairment losses on long-lived assets used in
operations when events and circumstances indicate that the assets might be
impaired and the undiscounted cash flows estimated to be generated by those
assets are less than the carrying amounts of those assets.
With respect to the carrying value of the excess of cost over net asset
value of purchased facilities and other intangible assets, the Company
determines on a quarterly basis whether an impairment event has occurred by
considering factors such as the market value of the asset; a significant adverse
change in legal factors or in the business climate; adverse action by a
regulator; a history of operating or cash flow losses; or a projection of
continuing losses associated with an operating entity. The carrying value of
excess cost over net asset value of purchased facilities and other intangible
assets will be evaluated if the facts and circumstances suggest that it has been
impaired. If this evaluation indicates that the value of the asset will not be
recoverable, as determined based on the undiscounted cash flows of the entity
acquired over the remaining amortization period, an impairment loss is
calculated based on the excess of the carrying amount of the asset over the
asset's fair value.
SELF-INSURANCE
The Company is self-insured for professional liability and comprehensive
general liability. Liabilities for asserted and unasserted claims are accrued
based upon specific claims and incidents and the claims history of the Company.
The reserves for estimated liabilities for asserted and unasserted claims, which
are not material in relation to the Company's consolidated financial position at
December 31, 1996 and 1997, are included with accrued interest payable and other
liabilities in the accompanying consolidated balance sheets.
RECLASSIFICATIONS
Certain amounts in 1995 and 1996 financial statements have been
reclassified to conform with the 1997 presentation. Such reclassifications had
no effect on previously reported consolidated financial position and
consolidated net income.
FOREIGN CURRENCY TRANSLATION
The Company translates the assets and liabilities of its foreign
subsidiaries stated in local functional currencies to U.S. dollars at the rates
of exchange in effect at the end of the period. Revenues and expenses are
translated using rates of exchange in effect during the period. Gains and losses
from currency translation are included in stockholders' equity. Currency
transaction gains or losses are recognized in current operations and have not
been significant to the Company's operating results in any period.
41
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED )
2. MERGERS
Effective June 13, 1995, a wholly-owned subsidiary of the Company merged
with Surgical Health Corporation ("SHC") and in connection therewith the Company
issued 17,062,960 shares of its common stock in exchange for all of SHC's common
and preferred stock. Prior to the merger, SHC operated a network of 36
freestanding surgery centers and five mobile lithotripters in eleven states,
with an aggregate of 156 operating and procedure rooms. Costs and expenses of
approximately $4,588,000 incurred by the Company in connection with the SHC
merger have been recorded in operations during 1995 and reported as merger
expenses in the accompanying consolidated statements of income. Fees related to
legal, accounting and financial advisory services accounted for $3,400,000 of
the expense. Costs related to employee separations were approximately
$1,188,000. Also in connection with the SHC Merger, the Company recognized a
$14,606,000 extraordinary loss as a result of the retirement of the SHC Notes
(see Note 7). The extraordinary loss consisted primarily of the associated debt
discount plus premiums and costs associated with the retirement, and is reported
net of income tax benefits of $5,550,000.
Effective October 26, 1995, a wholly-owned subsidiary of the Company merged
with Sutter Surgery Centers, Inc. ("SSCI"), and in connection therewith, the
Company issued 3,552,002 shares of its common stock in exchange for all of
SSCI's outstanding common stock. Prior to the merger, SSCI operated a network of
12 freestanding surgery centers in three states, with an aggregate of 54
operating and procedure rooms. Costs and expenses of approximately $4,965,000,
primarily legal, accounting and financial advisory fees, incurred by the Company
in connection with the SSCI merger have been recorded in operations during 1995
and reported as merger expenses in the accompanying consolidated statements of
income.
Effective January 17, 1996, a wholly-owned subsidiary of the Company merged
with Surgical Care Affiliates, Inc. ("SCA"), and in connection therewith the
Company issued 91,856,678 shares of its common stock in exchange for all of
SCA's outstanding common stock. Prior to the merger, SCA operated 67 surgery
centers in 24 states. Costs and expenses of approximately $19,727,000, primarily
legal, accounting and financial advisory fees, incurred by the Company in
connection with the SCA merger have been recorded in operations during 1996 and
recorded as merger expenses in the accompanying consolidated statements of
income.
Effective March 14, 1996, a wholly-owned subsidiary of the Company merged
with Advantage Health Corporation ("Advantage Health"), and in connection
therewith the Company issued 18,203,978 shares of its common stock in exchange
for all of Advantage Health's outstanding common stock. Prior to the merger,
Advantage Health operated a network of 136 sites of service, including four
freestanding rehabilitation hospitals, one freestanding multi-use hospital, one
nursing home, 68 outpatient rehabilitation facilities, 14 inpatient managed
rehabilitation units, 24 rehabilitation services management contracts and six
managed subacute rehabilitation units. Costs and expenses of approximately
$9,212,000, primarily legal, accounting and financial advisory fees, incurred by
the Company in connection with the Advantage Health merger have been recorded in
operations during 1996 and reported as merger expenses in the accompanying
consolidated statements of income.
Effective March 3, 1997, a wholly-owned subsidiary of the Company merged
with Health Images, Inc. ("Health Images"), and in connection therewith the
Company issued 10,343,470 shares of its common stock in exchange for all of
Health Images' outstanding common stock. Prior to the merger, Health Images
operated 49 freestanding diagnostic imaging centers in 13 states and six in the
United Kingdom. Costs and expenses of approximately $15,875,000, primarily
legal, accounting and financial advisory fees, incurred by the Company in
connection with the Health Images merger have been recorded in operations during
1997 and reported as merger expenses in the accompanying consolidated statements
of income.
42
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED
2. MERGERS - (CONTINUED)
The mergers of the Company with SHC, SSCI, SCA, Advantage Health and Health
Images were accounted for as poolings of interests and, accordingly, the
Company's consolidated financial statements have been restated to include the
results of the acquired companies for all periods presented. There were no
material transactions between the Company, SHC, SSCI, SCA, Advantage Health and
Health Images prior to the mergers. The effects of conforming the accounting
policies of the combined companies are not material.
Combined and separate results of the Company and its 1997 merger with
Health Images are as follows (in thousands):
HEALTH
HEALTHSOUTH IMAGES COMBINED
------------- ------------ --------------
Year ended December 31, 1995
Revenues .................. $ 2,003,146 $ 115,535 $ 2,118,681
Net income ................ 92,521 5,729 98,250
Year ended December 31, 1996
Revenues .................. $ 2,436,537 $ 131,618 $ 2,568,155
Net income (loss) ......... 220,818 (30,954) 189,864
Year ended December 31, 1997
Revenues .................. $ 2,995,782 $ 21,487 $ 3,017,269
Net income ................ 327,206 3,402 330,608
Prior to its merger with the Company, Advantage Health reported on a fiscal
year ending on August 31. Accordingly, the historical financial statements of
Advantage Health have been recast to a November 30 fiscal year end to more
closely conform to the Company's calendar fiscal year end. The restated
financial statements for all periods prior to and including December 31, 1995
are based on a combination of the Company's results for its December 31 fiscal
year and Advantage Health's results for its recast November 30 fiscal year.
Beginning January 1, 1996, all facilities acquired in the Advantage Health
merger adopted a December 31 fiscal year end; accordingly, all consolidated
financial statements for periods after December 31, 1995 are based on a
consolidation of all of the Company's subsidiaries on a December 31 year end.
Advantage Health's historical results of operations for the one month ended
December 31, 1995 are not included in the Company's consolidated statements of
income or cash flows. An adjustment has been made to stockholders' equity as of
January 1, 1996 to adjust for the effect of excluding Advantage Health's results
of operations for the one month ended December 31, 1995. The following is a
summary of Advantage Health's results of operations and cash flows for the one
month ended December 31, 1995 (in thousands):
Statement of Income Data:
Revenues .............................................. $16,111
Operating unit expenses ............................... 14,394
Corporate general and administrative expenses ......... 1,499
Provision for doubtful accounts ....................... 1,013
Depreciation and amortization ......................... 283
Loss on impairment of assets .......................... 21,111
Interest expense ...................................... 288
Interest income ....................................... (16)
-------
38,572
-------
43
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
2. MERGERS - (CONTINUED)
Loss before income taxes and minority interests ......... (22,461)
Benefit for income taxes ................................ (4,959)
Minority interests ...................................... 136
-------
Net loss ................................................ $ (17,638)
=========
Statement of Cash Flow Data:
Net cash used in operating activities ................... $ (2,971)
Net cash provided by investing activities ............... 105
Net cash used in financing activities ................... (771)
---------
Net decrease in cash .................................... $ (3,637)
=========
In December 1995, Advantage Health recorded an asset impairment charge of
approximately $21,111,000 relating to goodwill and tangible assets identifiable
with one inpatient rehabilitation hospital, one subacute facility and 32
outpatient rehabilitation centers, all acquired by the Company in the Advantage
Health merger. The Company intends to operate these facilities on an ongoing
basis.
The Company has historically assessed recoverability of goodwill and other
long-lived assets using undiscounted cash flows estimated to be received over
the useful lives of the related assets. In December 1995, certain events
occurred which significantly impacted the Company's estimates of future cash
flows to be received from the facilities described above. Those events primarily
related to a decline in operating results combined with a deterioration in the
reimbursement environment at these facilities. As a result of these events, the
Company revised its estimates of undiscounted cash flows to be received over the
remaining estimated useful lives of these facilities and determined that
goodwill and other long-lived assets (primarily property and equipment) had been
impaired. The Company developed its best estimates of future operating cash
flows at these locations, considering future requirements for capital
expenditures as well as the impact of inflation. The projections of cash flows
also took into account estimates of significant one-time expenses as well as
estimates of additional revenues and resulting income from future marketing
efforts in the respective locations. The amount of the impairment charge was
determined by discounting the estimates of future cash flows, using an estimated
8.5% incremental borrowing rate, which management believes is commensurate with
the risks involved. The resulting net present value of future cash flows was
then compared to the historical net book value of goodwill and other long-lived
assets at each operating location, which resulted in an impairment loss relative
to these centers of $21,111,000.
During 1996, wholly-owned subsidiaries of the Company merged with
Professional Sports Care Management, Inc. ("PSCM"), Fort Sutter Surgery Center,
Inc. ("FSSCI") and ReadiCare, Inc. ("ReadiCare"). In connection with these
mergers the Company issued an aggregate of 8,094,598 shares of its common stock.
Costs and expenses of approximately $12,576,000, primarily legal, accounting and
financial advisory fees, incurred by the Company in connection with the mergers
have been recorded in operations during 1996 and reported as merger expenses in
the accompanying consolidated statements of income.
The PSCM and ReadiCare mergers were accounted for as poolings of interests.
However, due to the immateriality of these mergers, the Company's historical
financial statements for all periods prior to the quarters in which the
respective mergers were completed have not been restated. Instead, stockholders'
equity has been increased by $43,230,000 to reflect the effects of the PSCM
merger and $15,431,000 to reflect the effects of the ReadiCare merger. The
results of operations of PSCM and ReadiCare are included in the accompanying
financial statements from the date of acquisition forward. In addition, the
FSSCI merger was a stock-for-stock acquisition. Stockholders' equity has been
increased by $8,908,000 to reflect the effects of the merger.
44
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED )
3. CASH, CASH EQUIVALENTS AND OTHER MARKETABLE SECURITIES
Cash, cash equivalents and other marketable securities consisted of the
following:
DECEMBER 31,
---------------------------
1996 1997
------------ ------------
(IN THOUSANDS)
Cash .................................................... $ 140,278 $ 135,399
Cash equivalents ........................................ 9,793 12,674
--------- ---------
Total cash and cash equivalents ....................... 150,071 148,073
Certificates of deposit ................................. 1,765 1,256
Municipal put bonds ..................................... 495 1,570
Municipal put bond mutual funds ......................... 500 500
Collateralized mortgage obligations ..................... 1,000 1,000
--------- ---------
Total other marketable securities ....................... 3,760 4,326
--------- ---------
Total cash, cash equivalents and other marketable
securities (approximates market value) ................ $ 153,831 $ 152,399
========= =========
For purposes of the consolidated balance sheets and statements of cash
flows, marketable securities purchased with an original maturity of ninety days
or less are considered cash equivalents.
4. OTHER ASSETS
Other assets consisted of the following:
DECEMBER 31,
-------------------------
1996 1997
----------- -----------
(IN THOUSANDS)
Notes receivable ............................... $ 38,359 $ 70,655
Investment in Caretenders Health Corp. ......... 7,370 7,809
Prepaid long-term lease ........................ 8,397 9,190
Other equity investments ....................... 15,362 37,027
Real estate investments ........................ 10,020 21,911
Trusteed funds ................................. 1,879 921
Other .......................................... 2,629 14,798
-------- ---------
$ 84,016 $ 162,311
======== =========
The Company has a 19% ownership interest in Caretenders Health Corp.
("Caretenders") which is being accounted for using the equity method of
accounting. The investment was initially valued at $7,250,000. The Company's
equity in earnings of Caretenders for the years ended December 31, 1995, 1996
and 1997 was not material to the Company's consolidated results of operations.
It was not practicable to estimate the fair value of the Company's various
other equity investments (involved in operations similar to those of the
Company) because of the lack of a quoted market price and the inability to
estimate fair value without incurring excessive costs. The carrying amount at
December 31, 1997 represents the original cost of the investments, which
management believes is not impaired.
45
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED )
5. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consisted of the following:
DECEMBER 31,
----------------------------
1996 1997
------------ -------------
(IN THOUSANDS)
Land ................................................................. $ 93,631 $ 112,944
Buildings ............................................................ 844,775 1,030,849
Leasehold improvements ............................................... 112,149 186,003
Furniture, fixtures and equipment .................................... 801,443 1,044,374
Construction-in-progress ............................................. 73,815 32,426
---------- ----------
1,925,813 2,406,596
Less accumulated depreciation and amortization ....................... 460,980 555,831
---------- ----------
$1,464,833 $1,850,765
========== ==========
6. INTANGIBLE ASSETS
Intangible assets consisted of the following:
DECEMBER 31,
-------------------------------
1996 1997
-------------- --------------
(IN THOUSANDS)
Organizational, partnership formation and start-up
costs (see Note 1) ................................................ $ 238,126 $ 255,810
Debt issue costs .................................................... 34,905 33,114
Noncompete agreements ............................................... 86,566 121,581
Cost in excess of net asset value of purchased
facilities ........................................................ 947,104 2,103,085
----------- -----------
1,306,701 2,513,590
Less accumulated amortization ....................................... 212,280 270,218
----------- -----------
$ 1,094,421 $ 2,243,372
=========== ===========
7. LONG-TERM DEBT
Long-term debt consisted of the following:
DECEMBER 31,
--------------------------
1996 1997
----------- --------------
(IN THOUSANDS)
Notes and bonds payable:
Advances under a $1,250,000,000 credit agreement with banks.......... $ 995,000 $ 1,175,000
9.5% Senior Subordinated Notes due 2001 ............................. 250,000 250,000
5.0% Convertible Subordinated Debentures due 2001 ................... 115,000 --
Notes payable to banks and various other notes payable, at interest
rates from 5.5% to 14.9% .......................................... 151,384 114,899
Hospital revenue bonds payable ...................................... 22,503 14,836
Noncompete agreements payable with payments due at intervals
ranging through December 2004 ..................................... 26,256 47,089
---------- -----------
1,560,143 1,601,824
Less amounts due within one year .................................... 47,089 46,489
---------- -----------
$1,513,054 $ 1,555,335
========== ===========
46
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
7. LONG-TERM DEBT - (CONTINUED)
The fair value of total long-term debt approximates book value at December
31, 1996 and 1997. The fair values of the Company's long-term debt are estimated
using discounted cash flow analysis, based on the Company's current incremental
borrowing rates for similar types of borrowing arrangements.
During 1995, the Company entered into a Credit Agreement with NationsBank,
N.A. ("NationsBank") and other participating banks (the "1995 Credit Agreement")
which consisted of a $1,000,000,000 revolving credit facility. On April 18,
1996, the Company amended and restated the 1995 Credit Agreement to increase the
size of the revolving credit facility to $1,250,000,000 (the "1996 Credit
Agreement"). Interest is paid based on LIBOR plus a predetermined margin, a base
rate, or competitively bid rates from the participating banks. The Company is
required to pay a fee on the unused portion of the revolving credit facility
ranging from 0.08% to 0.25%, depending on certain defined ratios. The principal
amount is payable in full on March 31, 2001 (see also Note 14). The Company
provided a negative pledge on all assets for the 1996 Credit Agreement and the
lenders released the first priority security interest in all shares of stock of
the Company's subsidiaries and rights and interests in the Company's controlled
partnerships which had been granted under the 1995 Credit Agreement. At December
31, 1997, the effective interest rate associated with the 1996 Credit Agreement
was approximately 6.13%.
In connection with the Horizon/CMS acquisition in 1997 (see Note 9), the
Company entered into a Bridge Credit Agreement with NationsBank and other banks
(the "Bridge Credit Agreement") which provided for a $1,250,000,000 Senior
Bridge Loan Facility on substantially the same terms as the 1996 Credit
Agreement. At the time of the closing of Horizon/CMS acquisition, approximately
$1,000,000,000 was drawn under the Senior Bridge Credit Facility, primarily to
repay certain existing indebtedness of Horizon/CMS. The Company repaid all
amounts drawn under the Bridge Credit Agreement upon the closing of the sale of
the Horizon/CMS long-term care assets to Integrated Health Services, Inc. on
December 31, 1997 (see Note 9), thereby permanently reducing the amount
available thereunder to $500,000,000. Any amounts drawn under the Bridge Credit
Agreement are payable in full on October 31, 1998.
On March 24, 1994, the Company issued $250,000,000 principal amount of 9.5%
Senior Subordinated Notes due 2001 (the "Notes"). Interest is payable on April 1
and October 1. The Notes are senior subordinated obligations of the Company and
as such are subordinated to all existing and future senior indebtedness of the
Company, and also are effectively subordinated to all existing and future
liabilities of the Company's subsidiaries and partnerships. The Notes rank
senior to all subordinated indebtedness of the Company. The Notes mature on
April 1, 2001.
Also on March 24, 1994, the Company issued $100,000,000 principal amount of
5% Convertible Subordinated Debentures due 2001 (the "Convertible Debentures").
An additional $15,000,000 of Convertible Debentures was issued in April 1994 to
cover underwriters' over allotments. Interest is payable on April 1 and October
1. The Convertible Debentures were convertible into Common Stock of the Company
at the option of the holder at a conversion price of $9.406 per share, subject
to adjustment in the occurrence of certain events. Substantially all of the
Convertible Debentures were converted into approximately 12,226,000 shares of
the Company's Common Stock on or prior to April 1, 1997.
In June 1994, SHC (see Note 2) issued $75,000,000 principal amount of 11.5%
Senior Subordinated Notes due July 15, 2004 (the "SHC Notes"). The proceeds of
the SHC Notes were used to pay down indebtedness outstanding under other
existing credit facilities. During 1995, the Company purchased $67,500,000 of
the $75,000,000 outstanding principal amount of the SHC Notes in a tender offer
at 115% of the face value of the Notes, and the remaining $7,500,000 balance was
purchased on the open market, using proceeds from the Company's other long-term
credit facilities. The loss on retirement of the SHC Notes totaled approximately
$14,606,000. The loss consists of the premium, write-off of unamortized bond
issue costs and other fees and is reported as an extraordinary loss on early
extinguishment of debt in the accompanying 1995 consolidated statement of income
(see Note 2).
47
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
7. LONG-TERM DEBT - (CONTINUED)
Principal maturities of long-term debt are as follows:
YEAR ENDING DECEMBER 31, (IN THOUSANDS)
- - --------------------------------- ---------------
1998 .......................... $ 46,489
1999 .......................... 378,564
2000 .......................... 20,953
2001 .......................... 1,088,656
2002 .......................... 28,426
After 2002 .................... 38,736
----------
$1,601,824
==========
8. STOCK OPTIONS
The Company has various stockholder-approved stock option plans which
provide for the grant of options to directors, officers and other key employees
to purchase Common Stock at 100% of the fair market value as of the date of
grant. The Audit and Compensation Committee of the Board of Directors
administers the stock option plans. Options may be granted as incentive stock
options or as non-qualified stock options. Incentive stock options vest 25%
annually, commencing upon completion of one year of employment subsequent to the
date of grant. Certain of the non-qualified stock options are not subject to any
vesting provisions, while others vest on the same schedule as the incentive
stock options. The options expire at dates ranging from five to ten years from
the date of grant.
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"). SFAS 123 is effective for fiscal years beginning
after December 15, 1995 and allows for the option of continuing to account for
stock-based compensation under Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25"), and related
interpretations, or selecting the fair value method of expense recognition as
described in SFAS 123. The Company has elected to follow APB 25 in accounting
for its employee stock options. The Company follows SFAS 123 in accounting for
its non-employee stock options. The total compensation expense associated with
non-employee stock options granted in 1996 and 1997 was not material.
Pro forma information regarding net income and earnings per share is
required by SFAS 123, and has been determined as if the Company had accounted
for its employee stock options under the fair value method of SFAS 123. The fair
value for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions for 1995,
1996 and 1997, respectively: risk-free interest rates of 5.87%, 6.01% and 6.12%;
dividend yield of 0%; volatility factors of the expected market price of the
Company's common stock of .36, .37 and .37; and a weighted-average expected life
of the options of 4.3 years for 1995 and 1996, and 6.2 years for 1997.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
48
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
8. STOCK OPTIONS - (CONTINUED)
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information follows:
YEAR ENDED DECEMBER 31,
------------------------------
1995 1996 1997
------------- -------------- --------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Pro forma net income ......... $ 80,059 $ 162,463 $ 290,517
Pro forma earnings per share:
Basic ....................... 0.28 0.51 0.84
Diluted ..................... 0.26 0.48 0.80
The effect of compensation expense from stock options on 1995 pro forma net
income reflects only the vesting of 1995 awards. The 1996 pro forma net income
reflects the second year of vesting of the 1995 awards and the first year of
vesting of 1996 awards. The 1997 pro forma net income reflects the third year of
vesting of the 1995 awards, the second year of vesting the 1996 awards and the
first year of vesting of the 1997 awards. Not until 1998 will the full effect of
recognizing compensation expense for stock options be representative of the
possible effects on pro forma net income for future years.
A summary of the Company's stock option activity and related information
for the years ended December 31 follows:
1995 1996 1997
------------------------ ------------------------ -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
OPTIONS EXERCISE OPTIONS EXERCISE OPTIONS EXERCISE
(000) PRICE (000) PRICE (000) PRICE
----------- ---------- ----------- ---------- ----------- ---------
Options outstanding January 1 ................ 30,150 $ 4 35,068 $ 5 32,806 $ 7
Granted ..................................... 7,639 9 4,769 17 10,485 22
Exercised ................................... (2,237) 4 (6,709) 5 (9,604) 7
Canceled .................................... (484) 5 (322) 6 (995) 20
------ ------ ------
Options outstanding at December 31 ........... 35,068 $ 5 32,806 $ 7 32,692 $12
Options exercisable at December 31 ........... 26,293 $ 5 27,678 $ 6 28,125 $11
Weighted average fair value of options granted
during the year ............................. $ 3.81 $ 7.13 $ 10.59
The following table summarizes information about stock options outstanding
at December 31, 1997.
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------- -------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
DECEMBER 31, REMAINING EXCERCISE DECEMBER 31, EXCERCISE
1997 LIFE PRICE 1997 PRICE
---------------- ----------- ----------- --------------- ----------
(IN THOUSANDS) (YEARS) (IN THOUSANDS)
Under $8.40.............. 17,933 5.44 $ 5.29 16,719 $ 5.07
$8.40 -- $20.15.......... 8,580 8.04 16.64 7,238 16.69
$20.16 and above......... 6,179 8.89 23.39 4,168 23.29
49
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED )
9. ACQUISITIONS
1995 ACQUISITIONS
Effective April 1, 1995, the Company acquired the rehabilitation hospitals
division of NovaCare, Inc. ("NovaCare"), consisting of 11 rehabilitation
hospitals, 12 other facilities and certificates of need to build two other
facilities. The total purchase price for the NovaCare facilities was
approximately $235,000,000 in cash. The cost in excess of net asset value was
approximately $173,000,000. Of this excess, approximately $129,000,000 was
allocated to leasehold value and the remaining $44,000,000 to cost in excess of
net asset value of purchased facilities. As part of the acquisition, the Company
acquired approximately $4,790,000 in deferred tax assets. The Company also
provided approximately $10,000,000 for the write-down of certain assets to net
realizable value as the result of a planned facility consolidation in a market
where the Company's existing services overlapped with those of an acquired
facility. The planned employee separations and facility consolidation were
completed by the end of 1995.
Effective December 1, 1995, the Company acquired Caremark Orthopedic
Services Inc. ("Caremark"). At the time of the acquisition, Caremark owned and
operated approximately 120 outpatient rehabilitation centers in 13 states. The
total purchase price was approximately $127,500,000 in cash.
Also at various dates during 1995, the Company acquired 70 separate
outpatient rehabilitation operations located throughout the United States, three
physical therapy practices, one home health agency, one nursing home, 75
licensed subacute beds, five outpatient surgery centers and 16 outpatient
diagnostic imaging operations. The combined purchase prices of these
acquisitions was approximately $178,393,000. The form of consideration
constituting the combined purchase prices was approximately $152,833,000 in cash
and $25,560,000 in notes payable.
In connection with these transactions, the Company entered into noncompete
agreements with former owners totaling $16,222,000. In general, these noncompete
agreements are payable in monthly or quarterly installments over periods ranging
from five to ten years.
The fair value of the total net assets relating to the 1995 acquisitions
described above, excluding the NovaCare acquisition, was approximately
$81,455,000. The total cost of these acquisitions exceeded the fair value of the
net assets acquired by approximately $224,438,000. Based on the evaluation of
each acquisition utilizing the criteria described above, the Company determined
that the cost in excess of net asset value of purchased facilities relating to
the 1995 acquisitions should be amortized over periods ranging from 25 to 40
years on a straight-line basis. No other identifiable intangible assets were
recorded in the acquisitions described above.
All of the 1995 acquisitions described above were accounted for as
purchases and, accordingly, the results of operations of the acquired businesses
are included in the accompanying consolidated financial statements from their
respective dates of acquisition. With the exception of the NovaCare
rehabilitation hospitals acquisition, none of the above acquisitions were
material individually or in the aggregate.
1996 ACQUISITIONS
At various dates during 1996, the Company acquired 80 outpatient
rehabilitation facilities, three outpatient surgery centers, one inpatient
rehabilitation hospital and one diagnostic imaging center. The acquired
operations are located throughout the United States. The total purchase price of
the acquired operations was approximately $104,321,000. The form of
consideration constituting the total purchase prices was approximately
$92,319,000 in cash and $12,002,000 in notes payable.
In connection with these transactions, the Company entered into noncompete
agreements with former owners totaling $11,900,000. In general, these noncompete
agreements are payable in monthly or quarterly installments over periods ranging
from five to ten years.
50
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
9. ACQUISITIONS - (CONTINUED)
The fair value of the total net assets relating to the 1996 acquisitions
described above was approximately $40,259,000. The total cost of the 1996
acquisitions exceeded the fair value of the net assets acquired by approximately
$64,062,000. Based on the evaluation of each acquisition utilizing the criteria
described above, the Company determined that the cost in excess of net asset
value of purchased facilities relating to the 1996 acquisitions should be
amortized over periods ranging from 25 to 40 years on a straight-line basis. No
other identifiable intangible assets were recorded in the acquisitions described
above.
All of the 1996 acquisitions described above were accounted for as
purchases and, accordingly, the results of operations of the acquired businesses
(not material individually or in the aggregate) are included in the accompanying
consolidated financial statements from their respective dates of acquisition.
1997 ACQUISITIONS
Effective October 29, 1997, the Company acquired Horizon/CMS Healthcare
Corporation ("Horizon/CMS") in a stock-for-stock merger in which the
stockholders of Horizon/CMS received 0.84338 of a share of the Company's common
stock per share of Horizon/CMS common stock. At the time of the acquisition,
Horizon/CMS operated 30 inpatient rehabilitation hospitals and approximately 275
outpatient rehabilitation centers, among other strategic businesses, as well as
certain long-term care businesses. In the transaction, the Company issued
approximately 45,261,000 shares of its common stock, valued at $975,824,000,
exchanged options to acquire 3,313,000 shares of common stock, valued at
$23,191,000, and assumed approximately $740,000,000 in long-term debt.
Effective December 31, 1997, the Company sold certain non-strategic assets
of Horizon/CMS to Integrated Health Services, Inc. ("IHS"). Under the terms of
the sale, the Company sold 139 long-term care facilities, 12 specialty
hospitals, 35 institutional pharmacy locations and over 1,000 rehabilitation
therapy contracts with long-term care facilities. The transaction was valued at
approximately $1,224,000,000, including the payment by IHS of approximately
$1,130,000,000 in cash (net of certain adjustments) and the assumption by IHS of
approximately $94,000,000 in debt.
In accordance with Emerging Issues Task Force Issue 87-11, "Allocation of
Purchase Price to Assets to be Sold" ("EITF 87-11"), the results of operations
of the non-strategic assets sold to IHS from the acquisition date to December
31, 1997, including a net loss of $7,376,000, have been excluded from the
Company's results of operations in the accompanying financial statements. The
gain on the disposition of the assets sold to IHS, totaling $10,996,000, has
been accounted for as an adjustment to the original Horizon/CMS purchase price
allocation.
The following table summarizes the unaudited pro forma combined results of
operations for the Company and Horizon/CMS, assuming the Horizon/CMS acquisition
and subsequent sale of non-strategic assets to IHS had occurred at the beginning
of each of the following periods:
YEAR ENDED DECEMBER 31,
-----------------------------------
1996 1997
---------------- ----------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Revenues .................................... $ 3,285,096 $ 3,615,123
Net income .................................. 199,773 292,651
Net income per common share -- assuming dilu-
tion ....................................... 0.52 0.72
The Company also intends to sell the physician and allied health
professional placement service business it acquired in the Horizon/CMS
acquisition (the "Physician Placement Services Subsidiary"). This sale is
currently expected to be completed by mid-1998. Accordingly, a portion of the
Horizon/CMS
51
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
9. ACQUISITIONS - (CONTINUED)
purchase price has been allocated to the Physician Placement Services Subsidiary
and this amount is classified as assets held for sale in the accompanying
December 31, 1997 consolidated balance sheet. The allocated amount of
$60,400,000 represents the net assets of the Physician Placement Services
Subsidiary, plus anticipated cash flows from (a) operations of the Physician
Placement Services Subsidiary during the holding period and (b) proceeds from
the sale of the Physician Placement Services Subsidiary. The results of
operations of the Physician Placement Services Subsidiary from the acquisition
date to December 31, 1997, including net income of $1,230,000, have been
excluded from the Company's results of operations in the accompanying financial
statement in accordance with EITF 87-11.
Effective September 30, 1997, the Company acquired ASC Network Corporation
("ASC") in a cash-for-stock merger. At the time of the acquisition, ASC operated
29 outpatient surgery centers in eight states. The total purchase price for ASC
was approximately $130,827,000 in cash, plus the assumption of approximately
$61,000,000 in long-term debt.
Effective October 23, 1997, the Company acquired National Imaging
Affiliates, Inc. ("NIA") in a stock-for-stock merger. At the time of the
acquisition, NIA operated eight diagnostic imaging centers in six states and a
radiology management services business. In conjunction with the transaction, NIA
spun off its radiology management services business, which continues to be owned
by the former NIA stockholders. In the transaction, the Company issued
approximately 984,000 shares of its common stock, valued at $20,706,000, in
exchange for all of the outstanding shares of NIA.
At various dates and in separate transactions throughout 1997, the Company
acquired 135 outpatient rehabilitation facilities, four outpatient surgery
centers and eight diagnostic imaging facilities located throughout the United
States. The Company also acquired an inpatient rehabilitation hospital located
in Australia. The total purchase price of the acquired operations was
approximately $136,819,000. The form of consideration constituting the total
purchase prices was $134,519,000 in cash and $2,300,000 in notes payable.
In connection with these transactions, the Company entered into noncompete
agreements with former owners totaling $29,275,000. In general, these noncompete
agreements are payable in monthly or quarterly installments over periods ranging
from five to ten years.
The fair value of the total net assets relating to the 1997 acquisitions
described above was approximately $233,469,000. The total cost of the 1997
acquisitions exceeded the fair value of the net assets acquired by approximately
$1,053,898,000. Based on the evaluation of each acquisition utilizing the
criteria described above, the Company determined that the cost in excess of net
asset value of purchased facilities relating to the 1997 acquisitions should be
amortized over a period of twenty-five to forty years on a straight-line basis.
At December 31, 1997 the purchase price allocation associated with the 1997
acquisitions is preliminary in nature. During 1998 the Company will make
adjustments, if necessary, to the purchase price allocation based on revisions
to the fair value of the assets acquired.
All of the 1997 acquisitions described above were accounted for as
purchases and, accordingly, the results of operations of the acquired businesses
are included in the accompanying consolidated financial statements from their
respective dates of acquisition. With the exception of the operations acquired
in the Horizon/CMS acquisition (for which pro forma data has been disclosed
above), the results of operations of the acquired businesses were not material
individually or in the aggregate to the Company's consolidated results of
operations and financial position.
10. INCOME TAXES
HEALTHSOUTH and its subsidiaries file a consolidated federal income tax
return. The limited partnerships and limited liability companies file separate
income tax returns. HEALTHSOUTH's allocable portion of each partnership's income
or loss is included in the taxable income of the Company. The remaining income
or loss of each partnership and limited liability company is allocated to the
limited partners.
52
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
10. INCOME TAXES - (CONTINUED)
The Company utilizes the liability method of accounting for income taxes,
as required by Financial Accounting Standards Board (FASB) Statement No. 109,
"Accounting for Income Taxes". Deferred income taxes reflect the net effects of
temporary differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes.
Significant components of the Company's deferred tax assets and liabilities as
of December 31, 1996 are as follows:
CURRENT NONCURRENT TOTAL
--------- ------------ -------------
(IN THOUSANDS)
Deferred tax assets:
Acquired net operating loss .................. $ -- $ 5,283 $ 5,283
Development costs ............................ -- 849 849
Accruals ..................................... 6,634 -- 6,634
Allowance for bad debts ...................... 34,700 -- 34,700
Other ........................................ 2,433 2,597 5,030
------- --------- ---------
Total deferred tax assets ..................... 43,767 8,729 52,496
Deferred tax liabilities:
Depreciation and amortization ................ -- 30,441 30,441
Purchase price accounting .................... -- 4,802 4,802
Non-accrual experience method ................ 17,694 -- 17,694
Contracts .................................... 3,849 -- 3,849
Capitalized costs ............................ 5,013 22,672 27,685
Other ........................................ 1,973 2,604 4,577
------- --------- ---------
Total deferred tax liabilities ................ 28,529 60,519 89,048
------- --------- ---------
Net deferred tax assets (liabilities) ......... $15,238 $ (51,790) $ (36,552)
======= ========= =========
At December 31, 1997, the Company has net operating loss carryforwards of
approximately $28,755,000 for income tax purposes expiring through the year
2017. Those carryforwards resulted from the Company's acquisitions of Diagnostic
Health Corporation, Renaissance Rehabilitation Center, Inc., Rebound, Inc.,
Health Images and Horizon/CMS.
Significant components of the Company's deferred tax assets and liabilities
as of December 31, 1997 are as follows:
CURRENT NONCURRENT TOTAL
------------- ------------ --------------
(IN THOUSANDS)
Deferred tax assets:
Accruals .............................. $ 19,564 $ -- $ 19,564
Net operating loss .................... -- 11,039 11,039
Other ................................. -- 2,834 2,834
--------- --------- ----------
Total deferred tax assets .............. 19,564 13,873 33,437
Deferred tax liabilities:
Depreciation and amortization ......... -- 90,486 90,486
Capitalized costs ..................... 9,038 -- 9,038
Allowance for bad debts ............... 41,023 -- 41,023
Other ................................. 3,622 -- 3,622
--------- --------- ----------
Total deferred tax liabilities ......... 53,683 90,486 144,169
--------- --------- ----------
Net deferred tax liabilities ........... $ (34,119) $ (76,613) $ (110,732)
========= ========= ==========
53
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
10. INCOME TAXES - (CONTINUED)
The provision for income taxes was as follows:
YEAR ENDED DECEMBER 31,
--------------------------------------
1995 1996 1997
---------- ----------- -----------
(IN THOUSANDS)
Currently payable:
Federal ......... $70,629 $116,023 $166,884
State ........... 9,586 13,598 26,749
------- -------- --------
80,215 129,621 193,633
Deferred expense:
Federal ......... 367 13,281 10,790
State ........... 29 1,027 1,730
------- -------- --------
396 14,308 12,520
------- -------- --------
$80,611 $143,929 $206,153
======= ======== ========
As part of the acquisitions of Horizon/CMS, ASC and NIA, the Company
acquired approximately $6,729,000 in deferred tax liabilities.
The Company made a retroactive election under Internal Revenue Code Section
475 which allowed it to mark certain assets to fair market value, resulting in
refunded income taxes and an increase to deferred tax liabilities of
approximately $54,931,000.
The difference between the provision for income taxes and the amount
computed by applying the statutory federal income tax rate to income before
taxes was as follows:
YEAR ENDED DECEMBER 31,
----------------------------------------
1995 1996 1997
------------ ----------- -----------
(IN THOUSANDS)
Federal taxes at statutory rates ................... $ 78,322 $ 134,457 $ 210,572
Add (deduct):
State income taxes, net of federal tax benefit..... 6,250 9,506 18,511
Minority interests ................................ (15,102) (17,303) (22,705)
Disposal/impairment charges ....................... 9,955 6,563 1,576
Other ............................................. 1,186 10,706 (1,801)
--------- --------- ---------
$ 80,611 $ 143,929 $ 206,153
========= ========= =========
11. COMMITMENTS AND CONTINGENCIES
The Company is a party to legal proceedings incidental to its business. In
the opinion of management, any ultimate liability with respect to these actions
will not materially affect the consolidated financial position or results of
operations of the Company.
Beginning December 1, 1993, the Company became self-insured for
professional liability and comprehensive general liability. The Company
purchased coverage for all claims incurred prior to December 1, 1993. In
addition, the Company purchased underlying insurance which would cover all
claims once established limits have been exceeded. It is the opinion of
management that at December 31, 1997 the Company has adequate reserves to cover
losses on asserted and unasserted claims.
Prior to consummation of the SCA and Advantage Health mergers (see Note 2),
these companies carried professional malpractice and general liability
insurance. The policies were carried on a claims
54
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
11. COMMITMENTS AND CONTINGENCIES - (CONTINUED)
made basis. The companies had policies in place to track and monitor incidents
of significance. Management is unaware of any claims that may result in a loss
in excess of amounts covered by existing insurance.
In connection with the Horizon/CMS acquisition, the Company assumed
Horizon/CMS's open professional and general liability claims. The Company has
entered into an agreement with an insurance carrier to assume responsibility for
the majority of open claims. Under this agreement, a "risk transfer" is being
conducted which will convert Horizon/CMS's self-insured claims to insured
liabilities consistent with the terms of the underlying insurance policy.
Horizon/CMS is currently a party, or is subject, to certain litigation
matters and disputes. The Company itself is, in general, not a party to such
litigation. These matters include actions on investigations initiated by the
Securities and Exchange Commission, New York Stock Exchange, various federal and
state regulatory agencies, stockholders of Horizon/CMS and other parties. Both
Horizon/CMS and the Company are working to resolve these matters and cooperating
fully with the various regulatory agencies involved. As of December 31, 1997, it
was not possible for the Company to predict the ultimate outcome or effect of
these matters. In management's opinion, the ultimate resolution of these matters
will not have a material effect on the Company's financial position.
At December 31, 1997, anticipated capital expenditures for the next twelve
months are $400,000,000. This amount includes expenditures for maintenance and
expansion of the Company's existing facilities as well as development and
integration of the Company's services in selected metropolitan markets.
Operating leases generally consist of short-term lease agreements for
buildings where facilities are located. These leases generally have 5-year
terms, with one or more renewal options, with terms to be negotiated at the time
of renewal. Total rental expense for all operating leases was $103,308,000,
$131,994,000 and $160,404,000 for the years ended December 31, 1995, 1996 and
1997, respectively.
The following is a schedule of future minimum lease payments under all
operating leases having initial or remaining non-cancelable lease terms in
excess of one year:
YEAR ENDING DECEMBER 31, (IN THOUSANDS)
- - ------------------------------------------------------ ---------------
1998 ..................................... $179,658
1999 ..................................... 150,855
2000 ..................................... 125,479
2001 ..................................... 98,643
2002 ..................................... 72,600
After 2002 ............................... 313,403
--------
Total minimum payments required .......... $940,638
========
12. EMPLOYEE BENEFIT PLANS
The Company has a 401(k) savings plan which matches 15% of the first 4% of
earnings that an employee contributes. All contributions are in the form of
cash. All employees who have completed one year of service with a minimum of
1,000 hours worked are eligible to participate in the plan. Company
contributions are gradually vested over a seven-year service period.
Contributions to the plan by the Company were approximately $1,408,000,
$2,420,000 and $2,628,000 in 1995, 1996 and 1997, respectively.
In 1991, the Company established an Employee Stock Ownership Plan ("ESOP")
for the purpose of providing substantially all employees of the Company the
opportunity to save for their retirement and acquire a proprietary interest in
the Company. The ESOP currently owns approximately 3,320,000 shares of the
Company's common stock, which were purchased with funds borrowed from the
Company, $10,000,000
55
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
12. EMPLOYEE BENEFIT PLANS - (CONTINUED)
in 1991 (the "1991 ESOP Loan") and $10,000,000 in 1992 (the "1992 ESOP Loan").
At December 31, 1997, the combined ESOP Loans had a balance of $12,247,000. The
1991 ESOP Loan, which bears an interest rate of 10%, is payable in annual
installments covering interest and principal over a ten-year period beginning in
1992. The 1992 ESOP Loan, which bears an interest rate of 8.5%, is payable in
annual installments covering interest and principal over a ten-year period
beginning in 1993. Company contributions to the ESOP began in 1992 and shall at
least equal the amount required to make all ESOP loan amortization payments for
each plan year. The Company recognizes compensation expense based on the shares
allocated method. Compensation expense related to the ESOP recognized by the
Company was $3,524,000, $3,198,000 and $3,249,000 in 1995, 1996 and 1997,
respectively. Interest incurred on the ESOP Loans was approximately $1,460,000,
$1,298,000 and $1,121,000 in 1995, 1996 and 1997, respectively. Approximately
1,508,000 shares owned by the ESOP have been allocated to participants at
December 31, 1997.
During 1993, the American Institute of Certified Public Accountants issued
Statement of Position 93-6, "Employers Accounting for Employee Stock Ownership
Plans" ("SOP 93-6"). Among other provisions, SOP 93-6 requires that compensation
expense relating to employee stock ownership plans be measured based on the fair
market value of the shares when allocated to the employees. The provisions of
SOP 93-6 apply only to leveraged ESOPs formed after December 31, 1992, or shares
newly acquired by an existing leveraged ESOP after December 31, 1992. Because
all shares owned by the Company's ESOP were acquired prior to December 31, 1992,
the Company's accounting policies for the shares currently owned by the ESOP are
not affected by SOP 93-6.
13. IMPAIRMENT OF LONG-TERM ASSETS
In 1995, the Company recorded an asset impairment charge of approximately
$53,549,000 relating to goodwill and tangible assets identifiable with fourteen
surgery centers. Approximately $47,984,000 of this charge related to ten surgery
centers which the Company intends to operate on an ongoing basis, while the
remaining loss of $5,565,000 is identifiable with four surgery centers which the
Company decided during the fourth quarter of 1995 to close.
With respect to the ten surgery centers the Company intends to continue
operating, certain events occurred in the fourth quarter of 1995 which
significantly impacted the Company's estimates of future cash flows to be
received from these centers. Those events primarily related to a decline in
operating results combined with a deterioration in relationships with key
physicians at certain of those locations. As a result of these events, the
Company revised its estimates of undiscounted cash flows to be received over the
remaining estimated useful lives of these centers and determined that goodwill
and other long-lived assets (primarily property and equipment) had been
impaired. The Company developed its best estimates of future operating cash
flows at these locations considering future requirements for capital
expenditures as well as the impact of inflation. The projections of cash flows
also took into account estimates of significant one-time expenses as well as
estimates of additional revenues and resulting income from future marketing
efforts in the respective locations. The amount of the impairment charge was
determined by discounting the estimates of future cash flows, using an estimated
8.5% incremental borrowing rate which management believes is commensurate with
the risks involved. The resulting net present value of future cash flows was
then compared to the historical net book value of goodwill and other long-lived
assets at each operating location which resulted in an impairment loss relative
to these centers of $47,984,000. The above amounts are included in operations
for 1995 in the accompanying consolidated statement of income.
In 1996, the Company recorded an asset impairment charge of approximately
$37,390,000 relating to tangible assets identifiable with the development and
manufacture of the HI Standard and HI STAR MRI systems. Approximately
$28,665,000 of this charge related to the development and manufacture of the HI
STAR MRI system, while the remaining charge of $8,725,000 related to HI Standard
MRI systems already in service.
56
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
13. IMPAIRMENT OF LONG-TERM ASSETS - (CONTINUED)
During the fourth quarter of 1996 the Company performed an evaluation of
the viability of continued development and manufacture, and the continued use of
mid-field (0.6 Tesla) MRI systems. Both the HI Standard and the HI STAR MRI
systems are mid-field MRI systems. The Company's evaluation revealed that due to
improvements in technology, high-field (1.5 Tesla) MRI systems could be
purchased at significantly lower costs than the production costs of the
Company's mid-field MRI systems. Additionally, it was noted that future
maintenance costs of the high-field MRI systems were significantly less than the
cost currently being incurred for maintenance of the internally developed
mid-field MRI systems. The evaluation also confirmed that procedures could be
performed in the high-field MRI systems in approximately one-third of the time
that the same procedure could be performed in a mid-field MRI system. In
addition, the Company was experiencing pressures from third-party payors and
referring physicians to implement high-field MRI systems due to increased
patient satisfaction from the reduced procedure time and the improved images
derived from such systems. Based on these facts and circumstances the Company
determined that there was a significant decrease in the market value of the
related assets. Accordingly, the Company decided to cease development and
manufacture of the HI STAR MRI system and developed a plan to replace all of its
HI Standard MRI systems during the following eighteen months.
With respect to the $28,665,000 charge related to the development and
manufacture of the HI STAR MRI system, approximately $20,503,000 was
work-in-process, $4,244,000 was a prototype HI STAR MRI system and inventory of
component parts and $3,918,000 was machinery and equipment used in the
development and manufacturing processes. The Company was not able to find any
application or use of these assets within its existing operations. Also, since
the HI STAR MRI system was not fully developed, the Company has not been able to
find a buyer for any of the assets. Therefore, the Company has assigned no fair
value at December 31, 1996 to the assets related to the development and
manufacture of the HI STAR MRI system.
With respect to the $8,725,000 charge related to the HI Standard MRI
systems already in service, the Company explored the market for the sale of
these systems in the open market or through trade with other manufacturers. For
the same reasons that led the Company to develop a plan to replace the HI
Standard MRI systems with high-field MRI systems, no potential purchaser, or
manufacturer willing to trade, has been found. Therefore, the Company has
assigned no fair value at December 31, 1996 to the HI Standard MRI systems to be
disposed of.
14. SUBSEQUENT EVENTS
On March 15, 1998, pursuant to the terms of the 1996 Credit Agreement (see
Note 7), the Company elected to convert $350,000,000 of the $1,250,000,000 1996
Credit Agreement into a two-year amortizing term note maturing on December 31,
1999. In conjunction with this election, the Company has received a $350,000,000
commitment from NationsBank for an additional 364-day facility (the "Interim
Revolving Credit Facility") which is on substantially the same terms as the 1996
Credit Agreement.
On March 20, 1998, the Company issued $500,000,000 in 3.25% Convertible
Subordinated Debentures due 2003 (the "Convertible Debentures due 2003") in a
private offering. The Convertible Debentures due 2003 are convertible into
Common Stock of the Company at the option of the holder at a conversion price of
$36.625 per share, subject to adjustment upon the occurrence of certain events.
The proceeds from this debt offering will be used by the Company to pay off all
amounts drawn subsequent to December 31, 1997 under the Bridge Credit Agreement
(see Note 7) and reduce outstanding amounts under the 1996 Credit Agreement.
Effective with the sale of the Convertible Debentures due 2003, the Bridge
Credit Agreement was terminated.
Because the Company intends to pay off the two-year term portion of the
1996 Credit Agreement with proceeds from the Interim Revolving Credit Facility
or other long-term financing arrangements, all amounts associated with the 1996
Credit Agreement outstanding at December 31, 1997 are classified as non-current.
57
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
The Company has not changed independent accountants within the 24 months
prior to December 31, 1997.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS.
DIRECTORS
The following table sets forth certain information with respect to the
Company's Directors.
PRINCIPAL OCCUPATION
AND ALL POSITIONS A DIRECTOR
NAME AGE WITH THE COMPANY SINCE
- - ---------------------------------- ----- ------------------------------------------------------- -----------
Richard M. Scrushy ............... 45 Chairman of the Board and Chief Executive Officer 1984
and Director
James P. Bennett ................. 40 President and Chief Operating Officer and Director 1993
Phillip C. Watkins, M.D. ......... 56 Physician, Birmingham, Alabama, and Director 1984
George H. Strong ................. 71 Private Investor, Locust, New Jersey, and Director 1984
C. Sage Givens ................... 41 General Partner, Acacia Venture Partners and Director 1985
Charles W. Newhall III ........... 53 Partner, New Enterprise Associates Limited Partner- 1985
ships, and Director
Larry R. House ................... 54 Private Investor, Birmingham, Alabama, and Director 1993
Anthony J. Tanner ................ 49 Executive Vice President -- Administration and Sec- 1993
retary and Director
P. Daryl Brown ................... 43 President -- HEALTHSOUTH Outpatient Centers 1995
and Director
John S. Chamberlin ............... 69 Private Investor, Princeton, New Jersey, and Director 1993
Joel C. Gordon ................... 68 Private Investor, Nashville, Tennessee, Consultant to 1996
the Company and Director
Michael D. Martin ................ 37 Executive Vice President, Chief Financial Officer and 1998
Treasurer and Director
Richard M. Scrushy, one of the Company's management founders, has served as
Chairman of the Board and Chief Executive Officer of the Company since 1984, and
also served as President of the Company from 1984 until March 1995. From 1979 to
1984, Mr. Scrushy was with Lifemark Corporation, a publicly-owned healthcare
corporation, serving in various operational and management positions. Mr.
Scrushy is also Chairman of the Board of MedPartners, Inc., a publicly-traded
physician practice management company for which he also served as Acting Chief
Executive Officer from January 16 through March 18, 1998, and Chairman of the
Board of Capstone Capital, Inc., a publicly-traded real estate investment trust.
He also serves on the boards of directors of several privately-held healthcare
corporations and is a principal of 21st Century Health Ventures L.L.C., a
private equity investment fund sponsor.
Phillip C. Watkins, M.D., FACC, is and has been for more than five years in
the private practice of medicine in Birmingham, Alabama. A graduate of The
Medical College of Alabama, Dr. Watkins is a Diplomate of the American Board of
Internal Medicine. He is also a Fellow of the American College of Cardiology and
the Subspecialty Board of Cardiovascular Disease.
59
George H. Strong retired as senior vice president and chief financial
officer of Universal Health Services, Inc. in December 1984, a position he held
for more than six years. Mr. Strong is a private investor and continued to act
as a Director of Universal Health Services, Inc., a publicly-traded hospital
management corporation, until 1993. Mr. Strong is also a director of Core Funds,
a public mutual fund group, Integrated Health Services, Inc., a publicly-traded
healthcare corporation, and AmeriSource, Inc., a large drug wholesaler.
C. Sage Givens is a general partner of Acacia Venture Partners, a private
venture capital fund capitalized at $66,000,000. From 1983 to June 30, 1995, Ms.
Givens was a general partner of First Century Partners, a private venture
capital fund capitalized at $100,000,000. Ms. Givens managed the fund's
healthcare investments. Ms. Givens serves on the boards of directors of PhyCor,
Inc. and UroHealth Systems, Inc., both publicly-traded healthcare corporations,
and several privately-held healthcare companies.
Charles W. Newhall III is a general partner and founder of New Enterprise
Associates Limited Partnerships, Baltimore, Maryland, where he has been engaged
in the venture capital business since 1978. Mr. Newhall is also a director of
Integrated Health Services, Inc., MedPartners, Inc. and Opta Food Ingredients,
Inc., all of which are publicly-traded corporations.
James P. Bennett joined the Company in May 1991 as Director of Inpatient
Operations, was promoted to Group Vice President -- Inpatient Rehabilitation
Operations in September 1991, again to President and Chief Operating Officer --
HEALTHSOUTH Rehabilitation Hospitals in June 1992, to President -- HEALTHSOUTH
Inpatient Operations in February 1993, and to President and Chief Operating
Officer of the Company in March 1995. Mr. Bennett was elected a Director in
February 1993. From August 1987 to May 1991, Mr. Bennett was employed by Russ
Pharmaceuticals, Inc., Birmingham, Alabama, as Vice President -- Operations,
Chief Financial Officer, Secretary and director. Mr. Bennett served as certified
public accountant on the audit staff of the Birmingham, Alabama office of Ernst
& Whinney (now Ernst & Young LLP) from October 1980 to August 1987.
Larry R. House served as Chairman of the Board, President and Chief
Executive Officer of MedPartners, Inc. a publicly-traded physician practice
management firm, from August 1993 until January 16, 1998. Mr. House was elected
a Director of the Company in February 1993. At the same time he became President
- - -- HEALTHSOUTH International, Inc. and New Business Ventures, a position which
he held until August 31, 1994, when he terminated his employment with the
Company to concentrate on his duties at MedPartners. Mr. House joined the
Company in September 1985 as Director of Marketing, subsequently served as
Senior Vice President and Chief Operating Officer of the Company, and in June
1992 became President and Chief Operating Officer -- HEALTHSOUTH Medical
Centers. Prior to joining the Company, Mr. House was president and chief
executive officer of a provider of clinical contract management services for
more than ten years.
Anthony J. Tanner, Sc.D., a management founder, serves as Executive Vice
President -- Administration and Secretary of the Company and was elected a
Director in February 1993. From 1980 to 1984, Mr. Tanner was with Lifemark
Corporation in the Shared Services Division as director, clinical and
professional programs (1982-1984) and director, quality assurance and education
(1980-1982), where he was responsible for the development of clinical programs
and marketing programs.
P. Daryl Brown joined the Company in April 1986 and served until June 1992
as Group Vice President -- Outpatient Operations. He became President --
HEALTHSOUTH Outpatient Centers in June 1992, and was elected as a Director in
March 1995. From 1977 to 1986, Mr. Brown served with the American Red Cross,
Alabama Region, in several positions, including Chief Operating Officer,
Administrative Director for Financing and Administration and Controller.
John S. Chamberlin retired in 1988 as president and chief operating officer
of Avon Products, Inc., a position he had held since 1985. From 1976 until 1985,
he served as chairman and chief executive officer of Lenox, Incorporated, after
22 years in various assignments for General Electric. From 1990 to 1991, he
served as chairman and chief executive officer of New Jersey Publishing Co. Mr.
Chamberlin is chairman of the board of Life Fitness Company and WNS, Inc., and
is a director of The Scotts Company and UroHealth Systems, Inc. He is a member
of the Board of Trustees of the Medical Center at Princeton and is a trustee of
the Woodrow Wilson National Fellowship Foundation.
60
Joel C. Gordon served as Chairman of the Board of Directors of SCA from its
founding in 1982 until January 17, 1996, when SCA was acquired by the Company.
Mr. Gordon also served as Chief Executive Officer of SCA from 1987 until January
17, 1996. Mr. Gordon serves on the boards of directors of Genesco, Inc., an
apparel manufacturer, and SunTrust Bank of Nashville, N.A.
Michael D. Martin joined the Company in October 1989 as Vice President and
Treasurer, and was named Senior Vice President -- Finance and Treasurer in
February 1994 and Executive Vice President -- Finance and Treasurer in May 1996.
In October 1997, he was additionally named Chief Financial Officer of the
Company, and in March 1998, he was named a Director of the Company. From 1983
through September 1989, Mr. Martin specialized in healthcare lending with
AmSouth Bank N.A., Birmingham, Alabama, where he was a Vice President
immediately prior to joining the Company. Mr. Martin is a Director of Capstone
Capital, Inc. and MedPartners, Inc. and is a principal of 21st Century Health
Ventures.
EXECUTIVE OFFICERS
The following table sets forth certain information with respect to the
Company's executive officers.
ALL POSITIONS AN OFFICER
NAME AGE WITH THE COMPANY SINCE
- - ---------------------------- ----- ------------------------------------------------------- -----------
Richard M. Scrushy ......... 45 Chairman of the Board and Chief Executive Officer 1984
and Director
James P. Bennett ........... 40 President and Chief Operating Officer and Director 1991
Anthony J. Tanner .......... 49 Executive Vice President -- Administration and Sec- 1984
retary and Director
Michael D. Martin .......... 37 Executive Vice President, Chief Financial Officer and 1989
Treasurer and Director
Thomas W. Carman ........... 46 Executive Vice President -- Corporate Development 1985
P. Daryl Brown ............. 43 President -- HEALTHSOUTH Outpatient Centers 1986
and Director
Robert E. Thomson .......... 50 President -- HEALTHSOUTH Inpatient Operations 1987
Patrick A. Foster .......... 51 President -- HEALTHSOUTH Surgery Centers 1994
Russell H. Maddox .......... 57 President -- HEALTHSOUTH Imaging Centers 1995
William T. Owens ........... 39 Group Senior Vice President -- Finance and Controller 1986
William W. Horton .......... 38 Senior Vice President and Corporate Counsel and As- 1994
sistant Secretary
Biographical information for Messrs. Scrushy, Bennett, Tanner, Brown and
Martin is set forth above under this Item, "Directors and Executive Officers --
Directors".
Thomas W. Carman joined the Company in 1985 as Regional Director --
Corporate Development, and now serves as Executive Vice President -- Corporate
Development. From 1983 to 1985, Mr. Carman was director of development for
Medical Care International. From 1981 to 1983, Mr. Carman was assistant
administrator at the Children's Hospital of Birmingham, Alabama.
Robert E. Thomson joined the Company in August 1985 as administrator of its
Florence, South Carolina inpatient rehabilitation facility, and subsequently
served as Regional Vice President -- Inpatient Operations, Vice President --
Inpatient Operations, Group Vice President -- Inpatient Operations, and Senior
Vice President -- Inpatient Operations. Mr. Thomson was named President --
HEALTHSOUTH Inpatient Operations in February 1996.
61
Patrick A. Foster joined the Company in February 1994 as Director of
Operations and subsequently served as Group Vice President -- Inpatient
Operations and Senior Vice President -- Inpatient Operations. He was named
President -- HEALTHSOUTH Surgery Centers in October 1997. From August 1992 until
February 1994, he served as Senior Vice President of the Rehabilitation/Medical
Division of The Mediplex Group.
Russell H. Maddox became President -- HEALTHSOUTH Imaging Centers in
January 1996. He served as President -- HEALTHSOUTH Surgery & Imaging Centers
from June 1995 through January 1996. From January 1992 until May 1995, Mr.
Maddox served as Chairman of the Board, President and Chief Executive Officer of
Diagnostic Health Corporation, an outpatient diagnostic imaging company which
became a wholly-owned subsidiary of the Company in 1996. Mr. Maddox was founder
and President of Russ Pharmaceuticals, Inc., Birmingham, Alabama, which was
acquired by Ethyl Corporation in March 1989.
William T. Owens, C.P.A., joined the Company in March 1986 as Controller
and was appointed Vice President and Controller in December 1986. He was
appointed Group Vice President -- Finance and Controller in June 1992 and Senior
Vice President -- Finance and Controller in February 1994 and Group Senior Vice
President -- Finance and Controller in March 1998. Prior to joining the Company,
Mr. Owens served as a certified public accountant on the audit staff of the
Birmingham, Alabama office of Ernst & Whinney (now Ernst & Young LLP) from 1981
to 1986.
William W. Horton joined the Company in July 1994 as Group Vice President
- - -- Legal Services and was named Senior Vice President and Corporate Counsel in
May 1996. From August 1986 through June 1994, Mr. Horton practiced corporate,
securities and healthcare law with the Birmingham, Alabama-based firm now known
as Haskell Slaughter & Young, L.L.C., where he served as Chairman of the
Healthcare Practice Group.
GENERAL
Directors of the Company hold office until the next Annual Meeting of
Stockholders of the Company and until their successors are elected and
qualified. Executive officers of the Company are elected annually by, and serve
at the discretion of the Board of Directors. There are no arrangements or
understandings known to the Company between any of the Directors, nominees for
Director or executive officers of the Company and any other person pursuant to
which any of such persons was elected as a Director or an executive officer,
except the Employment Agreement between the Company and Richard M. Scrushy (see
Item 11, "Executive Compensation -- Chief Executive Officer Employment
Agreement") and except that the Company agreed to appoint Mr. Gordon to the
Board of Directors in connection with the SCA merger. There are no family
relationships between any Directors, nominees for Director or executive officers
of the Company.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
officers and Directors, and persons who beneficially own more than 10% of a
registered class of the Company's equity securities, to file reports of
ownership and changes in ownership with the Securities and Exchange Commission
and the New York Stock Exchange. Officers, Directors and beneficial owners of
more than 10% of the Company's Common Stock are required by Securities and
Exchange Commission regulations to furnish the Company with copies of all
Section 16(a) forms that they file. Based solely on review of the copies of such
forms furnished to the Company, or written representations that no reports on
Form 5 were required, the Company believes that for the period from January 1,
1997, through December 31, 1997, all of its officers, Directors and
greater-than-10% beneficial owners complied with all Section 16(a) filing
requirements applicable to them, except as set forth below.
Joel C. Gordon, a Director of the Company, failed to timely report three
open market sales aggregating 15,000 shares of the Company's Common Stock in
December 1995, which sales were reported on Form 5 in February 1998. The sales
were made by a trust of which Mr. Gordon is a trustee. George H. Strong, a
Director of the Company, failed to timely report a sale of 40,000 shares of
Common Stock by
62
a trust of which he is a trustee in September 1997, which sale was reported on
Form 5 in February 1998. Charles W. Newhall III, a Director of the Company,
failed to timely report a sale of 61 shares of Common Stock in February 1996, a
sale of 30,133 shares of Common Stock in March 1996, and a sale of 30,440 shares
of Common Stock in January 1997, each of which sales was reported on Form 4 in
November 1997. The Company has consulted with the foregoing persons concerning
their obligations to comply with Section 16(a).
63
ITEM 11. EXECUTIVE COMPENSATION.
EXECUTIVE COMPENSATION -- GENERAL
The following table sets forth compensation paid or awarded to the Chief
Executive Officer and each of the other four most highly compensated executive
officers of the Company (the "Named Executive Officers") for all services
rendered to the Company and its subsidiaries in 1995, 1996 and 1997.
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION LONG-TERM COMPENSATION
--------------------------------------- -------------------------
BONUS/ANNUAL STOCK LONG-TERM ALL
INCENTIVE OPTION INCENTIVE OTHER COM-
NAME AND PRINCIPAL POSITION YEAR SALARY AWARD AWARDS PAYOUTS PENSATION(1)
- - -------------------------------- ------ ------------- -------------- ----------- ----------- -----------------
Richard M. Scrushy 1995 $1,748,646 $ 5,000,000 2,000,000 -- $ 650,108
Chairman of the Board 1996 3,391,775 8,000,000 1,500,000 -- 34,286 (2)
and Chief Executive Officer(3) 1997 3,398,999 10,000,000 1,300,000 -- 21,430
James P. Bennett 1995 382,528 600,000 300,000 -- 7,985
President and Chief 1996 496,590 800,000 200,000 -- 32,106 (2)
Operating Officer 1997 639,161 1,500,000 700,000 -- 10,158
Michael D. Martin 1995 176,746 500,000 170,000 -- 7,919
Executive Vice President, 1996 281,644 750,000 120,000 -- 31,586 (2)
Chief Financial Officer 1997 359,672 2,000,000 450,000 -- 9,700
and Treasurer
P. Daryl Brown 1995 274,582 310,000 260,000 -- 8,580
President -- HEALTHSOUTH 1996 335,825 400,000 100,000 -- 11,181
Outpatient Centers 1997 370,673 450,000 250,000 -- 10,737
Anthony J. Tanner 1995 249,438 300,000 200,000 -- 8,728
Executive Vice President -- 1996 298,078 350,000 100,000 -- 7,763
Administration and Secretary 1997 371,114 450,000 450,000 -- 9,817
- - ----------
(1) Includes car allowances of $500 per month for Mr. Scrushy and $350 per
month for the other Named Executive Officers. Also includes (a) matching
contributions under the Company's Retirement Investment Plan for 1995, 1996
and 1997, respectively, of: $292, $708 and $791 to Mr. Scrushy; $900,
$1,425 and $1,425 to Mr. Bennett; $900, $1,371 and $1,324 to Mr. Martin;
$900, $1,897 and $1,319 to Mr. Brown; and $2,044, $1,290 and $1,215 to Mr.
Tanner; (b) awards under the Company's Employee Stock Benefit Plan for
1995, 1996 and 1997, respectively, of $1,626, $3,389 and $2,889 to Mr.
Scrushy; $1,626, $3,387 and $2,889 to Mr. Bennett; $1,626, $3,386 and
$2,889 to Mr. Martin; $1,626, $3,389 and $2,889 to Mr. Brown; and $509,
$1,276 and $2,889 to Mr. Tanner; and (c) split-dollar life insurance
premiums paid in 1995, 1995 and 1997 of $2,190, $2,312 and $11,750 with
respect to Mr. Scrushy; $1,109, $1,217 and $1,644 with respect to Mr.
Bennett; $1,193, $752 and $1,287 with respect to Mr. Martin; $1,854, $1,695
and $2,329 with respect to Mr. Brown; and $1,975, $997 and $1,513 to Mr.
Tanner. See this Item, "Executive Compensation -- Retirement Investment
Plan" and "Executive Compensation -- Employee Stock Benefit Plan".
(2) In addition to the amounts described in the preceding footnote, includes
the conveyance of real property valued at $640,000 to Mr. Scrushy in 1995,
and the forgiveness of loans in the amount of $21,877 each owed by Messrs.
Scrushy, Bennett and Martin in 1996.
(3) Salary amounts for Mr. Scrushy include monthly incentive compensation
amounts payable upon achievement of certain budget targets. See this
Item,"Executive Compensation -- Chief Executive Officer Employment
Agreement".
64
STOCK OPTION GRANTS IN 1997
INDIVIDUAL GRANTS
---------------------------------------------------------
% OF TOTAL
OPTIONS
NUMBER OF GRANTED TO EXERCISE
OPTIONS EMPLOYEES IN PRICE EXPIRATION GRANT DATE
NAME GRANTED FISCAL YEAR PER SHARE DATE PRESENT VALUE (1)
- - -------------------- ----------- -------------- ----------- ------------ ------------------
Richard M. Scrushy 600,000 8.9% $ 20.125 2/29/07 $ 6,690,000
700,000 10.47% 23.625 8/14/07 9,163,000
James P. Bennett 350,000 5.2% 20.125 2/28/07 3,902,500
350,000 5.2% 23.625 8/14/07 4,581,500
Michael D. Martin 150,000 2.2% 20.125 2/28/07 1,672,500
300,000 4.5% 23.625 8/14/07 3,927,000
P. Daryl Brown 100,000 1.5% 20.125 2/28/07 1,115,000
150,000 2.2% 23.625 8/14/07 1,963,500
Anthony J. Tanner 150,000 2.2% 20.125 2/28/07 1,672,500
300,000 4.5% 23.625 8/14/07 3,927,000
- - ----------
(1) Based on the Black-Scholes option pricing model adapted for use in
valuating executive stock options. The actual value, if any, an executive
may realize will depend upon the excess of the stock price over the
exercise price on the date the option is exercised, so that there is no
assurance that the value realized by an executive will be at or near the
value estimated by the Black-Scholes model. The estimated values under that
model are based on arbitrary assumptions as to certain variables, including
the following: (i) stock price volatility is assumed to be 38%; (ii) the
risk-free rate of return is assumed to be 5.69%; (iii) dividend yield is
assumed to be 0; and (iv) the time of exercise is assumed to be 8.4 years
from the date of grant.
STOCK OPTION EXERCISES IN 1997 AND OPTION VALUES AT DECEMBER 31, 1997
NUMBER VALUE OF UNEXERCISED
OF SHARES NUMBER OF UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS
ACQUIRED AT DECEMBER 31, 1997 (1) AT DECEMBER 31, 1997 (2)
ON VALUE ----------------------------- -------------------------------
NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- - ---------------------------- ----------- -------------- ------------- --------------- --------------- --------------
Richard M. Scrushy ......... 4,000,000 $93,384,947 11,172,524 -- $216,170,768 --
James P. Bennett ........... 250,000 5,369,011 1,310,000 -- 14,730,175 --
Michael D. Martin. ......... 123,000 2,050,069 570,000 60,000 3,757,500 $1,162,500
P. Daryl Brown ............. 147,000 2,882,846 1,038,000 -- 18,262,098 --
Anthony J. Tanner .......... 270,000 6,198,039 940,000 -- 11,960,075 --
- - ----------
(1) Does not reflect any options granted and/or exercised after December 31,
1997. The net effect of any such grants and exercises is reflected in the
table appearing under Item 12, "Security Ownership of Certain Beneficial
Owners and Management".
(2) Represents the difference between market price of the Company's Common
Stock and the respective exercise prices of the options at December 31,
1997. Such amounts may not necessarily be realized. Actual values which may
be realized, if any, upon any exercise of such options will be based on the
market price of the Common Stock at the time of any such exercise and thus
are dependent upon future performance of the Common Stock.
STOCK OPTION PLANS
Set forth below is information concerning the various stock option plans of
the Company at December 31, 1997. All share numbers and exercise prices have
been adjusted to reflect the Company's March 1997 two-for-one stock split.
1984 Incentive Stock Option Plan
The Company had a 1984 Incentive Stock Option Plan (the "ISO Plan"),
intended to qualify under Section 422(b) of the Internal Revenue Code of 1986,
as amended (the "Code"), covering an aggregate of 4,800,000 shares of Common
Stock. The ISO Plan expired on February 28, 1994, in accordance with
65
its terms. As of December 31, 1997, there were outstanding under the ISO Plan
options to purchase 19,702 shares of the Company's Common Stock at prices
ranging from $2.52 to $3.7825 per share. All such options remain in full force
and effect in accordance with their terms and the ISO Plan. Under the ISO Plan,
which was administered by the Board of Directors, key employees could be granted
options to purchase shares of Common Stock at 100% of fair market value on the
date of grant (or 110% of fair market value in the case of a 10% stockholder/
grantee). The outstanding options granted under the ISO Plan must be exercised
within ten years from the date of grant, are cumulatively exercisable with
respect to 25% of the shares covered thereby after the expiration of each of the
first through the fourth years following the date of grant, are nontransferable
except by will or pursuant to the laws of descent and distribution, are
protected against dilution and expire within three months after termination of
employment, unless such termination is by reason of death.
1988 Non-Qualified Stock Option Plan
The Company also has a 1988 Non-Qualified Stock Option Plan (the "NQSO
Plan") covering a maximum of 4,800,000 shares of Common Stock. As of December
31, 1997, there were outstanding under the NQSO Plan options to purchase 57,300
shares of the Company's Common Stock at prices ranging from $8.375 to $16.25 per
share. The NQSO Plan, which is administered by the Audit and Compensation
Committee of the Board of Directors, provides that Directors, executive officers
and other key employees may be granted options to purchase shares of Common
Stock at 100% of fair market value on the date of grant. The NQSO Plan expires
on February 28, 1998. Options granted pursuant to the NQSO Plan have a ten-year
term are exercisable at any time during such period, are nontransferable except
by will or pursuant to the laws of descent and distribution, are protected
against dilution and expire within three months of termination of association
with the Company as a Director or termination of employment, unless such
termination is by reason of death.
1989, 1990, 1991, 1992, 1993, 1995 and 1997 Stock Option Plans
The Company also has a 1989 Stock Option Plan (the "1989 Plan"), a 1990
Stock Option Plan (the "1990 Plan"), a 1991 Stock Option Plan (the "1991 Plan"),
a 1992 Stock Option Plan (the "1992 Plan"), a 1993 Stock Option Plan (the "1993
Plan"), a 1995 Stock Option Plan (the "1995 Plan") and a 1997 Stock Option Plan
(the "1997 Plan"), under each of which incentive stock options ("ISOs") and
non-qualified stock options ("NQSOs") may be granted. The 1989, 1990, 1991,
1992, 1993 and 1995 Plans cover a maximum of 2,400,000 shares, 3,600,000 shares,
11,200,000 shares, 5,600,000 shares, 5,600,000 shares, 15,134,463 (to be
increased by 0.9% of the outstanding Common Stock of the Company on each January
1, beginning January 1, 1996) shares and 5,000,000 shares, respectively, of the
Company's Common Stock. As of December 31, 1997, there were outstanding options
to purchase an aggregate of 27,213,453 shares of the Company's Common Stock
under such Plans at exercise prices ranging from $2.52 to $23.625 per share. An
additional 4,783,021 shares were reserved for future grants under such Plans.
Each of the 1989, 1990, 1991, 1992, 1993, 1995 and 1997 Plans is administered in
the same manner as the NQSO Plan and provides that Directors, executive officers
and other key employees may be granted options to purchase shares of Common
Stock at 100% of fair market value on the date of grant. The 1989, 1990, 1991,
1992, 1993, 1995 and 1997 Plans terminate on the earliest of (a) October 25,
1999, October 15, 2000, June 19, 2001, June 16, 2002, April 19, 2003, June 5,
2005 and April 30, 2007, respectively, (b) such time as all shares of Common
Stock reserved for issuance under the respective Plan have been acquired through
the exercise of options granted thereunder, or (c) such earlier times as the
Board of Directors of the Company may determine. Options granted under these
Plans which are designated as ISOs contain vesting provisions similar to those
contained in options granted under the ISO Plan and have a ten-year term. NQSOs
granted under these Plans have a ten-year term. Options granted under these
Plans are nontransferable except by will or pursuant to the laws of descent and
distribution (except for certain permitted transfers to family members or
charities), are protected against dilution and will expire within three months
of termination of association with the Company as a Director or termination of
employment, unless such termination is by reason of death.
66
1993 Consultants' Stock Option Plan
The Company also has a 1993 Consultants' Stock Option Plan (the "1993
Consultants' Plan"), under which NQSOs may be granted, covering a maximum of
3,500,000 shares of Common Stock. As of December 31, 1997, there were
outstanding under the 1993 Consultants' Plan options to purchase 1,509,750
shares of Common Stock at prices ranging from $3.375 to $23.625 per share. An
additional 440,000 shares were reserved for grants under such Plans. The 1993
Consultants' Plan, which is administered by the Board of Directors, provides
that certain non-employee consultants who provide significant services to the
Company may be granted options to purchase shares of Common Stock at such prices
as are determined by the Board of Directors or the appropriate committee. The
1993 Consultants' Plan terminates on the earliest of (a) February 25, 2003, (b)
such time as all shares of Common Stock reserved for issuance under the 1993
Consultants' Plan have been acquired through the exercise of options granted
thereunder, or (c) such earlier time as the Board of Directors of the Company
may determine. Options granted under the 1993 Consultants' Plan have a ten-year
term. Options granted under the 1993 Consultants' Plan are nontransferable
except by will or pursuant to the laws of descent and distribution, are
protected against dilution and expire within three months of termination of
association with the Company as a consultant, unless such termination is by
reason of death.
Other Stock Option Plans
In connection with the acquisitions of SHC, SSCI, SCA, PSCM, ReadiCare,
Health Images and Horizon/CMS, the Company assumed certain existing stock option
plans of the acquired companies, and outstanding options to purchase stock of
the acquired companies under such plans were converted into options to acquire
Common Stock of the Company in accordance with the exchange ratios applicable to
such mergers. At December 31, 1997, there were outstanding under these assumed
plans options to purchase 3,896,820 shares of the Company's Common Stock at
exercise prices ranging from $1.6363 to $53.8192 per share. No additional
options are being granted under any such assumed plans.
RETIREMENT INVESTMENT PLAN
Effective January 1, 1990, the Company adopted the HEALTHSOUTH Retirement
Investment Plan (the "401(k) Plan"), a retirement plan intended to qualify under
Section 401(k) of the Internal Revenue Code of 1986, as amended. The 401(k) Plan
is open to all full-time and part-time employees of the Company who are over the
age of 21, have one full year of service with the Company and have at least
1,000 hours of service in the year in which they enter the 401(k) Plan. Eligible
employees may elect to participate in the Plan on January 1 and July 1 in each
year.
Under the 401(k) Plan, participants may elect to defer up to 20% of their
annual compensation (subject to nondiscrimination rules under the Internal
Revenue Code). The deferred amounts may be invested among four options, at the
participant's direction: a money market fund, a bond fund, a guaranteed
insurance contract or an equity fund. The Company will match a minimum of 10% of
the amount deferred by each participant, up to 4% of such participant's total
compensation, with the matched amount also directed by the participant. See Note
12 of "Notes to Consolidated Financial Statements".
Michael D. Martin, Executive Vice President, Chief Financial Officer and
Treasurer of the Company, and Anthony J. Tanner, Executive Vice President --
Administration and Secretary of the Company, serve as Trustees of the 401(k)
Plan, which is administered by the Company.
EMPLOYEE STOCK BENEFIT PLAN
Effective January 1, 1991, the Company adopted the HEALTHSOUTH
Rehabilitation Corporation and Subsidiaries Employee Stock Benefit Plan (the
"ESOP"), a retirement plan intended to qualify under sections 401(a) and
4975(e)(7) of the Internal Revenue Code of 1986, as amended. The ESOP is open to
all full-time and part-time employees of the Company who are over the age of 21,
have one full year of service with the Company and have at least 1,000 hours of
service in the year in which they begin participation in the ESOP on the next
January 1 or July 1 after the date on which such employee satisfies the
aforementioned conditions.
67
The ESOP was established with a $10,000,000 loan from the Company, the
proceeds of which were used to purchase 1,655,172 shares of the Company's Common
Stock. In 1992, an additional $10,000,000 loan was made to the ESOP, which was
used to purchase an additional 1,666,664 shares of Common Stock. Under the ESOP,
a Company Common Stock account (a "company stock account") is established and
maintained for each eligible employee who participates in the ESOP. In each plan
year, such account is credited with such employee's allocable share of the
Common Stock held by the ESOP and allocated with respect to such plan year. Each
employee's allocable share for any given plan year is determined according to
the ratio which such employee's compensation for such plan year bears to the
compensation of all eligible participating employees for the same plan year.
Under the ESOP, eligible employees who participate in the ESOP and who have
attained age 55 and have completed 10 years of participation in the ESOP may
elect to diversify the assets in their company stock account by directing the
plan administrator to transfer to the 401(k) Plan a portion of their company
stock account to be invested, as the eligible employee directs, in one or more
of the investment options available under the 401(k) Plan. See Note 12 of "Notes
to Consolidated Financial Statements".
Richard M. Scrushy, Chairman of the Board and Chief Executive Officer of
the Company, Michael D. Martin, Executive Vice President, Chief Financial
Officer and Treasurer of the Company, and Anthony J. Tanner, Executive Vice
President -- Administration and Secretary of the Company, serve as Trustees of
the ESOP, which is administered by the Company.
STOCK PURCHASE PLAN
In order to further encourage employees to obtain equity ownership in the
Company, the Company's Board of Directors adopted an Employee Stock Purchase
Plan (the "Stock Purchase Plan") effective January 1, 1994. Under the Stock
Purchase Plan, participating employees may contribute $10 to $200 per pay period
toward the purchase of the Company's Common Stock in open-market transactions.
The Stock Purchase Plan is open to regular full-time or part-time employees who
have been employed for six months and are at least 21 years old. After six
months of participation in the Stock Purchase Plan, the Company will provide a
10% matching contribution to be applied to purchases under the Stock Purchase
Plan. The Company also pays all fees and brokerage commissions associated with
the purchase of the stock. The Stock Purchase Plan is administered by a
broker-dealer firm not affiliated with the Company.
DEFERRED COMPENSATION PLAN
In 1997, the Board of Directors adopted an Executive Deferred Compensation
Plan (the "Deferred Compensation Plan"), which allows senior management
personnel to elect, on an annual basis, to defer receipt of up to 50% of their
base salary and up to 100% of their annual bonus, if any (but not less than an
aggregate of $2,400 per year) for a minimum of five years from the date such
compensation would otherwise have been received. Amounts deferred are held by
the Company pursuant to a "rabbi trust" arrangement, and amounts deferred are
credited with earnings at an annual rate equal to the Moody's Average Corporate
Bond Yield Index (the "Moody's Rate"), as adjusted from time to time, or the
Moody's Rate plus 2% if a participant's employment is terminated by reason of
retirement, disability or death or within 24 months of a change in control of
the Company. Amounts deferred may be withdrawn upon retirement, termination of
employment or death, upon a showing of financial hardship, or voluntarily with
certain penalties. The Deferred Compensation Plan is administered by an
Administrative Committee, currently consisting of Michael D. Martin, Executive
Vice President, Chief Financial Officer and Treasurer of the Company, and
Anthony J. Tanner, Executive Vice President -- Administration and Secretary of
the Company.
BOARD COMPENSATION
Directors who are not also employed by the Company are paid Directors' fees
of $10,000 per annum, plus $3,000 for each meeting of the Board of Directors and
$1,000 for each Committee meeting attended. In addition, Directors are
reimbursed for all out-of-pocket expenses incurred in connection
68
with their duties as Directors. The Directors of the Company, including Mr.
Scrushy, have been granted non-qualified stock options to purchase shares of the
Company's Common Stock. Under the Company's existing stock option plans, each
non-employee Director is granted an option covering 25,000 shares of such Common
Stock on the first business day in January of each year. See this Item,
"Executive Compensation -- Stock Option Plans" above.
CHIEF EXECUTIVE OFFICER EMPLOYMENT AGREEMENT
The Company is a party to an Employment Agreement with Richard M. Scrushy,
pursuant to which Mr. Scrushy, a management founder of the Company, is employed
as Chairman of the Board and Chief Executive Officer of the Company for a
five-year term which ends December 31, 2001. Such term is automatically extended
for an additional year on December 31 of each year. In addition, the Company has
agreed to use its best efforts to cause Mr. Scrushy to be elected as a Director
of the Company during the term of the Agreement. Under the Agreement, Mr.
Scrushy received a base salary of $999,000, excluding incentive compensation of
up to $2,400,000, in 1997 and is to receive the same base salary in 1998 and
each year thereafter, with incentive compensation of up to $2,400,000, subject
to annual review by the Board of Directors, and is entitled to participate in
any bonus plan approved by the Board of Directors for the Company's management.
The incentive compensation is earned at $200,000 per month in 1997 and 1998,
contingent upon the Company's success in meeting certain monthly budgeted
earnings per share targets. Mr. Scrushy earned the entire $2,400,000 incentive
component of his compensation in 1997, as all such targets were met. In
addition, Mr. Scrushy was awarded $10,000,000 under the management bonus plan.
Such additional bonus was based on the Committee's assessment of Mr. Scrushy's
contribution to the establishment of the Company as the industry leader in
outpatient and rehabilitative healthcare services, including his role in the
negotiation and consummation of the Health Images, Horizon/CMS and ASC Network
acquisitions and his role in completing the divestiture of the Horizon/ CMS
non-strategic assets within two months after consummation of the Horizon/CMS
acquisition, as well as the Company's success in achieving annual budgeted net
income targets and certain other factors reflecting the Company's growth and
performance. Mr. Scrushy is also provided with a car allowance in the amount of
$500 per month and disability insurance. Under the Agreement, Mr. Scrushy's
employment may be terminated for cause or if he should become disabled.
Termination of Mr. Scrushy's employment under the Agreement will result in
certain severance pay arrangements. In the event that the Company shall be
acquired, merged or reorganized in such a manner as to result in a change of
control of the Company, Mr. Scrushy has the right to terminate his employment
under the Agreement, in which case he will receive a lump sum payment equal to
three years' annual base salary (including the gross incentive portion thereof)
under the Agreement. Mr. Scrushy has agreed not to compete with the Company
during any period to which any such severance pay relates. Mr. Scrushy may
terminate the Agreement at any time upon 180 days' notice, in which case he will
receive one year's base salary as severance pay.
69
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth certain information regarding beneficial
ownership of the Company's Common Stock as of March 13, 1998, (a) by each person
who is known by the Company to own beneficially more than 5% of the Company's
Common Stock, (b) by each of the Company's Directors and (c) by the Company's
five most highly compensated executive officers and all executive officers and
Directors as a group.
NAME AND NUMBER OF SHARES PERCENTAGE
ADDRESS OF OWNER BENEFICIALLY OWNED (1) COMMON STOCK
- - ------------------------------------------------------ ------------------------ -------------
Richard M. Scrushy ................................ 11,776,658(2) 2.88%
John S. Chamberlin ................................ 247,000(3) *
C. Sage Givens .................................... 387,100(4) *
Charles W. Newhall III ............................ 755,846(5) *
George H. Strong .................................. 514,692(6) *
Phillip C. Watkins, M.D. .......................... 609,254(7) *
James P. Bennett .................................. 1,390,500(8) *
Larry R. House .................................... 84,600(9) *
Anthony J. Tanner ................................. 1,061,358(10) *
P. Daryl Brown .................................... 1,069,736(11) *
Joel C. Gordon .................................... 3,553,268(12) *
Michael D. Martin ................................. 632,008(13) *
FMR Corp. ......................................... 39,920,762(14) 10.02%
82 Devonshire Street
Boston, Massachusetts 02109
Putnam Investments, Inc. .......................... 28,339,151(15) 7.12%
One Post Office Square
Boston, Massachusetts 02109
All Executive Officers and Directors as a Group (18
persons) ........................................ 24,716,836(16) 5.90%
- - ----------
(1) The persons named in the table have sole voting and investment power with
respect to all shares of Common Stock shown as beneficially owned by them,
except as otherwise indicated.
(2) Includes 11,172,524 shares subject to currently exercisable stock options.
(3) Includes 175,000 shares subject to currently exercisable stock options.
(4) Includes 2,100 shares owned by Ms. Givens's spouse and 385,000 shares
subject to currently exercisable stock options.
(5) Includes 460 shares owned by members of Mr. Newhall's immediate family and
635,000 shares subject to currently exercisable stock options. Mr. Newhall
disclaims beneficial ownership of the shares owned by his family members
except to the extent of his pecuniary interest therein.
(6) Includes 93,373 shares owned by trusts of which Mr. Strong is a trustee and
claims shared voting and investment power and 275,000 shares subject to
currently exercisable stock options.
(7) Includes 465,000 shares subject to currently exercisable stock options.
(8) Includes 1,310,000 shares subject to currently exercisable stock options.
(9) Includes 82,996 shares subject to currently exercisable stock options.
(10) Includes 60,000 shares held in trust by Mr. Tanner for his children and
940,000 shares subject to currently exercisable stock options.
(11) Includes 1,013,000 shares subject to currently exercisable stock options.
(12) Includes 354,340 shares owned by his spouse, 100,988 shares owned by trusts
of which he is a trustee and 409,520 shares subject to currently
exercisable stock options.
(13) Includes 570,000 shares subject to currently exercisable stock options.
70
(14) Shares held by various investment funds for which affiliates of FMR Corp.
act as investment advisor. FMR Corp. or its affiliates claim sole power to
vote 3,327,604 of the shares and sole power to dispose of all of the
shares.
(15) Shares held by various investment funds for which affiliates of Putnam
Investments, Inc. act as investment advisor. Putnam Investments, Inc. or
its affiliates claim shared power to vote 3,338,400 of the shares and
shared power to dispose of all of the shares.
(16) Includes 20,335,344 shares subject to currently exercisable stock options
held by executive officers and Directors.
* Less than 1%
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
During 1997, the Company paid $33,909,000 for the purchase of new NCR
computer equipment from GG Enterprises, a value-added reseller of computer
equipment which is owned by Grace Scrushy, the mother of Richard M. Scrushy,
Chairman of the Board and Chief Executive Officer of the Company, and Gerald P.
Scrushy, Senior Vice President -- Physical Resources of the Company. Such
purchases were made in the ordinary course of the Company's business. The price
paid for this equipment was more favorable to the Company than that which could
have been obtained from an independent third party seller.
In June 1994, the Company sold selected properties, including six ancillary
hospital facilities, three outpatient rehabilitation facilities, two outpatient
surgery centers, one uncompleted medical office building and one research
facility to Capstone Capital Corporation ("Capstone"), a publicly-traded real
estate investment trust. The net proceeds of the Company as a result of the
transaction were approximately $58,425,000. The net book value of the properties
was approximately $50,735,000. The Company leases back substantially all these
properties from Capstone and guarantees the associated operating leases,
payments under which aggregate approximately $6,900,000 annually. In addition,
in 1995 Capstone acquired ownership of the Company's Erie, Pennsylvania
inpatient rehabilitation facility, which had been leased by the Company from an
unrelated lessor. The Company's annual lease payment under that lease is
$1,700,000. In 1996 Capstone also acquired ownership of the Company's Altoona
and Mechanicsburg, Pennsylvania inpatient rehabilitation facilities, which had
been leased by the Company from unrelated lessors. The Company's annual lease
payments under such leases aggregate $2,818,000. In 1997, Capstone also acquired
ownership of the Company's Greater Pittsburgh, Pennsylvania inpatient
rehabilitation facility, which had been leased by the Company from an unrelated
lessor. The Company's annual lease payment under such lease is $1,500,000.
Richard M. Scrushy, Chairman of the Board and Chief Executive Officer of the
Company, and Michael D. Martin, Executive Vice President, Chief Financial
Officer and Treasurer of the Company, were among the founders of Capstone and
serve on its Board of Directors. At March 1, 1998, Mr. Scrushy owned
approximately 1.62% of the issued and outstanding capital stock of Capstone, and
Mr. Martin owned approximately 0.61% of the issued and outstanding capital stock
of Capstone. In addition, the Company owned approximately 0.32% of the issued
and outstanding capital stock of Capstone at March 1, 1998. The Company believes
that all transactions involving Capstone were effected on terms no less
favorable than those which could have been obtained in transactions with
independent third parties.
Horizon/CMS is party to an agreement with AMI Aviation II, L.L.C. ("AMI")
with respect to the use of an airplane owned by AMI. Neal M. Elliott, who was
Chairman, President and Chief Executive Officer of Horizon/CMS prior to its
acquisition by the Company in October 1997 and who served as a Director of the
Company from October 1997 until his death in February 1998, was Managing Member
of AMI, a position which is now held by a trust of which Mr. Elliott's widow is
a trustee. Mr. Elliott owned, and such trust now owns, a 99% interest in AMI.
Under the use agreement, Horizon/CMS is obligated to pay $43,000 per month
through December 1999 and $57,600 per month from January 2000 through December
2004 for up to 30 hours per month of utilization of the airplane, plus certain
operating expenses of the airplane. The Company has caused Horizon/CMS to
continue to honor such use agreement, and is currently exploring available
options with respect to continued use of the airplane.
In November 1997, the Company agreed to lend up to $10,000,000 to 21st
Century Health Ventures L.L.C. ("21st Century"), an entity formed to sponsor a
private equity investment fund investing in the healthcare industry. Richard M.
Scrushy, Chairman of the Board and Chief Executive Officer of the
71
Company and Michael D. Martin, Executive Vice President, Chief Financial Officer
and a Director of the Company, along with another individual not employed by the
Company, are the principals of 21st Century. The purpose of the loan was to
facilitate certain investments by 21st Century prior to the establishment of its
proposed private equity fund, in which the Company and third party investors are
expected to invest. When established, investment by the Company in such private
equity fund is expected to allow the Company to benefit from the opportunity to
participate in investments in healthcare businesses that are not part of the
Company's core businesses, but which the Company believes provide opportunities
for growth. Amounts outstanding under the loan bear interest at 1% over the
prime rate announced from time to time by AmSouth Bank of Alabama and are
repayable upon demand by the Company. At December 31, 1997, 21st Century had
drawn an aggregate of $1,708,333 under the $10,000,000 commitment, of which
$1,500,000 was used to purchase 576,924 shares of Series B Preferred Convertible
Preferred Stock in Summerville Healthcare Group, Inc. ("Summerville"), a
developer and operator of assisted living facilities, and the remainder of which
was used to provide a loan to Physician Solutions, Inc., a provider of
management services to pathology groups. The Company owns an aggregate of
3,361,539 shares of Series B Convertible Preferred Stock of Summerville, which
it acquired in two transactions in July and November 1997. In connection with
the July transaction, Mr. Scrushy and Mr. Martin were appointed to the Board of
Directors of Summerville.
At various times, the Company has made loans to executive officers to
assist them in meeting financial obligations at certain times when they were
requested by the Company to refrain from selling Common Stock in the open
market. At January 1, 1997, loans in the following original principal amounts
were outstanding: $460,000 to Larry R. House, a Director and a former executive
officer, $500,000 to Aaron Beam, Jr., then Executive Vice President and Chief
Financial Officer and a Director, and $140,000 and $350,000 to William T. Owens,
Senior Vice President and Controller. Outstanding principal balances at December
31, 1997 were $447,000 for Mr. House, $500,000 for Mr. Beam and an aggregate of
$476,000 for Mr. Owens. In connection with Mr. Beam's retirement, the Company
agreed to forgive his loan over a period of five years in exchange for his
provision of consulting services to the Company over such period. Such loans
bear interest at the rate of 1-1/4% per annum below the prime rate of AmSouth
Bank of Alabama, Birmingham, Alabama, and are payable on demand.
72
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) Financial Statements, Financial Statement Schedules and Exhibits.
1. Financial Statements.
The consolidated financial statements of the Company and its subsidiaries
filed as a part of this Annual Report on Form 10-K are listed in Item 8 of this
Annual Report on Form 10-K, which listing is hereby incorporated herein by
reference.
2. Financial Statement Schedules.
The financial statement schedules required by Regulation S-X are filed
under Item 14(d) of this Annual Report on Form 10-K, as listed below:
Schedules Supporting the Financial Statements
Schedule II Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission have been
omitted because they are not required under the related instructions or are
inapplicable, or because the information has been provided in the Consolidated
Financial Statements or the Notes thereto.
3. Exhibits.
The Exhibits filed as a part of this Annual Report are listed in Item 14(c)
of this Annual Report on Form 10-K, which listing is hereby incorporated herein
by reference.
(b) Reports on Form 8-K.
During the last quarter of the period covered by this Annual Report on Form
10-K, the Company filed (i) a Current Report on Form 8-K dated October 29, 1997,
reporting under Item 2 the consummation of the acquisition of Horizon/CMS
Healthcare Corporation and reporting under Item 7 certain required historical
and pro forma financial information and (ii) a Current Report on Form 8-K dated
December 31, 1997, reporting under Item 2 the sale of the long-term care assets
of Horizon/CMS to Integrated Health Services, Inc. and reporting under Item 7
certain required pro forma financial information.
(c) Exhibits.
The Exhibits required by Regulation S-K are set forth in the following list
and are filed either by incorporation by reference from previous filings with
the Securities and Exchange Commission or by attachment to this Annual Report on
Form 10-K as so indicated in such list.
(2)-1 Amended and Restated Plan and Agreement of Merger, dated as of
September 18, 1994, among HEALTHSOUTH Rehabilitation Corporation, RRS
Acquisitions Company, Inc. and ReLife, Inc., filed as Exhibit (2)-1 to
the Company's Registration Statement on Form S-4 (Registration No.
33-55929), is hereby incorporated by reference.
(2)-2 Amended and Restated Plan and Agreement of Merger, dated as of January
22, 1995, among HEALTHSOUTH Corporation, ASC Atlanta Acquisition
Company, Inc. and Surgical Health Corporation, filed as Exhibit (2)-4
to the Company's Annual Report on Form 10-K for the Fiscal Year Ended
December 31, 1994, is hereby incorporated by reference.
(2)-3 Stock Purchase Agreement, dated February 3, 1995, among HEALTHSOUTH
Corporation, NovaCare, Inc. and NC Resources, Inc., filed as Exhibit
(2)-3 to the Company's Annual Report on Form 10-K for the Fiscal Year
Ended December 31, 1994, is hereby incorporated by reference.
73
(2)-4 Plan and Agreement of Merger, dated August 23, 1995, among HEALTHSOUTH
Corporation, SSCI Acquisition Corporation and Sutter Surgery Centers,
Inc., filed as Exhibit (2) to the Company's Registration Statement on
Form S-4 (Registration No. 33-63-055) is hereby incorporated by
reference.
(2)-5 Amendment to Plan and Agreement of Merger, dated October 26, 1995,
among HEALTHSOUTH Corporation, SSCI Acquisition Corporation and Sutter
Surgery Centers, Inc., filed as Exhibit (2)-5 to the Company's Annual
Report on Form 10-K for the Fiscal Year Ended December 31, 1995, is
hereby incorporated by reference.
(2)-6 Amended and Restated Plan and Agreement of Merger, dated as of October
9, 1995, among HEALTHSOUTH Corporation, SCA Acquisition Corporation
and Surgical Care Affiliates, Inc., filed as Exhibit (2)-1 to
Amendment No. 1 to the Company's Registration Statement on Form S-4
(Registration No. 33-64935), is hereby incorporated by reference.
(2)-7 Agreement and Plan of Merger, dated December 16, 1995, among
HEALTHSOUTH Corporation, Aladdin Acquisition Corporation and Advantage
Health Corporation, filed as Exhibit (2)-1 to the Company's
Registration Statement on Form S-4 (Registration No. 333-825), is
hereby incorporated by reference.
(2)-8 Plan and Agreement of Merger, dated May 16, 1996, among HEALTHSOUTH
Corporation, Empire Acquisition Corporation and Professional Sports
Care Management, Inc., filed as Exhibit (2)-1 to the Company's
Registration Statement on Form S-4 (Registration No. 333- 08449), is
hereby incorporated by reference.
(2)-9 Plan and Agreement of Merger, dated September 11, 1996, among
HEALTHSOUTH Corporation, Warwick Acquisition Corporation and
ReadiCare, Inc., filed as Exhibit (2)-1 to the Company's Registration
Statement on Form S-4 (Registration No. 333-14697), is hereby
incorporated by reference.
(2)-10 Plan and Agreement of Merger, dated December 2, 1996, among
HEALTHSOUTH Corporation, Hammer Acquisition Corporation and Health
Images, Inc., filed as Exhibit (2)-1 to the Company's Registration
Statement on Form S-4 (Registration No. 333-19439), is hereby
incorporated by reference.
(2)-11 Plan and Agreement of Merger, dated February 17, 1997, among
HEALTHSOUTH Corporation, Reid Acquisition Corporation and Horizon/CMS
Healthcare Corporation, as amended, filed as Exhibit 2 to the
Company's Registration Statement on Form S-4 (Registration No.
333-36419), is hereby incorporated by reference.
(2)-12 Purchase and Sale Agreement, dated November 3, 1997, among HEALTHSOUTH
Corporation, Horizon/CMS Healthcare Corporation and Integrated Health
Services, Inc., filed as Exhibit 2.1 to the Company's Current Report
on Form 8-K, dated December 31, 1997, is hereby incorporated by
reference.
(2)-13 Amendment to Purchase and Sale Agreement, dated December 31, 1997,
among HEALTH- SOUTH Corporation, Horizon/CMS Healthcare Corporation
and Integrated Health Services, Inc., filed as Exhibit 2.2 to the
Company's Current Report on Form 8-K, dated Decem- ber 31, 1997, is
hereby incorporated by reference.
(2)-14 Second Amendment to Purchase and Sale Agreement, dated March 4, 1998,
among HEALTHSOUTH Corporation, Horizon/CMS Healthcare Corporation and
Integrated Health Services, Inc.
(3)-1 Restated Certificate of Incorporation of HEALTHSOUTH Corporation, as
filed in the Office of the Secretary of State of the State of Delaware
on March 13, 1997, filed as Exhibit (3)-1 to the Company's Annual
Report on Form 10-K for the Fiscal Year Ended December 31, 1996, is
hereby incorporated by reference.
(3)-2 Bylaws of HEALTHSOUTH Rehabilitation Corporation, filed as Exhibit
(3)-2 to the Company's Annual Report on Form 10-K for the Fiscal Year
Ended December 31, 1991, are hereby incorporated by reference.
74
(4)-1 Indenture, dated March 24, 1994, between HEALTHSOUTH Rehabilitation
Corporation and NationsBank of Georgia, National Association, relating
to the Company's 9.5% Senior Subordinated Notes due 2001, filed as
Exhibit (4)-1 to the Company's Annual Report on Form 10-K for the
Fiscal Year Ended December 31, 1994, is hereby incorporated by
reference.
(4)-2 Subordinated Indenture, dated March 20, 1998, between HEALTHSOUTH
Corporation and The Bank of Nova Scotia Trust Company of New York, as
Trustee.
(4)-3 Officer's Certificate pursuant to Sections 2.3 and 11.5 of the
Subordinated Indenture, dated March 20, 1998, between HEALTHSOUTH
Corporation and The Bank of Nova Scotia Trust Company of New York, as
Trustee, relating to the Company's 3.25% Convertible Subordinated
Debentures due 2003.
(4)-4 Registration Rights Agreement, dated March 17, 1998, among HEALTHSOUTH
Corporation and Smith Barney Inc., Bear, Stearns & Co. Inc., Cowen &
Company, Credit Suisse First Boston Corporation, J.P. Morgan
Securities Inc., Morgan Stanley & Co. Incorporated, NationsBanc
Montgomery Securities LLC and PaineWebber Incorporated, relating to
the Company's 3.25% Convertible Subordinated Debentures due 2003.
(10)-1 1984 Incentive Stock Option Plan, as amended, filed as Exhibit (10)-1
to the Company's Annual Report on Form 10-K for the Fiscal Year Ended
December 31, 1987, is hereby incorporated herein by reference.
(10)-2 1988 Non-Qualified Stock Option Plan, filed as Exhibit 4(a) to the
Company's Registration Statement on Form S-8 (Registration No.
33-23642), is hereby incorporated herein by reference.
(10)-3 1989 Stock Option Plan, filed as Exhibit (10)-6 to the Company's
Annual Report on Form 10-K for the Fiscal Year Ended December 31,
1989, is hereby incorporated by reference.
(10)-4 1990 Stock Option Plan, filed as Exhibit (10)-13 to the Company's
Annual Report on Form 10-K for the Fiscal Year ended December 31,
1990, is hereby incorporated by reference.
(10)-5 1991 Stock Option Plan, as amended, filed as Exhibit (10)-15 to the
Company's Annual Report on Form 10-K for the Fiscal Year ended
December 31, 1991, is hereby incorporated herein by reference.
(10)-6 1992 Stock Option Plan, filed as Exhibit (10)-8 to the Company's
Annual Report on Form 10-K for the Fiscal Year Ended December 31,
1992, is hereby incorporated by reference.
(10)-7 1993 Stock Option Plan, filed as Exhibit (10)-10 to the Company's
Annual Report on Form 10-K for the Fiscal Year Ended December 31,
1993, is hereby incorporated by reference.
(10)-8 Amended and Restated 1993 Consultants Stock Option Plan, filed as
Exhibit 4 to the Company's Registration Statement on Form S-8
(Commission File No. 333-42305), is hereby in- corporated by
reference.
(10)-9 1995 Stock Option Plan, filed as Exhibit (10)-14 to the Company's
Annual Report on Form 10-K for the Fiscal Year Ended December 31,
1995, is hereby incorporated by reference.
(10)-10 Employment Agreement, dated July 23, 1986, between HEALTHSOUTH
Rehabilitation Corporation and Richard M. Scrushy, as amended, filed
as Exhibit (10)-16 to the Company's Annual Report on Form 10-K for the
Fiscal Year Ended December 31, 1995, is hereby incorporated by
reference.
(10)-11 Third Amended and Restated Credit Agreement, dated as of April 11,
1996, between HEALTHSOUTH Corporation and NationsBank, N.A., filed as
Exhibit (10)-17 to the Company's Annual Report on Form 10-K for the
Fiscal Year Ended December 31, 1996, is hereby incorporated by
reference.
75
(10)-12 Form of Indemnity Agreement entered into between HEALTHSOUTH
Rehabilitation Corporation and each of its Directors, filed as Exhibit
(10)-13 to the Company's Annual Report on Form 10-K for the Fiscal
Year Ended December 31, 1991, is hereby incorporated by reference.
(10)-13 Surgical Health Corporation 1992 Stock Option Plan, filed as Exhibit
10(aa) to Surgical Health Corporation's Registration Statement on Form
S-4 (Commission File No. 33-70582), is hereby incorporated by
reference.
(10)-14 Surgical Health Corporation 1993 Stock Option Plan, filed as Exhibit
10(bb) to Surgical Health Corporation's Registration Statement on Form
S-4 (Commission File No. 33-70582), is hereby incorporated by
reference.
(10)-15 Surgical Health Corporation 1994 Stock Option Plan, filed as Exhibit
10(pp) to Surgical Health Corporation's Quarterly Report on Form 10-Q
for the Quarter Ended September 30, 1994, is hereby incorporated by
reference.
(10)-16 Heritage Surgical Corporation 1992 Stock Option Plan, filed as Exhibit
4(d) to the Company's Registration Statement on Form S-8 (Commission
File No. 33-60231), is hereby incorporated by reference.
(10)-17 Heritage Surgical Corporation 1993 Stock Option Plan, filed as Exhibit
4(e) to the Company's Registration Statement on Form S-8 (Commission
File No. 33-60231), is hereby incorporated by reference.
(10)-18 Sutter Surgery Centers, Inc. 1993 Stock Option Plan, Non-Qualified
Stock Option Plan and Agreement (Saibeni), Non-Qualified Stock Option
Plan and Agreement (Shah), NonQualified Stock Option Plan and
Agreement (Akella), Non-Qualified Stock Option Plan and Agreement
(Kelly) and Non-Qualified Stock Option Plan and Agreement (May), filed
as Exhibits 4(a) -- 4(f) to the Company's Registration Statement on
Form S-8 (Commission File No. 33-64615), are hereby incorporated by
reference.
(10)-19 Surgical Care Affiliates Incentive Stock Plan of 1986, filed as
Exhibit 10(g) to Surgical Care Affiliates Inc.'s Annual Report on Form
10-K for the Fiscal Year Ended December 31, 1993, is hereby
incorporated by reference.
(10)-20 Surgical Care Affiliates 1990 Non-Qualified Stock Option Plan for
Non-Employee Directors, filed as Exhibit 10(i) to Surgical Care
Affiliates, Inc.'s Annual Report on Form 10-K for the Fiscal Year
Ended December 31, 1990, is hereby incorporated by reference.
(10)-21 Professional Sports Care Management, Inc. 1992 Stock Option Plan, as
amended, filed as Exhibits 10.1 -- 10.3 to Professional Sports Care
Management, Inc.'s Registration Statement on Form S-1 (Commission File
No. 33-81654), is hereby incorporated by reference.
(10)-22 Professional Sports Care Management, Inc. 1994 Stock Incentive Plan,
filed as Exhibit 10.4 to Professional Sports Care Management, Inc.'s
Registration Statement on Form S-1 (Commission File No. 33-81654), is
hereby incorporated by reference.
(10)-23 Professional Sports Care Management, Inc. 1994 Directors' Stock Option
Plan, filed as Exhibit 10.5 to Professional Sports Care Management,
Inc.'s Registration Statement on Form S-1 (Commission File No.
33-81654), is hereby incorporated by reference.
(10)-24 ReadiCare, Inc. 1991 Stock Option Plan, filed as an exhibit to
ReadiCare, Inc.'s Annual Report on Form 10-K for the Fiscal Year Ended
February 29, 1992, is hereby incorporated by reference.
(10)-25 ReadiCare, Inc. Stock Option Plan for Non-Employee Directors, as
amended, filed as an exhibit to ReadiCare, Inc's Annual Report on Form
10-K for the Fiscal Year Ended February 29, 1992 and as an exhibit to
ReadiCare, Inc.'s Annual Report on Form 10-K for the Fiscal Year Ended
February 28, 1994, is hereby incorporated by reference.
(10)-26 1997 Stock Option Plan, filed as Exhibit 4 to the Company's
Registration Statement on Form S-8 (Registration No. 333-42307) is
hereby incorporated by reference.
76
(10)-27 Bridge Credit Agreement, dated October 22, 1997, between HEALTHSOUTH
Corporation and NationsBank, National Association.
(10)-28 Health Images, Inc. Non-Qualified Stock Option Plan, filed as Exhibit
10(d)(i) to Health Images, Inc.'s Annual Report on Form 10-K for the
Fiscal Year Ended December 31, 1995, is hereby incorporated by
reference.
(10)-29 Amended and Restated Employee Incentive Stock Option Plan, as amended,
of Health Images, Inc., filed as Exhibits 10(c)(i), 10(c)(ii),
10(c)(iii) and 10(c)(iv) to Health Images, Inc.'s Annual Report on
Form 10-K for the Fiscal Year Ended December 31, 1995, is hereby
incorporated herein by reference.
(10)-30 Form of Health Images, Inc. 1995 Formula Stock Option Plan, filed as
Exhibit 10(d)(iv) to Health Images, Inc.'s Annual Report on Form 10-K
for the Fiscal Year Ended December 31, 1995, is hereby incorporated
herein by reference.
(10)-31 1996 Employee Incentive Stock Option Plan of Health Images, Inc.,
filed as Exhibit 4(v) to the Company's Registration Statement on Form
S-8 (Registration No. 333-24429), is hereby incorporated by reference.
(10)-32 Employee Stock Option Plan of Horizon/CMS Healthcare Corporation,
filed as Exhibit 10.5 to Horizon/CMS Healthcare Corporation's Annual
Report on Form 10-K for the Fiscal Year Ended May 31, 1994, is hereby
incorporated by reference.
(10)-33 First Amendment to Employee Stock Option Plan of Horizon/CMS
Healthcare Corporation, filed as Exhibit 10.6 to Horizon/CMS
Healthcare Corporation's Annual Report on Form 10-K for the Fiscal
Year Ended May 31, 1994, is hereby incorporated by reference.
(10)-34 Corrected Second Amendment to Employee Stock Option Plan of
Horizon/CMS Healthcare Corporation, filed as Exhibit 10.7 to
Horizon/CMS Healthcare Corporation's Annual Report on Form 10-K for
the Fiscal Year Ended May 31, 1994, is hereby incorporated by
reference.
(10)-35 Amendment No. 3 to Employee Stock Option Plan of Horizon/CMS
Healthcare Corporation, filed as Exhibit 10.12 to Horizon/CMS
Healthcare Corporation's Annual Report on Form 10-K for the Fiscal
Year Ended May 31, 1995, is hereby incorporated by reference.
(10)-36 Horizon Healthcare Corporation Stock Option Plan for Non-Employee
Directors, filed as Exhibit 10.6 to Horizon/CMS Healthcare
Corporation's Annual Report on Form 10-K for the Fiscal Year Ended May
31, 1994, is hereby incorporated by reference.
(10)-37 Amendment No. 1 to Horizon Healthcare Corporation Stock Option Plan
for Non-Employee Directors, filed as Exhibit 10.14 to Horizon/CMS
Healthcare Corporation's Annual Report on Form 10-K for the Fiscal
Year Ended May 31, 1996, is hereby incorporated by reference.
(10)-38 Horizon/CMS Healthcare Corporation 1995 Incentive Plan, filed as
Exhibit 4.1 to Horizon/ CMS Healthcare Corporation's Registration
Statement on Form S-8 (Registration No. 33- 63199), is hereby
incorporated by reference.
(10)-39 Horizon/CMS Healthcare Corporation 1995 Non-Employee Directors' Stock
Option Plan, filed as Exhibit 4.2 to Horizon/CMS Healthcare
Corporation's Registration Statement on Form S-8 (Registration No.
33-63199), is hereby incorporated by reference.
(10)-40 First Amendment to Horizon Healthcare Corporation Employee Stock
Purchase Plan, filed as Exhibit 10.18 to Horizon/CMS Healthcare
Corporation's Annual Report on Form 10-K for the Fiscal Year Ended May
31, 1996, is hereby incorporated by reference.
(10)-41 Continental Medical Systems, Inc. 1994 Stock Option Plan (as amended
and restated effective December 1, 1991), Amendment No. 1 to
Continental Medical Systems, Inc. 1986 Stock Option Plan and Amendment
No. 2 to Continental Medical Systems, Inc. 1986 Stock Option Plan,
filed as Exhibit 4.1 to Horizon/CMS Healthcare Corporation's
Registration Statement on Form S-8 (Registration No. 33-61697), is
hereby incorporated by reference.
77
(10)-42 Continental Medical Systems, Inc. 1989 Non-Employee Directors' Stock
Option Plan (as amended and restated effective December 1, 1991),
filed as Exhibit 4.2 to Horizon/CMS Healthcare Corporation's
Registration Statement on Form S-8 (Registration No. 33-61697), is
hereby incorporated by reference.
(10)-43 Continental Medical Systems, Inc. 1992 CEO Stock Option Plan and
Amendment No. 1 to Continental Medical Systems, Inc. 1992 CEO Stock
Option Plan, filed as Exhibit 4.3 to Horizon/CMS Healthcare
Corporation's Registration Statement on Form S-8 (Registration No.
33-61697), is hereby incorporated by reference.
(10)-44 Continental Medical Systems, Inc. 1993 Nonqualified Stock Option Plan,
Amendment No. 1 to Continental Medical Systems, Inc. 1993 Nonqualified
Stock Option Plan and Amendment No. 2 to Continental Medical Systems,
Inc. 1993 Nonqualified Stock Option Plan, filed as Exhibit 4.4 to
Horizon/CMS Healthcare Corporation's Registration Statement on Form
S-8 (Registration No. 33-61697), is hereby incorporated by reference.
(10)-45 Continental Medical Systems, Inc. 1994 Stock Option Plan, filed as
Exhibit 4.5 to Horizon/CMS Healthcare Corporation's Registration
Statement on Form S-8 (Registration No. 33-61697), is hereby
incorporated by reference.
(21) Subsidiaries of HEALTHSOUTH Corporation.
(23) Consent of Ernst & Young LLP.
(27) Financial Data Schedule.
(d) Financial Statement Schedules.
Schedule II: Valuation and Qualifying Accounts
78
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
- - --------------------------------------- -------------- ----------------------------------------- ------------------ --------------
BALANCE AT ADDITIONS CHARGED ADDITIONS CHARGED
BEGINNING OF TO COSTS AND TO OTHER ACCOUNTS - DEDUCTIONS - BALANCE AT
DESCRIPTION PERIOD EXPENSES DESCRIBE DESCRIBE END OF PERIOD
- - --------------------------------------- -------------- ------------------- --------------------- ------------------ --------------
(IN THOUSANDS)
Year ended December 31, 1995:
Allowance for doubtful accounts ....... $44,662 $42,305 $ 21,078 (1) $ 47,945 (2) $ 60,100
======= ======= ========= ======== ========
Year ended December 31, 1996:
Allowance for doubtful accounts ....... $60,100 $58,637 $ 13,643 (1) $ 57,020 (2) $ 75,360
======= ======= ========= ========== ========
Year ended December 31, 1997:
Allowance for doubtful accounts ....... $75,360 $71,468 $ 40,496 (1) $ 63,778 (2) $123,545
======= ======= ========= ========== ========
- - ----------
(1) Allowances of acquisitions in years 1995, 1996 and 1997, respectively.
(2) Write-offs of uncollectible patient accounts receivable.
79
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HEALTHSOUTH CORPORATION
By RICHARD M. SCRUSHY
-----------------------------
Richard M. Scrushy,
Chairman of the Board
and Chief Executive Officer
Date: March 30, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE CAPACITY DATE
- - ------------------------------ ------------------------------- --------------
RICHARD M. SCRUSHY Chairman of the Board March 30, 1998
--------------------------- and Chief Executive Officer
Richard M. Scrushy and Director
MICHAEL D. MARTIN Executive Vice President, March 30, 1998
--------------------------- Chief Financial Officer
Michael D. Martin and Treasurer
and Director
WILLIAM T. OWENS Group Senior Vice March 30, 1998
--------------------------- President-Finance
William T. Owens and Controller
(Principal Accounting Officer)
C. SAGE GIVENS March 30, 1998
---------------------------
C. Sage Givens Director
CHARLES W. NEWHALL III March 30, 1998
---------------------------
Charles W. Newhall III Director
GEORGE H. STRONG March 30, 1998
---------------------------
George H. Strong Director
PHILLIP C. WATKINS March 30, 1998
---------------------------
Phillip C. Watkins Director
JOHN S. CHAMBERLIN March 30, 1998
---------------------------
John S. Chamberlin Director
LARRY R. HOUSE March 30, 1998
---------------------------
Larry R. House Director
80
ANTHONY J. TANNER
- - ---------------------------
Anthony J. Tanner Director March 30, 1998
JAMES P. BENNETT March 30, 1998
---------------------------
James P. Bennett Director
P. DARYL BROWN March 30, 1998
---------------------------
P. Daryl Brown Director
JOEL C. GORDON March 30, 1998
---------------------------
Joel C. Gordon Director
81
HEALTHSOUTH CORPORATION
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED
DECEMBER 31, 1997
EXHIBITS
INDEX TO EXHIBITS
(2)-1 Amended and Restated Plan and Agreement of Merger, dated as of
September 18, 1994, among HEALTHSOUTH Rehabilitation Corporation, RRS
Acquisitions Company, Inc. and ReLife, Inc., filed as Exhibit (2)-1 to
the Company's Registration Statement on Form S-4 (Registration No.
33-55929), is hereby incorporated by reference.
(2)-2 Amended and Restated Plan and Agreement of Merger, dated as of January
22, 1995, among HEALTHSOUTH Corporation, ASC Atlanta Acquisition
Company, Inc. and Surgical Health Corporation, filed as Exhibit (2)-4
to the Company's Annual Report on Form 10-K for the Fiscal Year Ended
December 31, 1994, is hereby incorporated by reference.
(2)-3 Stock Purchase Agreement, dated February 3, 1995, among HEALTHSOUTH
Corporation, NovaCare, Inc. and NC Resources, Inc., filed as Exhibit
(2)-3 to the Company's Annual Report on Form 10-K for the Fiscal Year
Ended December 31, 1994, is hereby incorporated by reference.
(2)-4 Plan and Agreement of Merger, dated August 23, 1995, among HEALTHSOUTH
Corporation, SSCI Acquisition Corporation and Sutter Surgery Centers,
Inc., filed as Exhibit (2) to the Company's Registration Statement on
Form S-4 (Registration No. 33-63-055) is hereby incorporated by
reference.
(2)-5 Amendment to Plan and Agreement of Merger, dated October 26, 1995,
among HEALTHSOUTH Corporation, SSCI Acquisition Corporation and Sutter
Surgery Centers, Inc., filed as Exhibit (2)-5 to the Company's Annual
Report on Form 10-K for the Fiscal Year Ended December 31, 1995, is
hereby incorporated by reference.
(2)-6 Amended and Restated Plan and Agreement of Merger, dated as of October
9, 1995, among HEALTHSOUTH Corporation, SCA Acquisition Corporation
and Surgical Care Affiliates, Inc., filed as Exhibit (2)-1 to
Amendment No. 1 to the Company's Registration Statement on Form S-4
(Registration No. 33-64935), is hereby incorporated by reference.
(2)-7 Agreement and Plan of Merger, dated December 16, 1995, among
HEALTHSOUTH Corporation, Aladdin Acquisition Corporation and Advantage
Health Corporation, filed as Exhibit (2)-1 to the Company's
Registration Statement on Form S-4 (Registration No. 333-825), is
hereby incorporated by reference.
(2)-8 Plan and Agreement of Merger, dated May 16, 1996, among HEALTHSOUTH
Corporation, Empire Acquisition Corporation and Professional Sports
Care Management, Inc., filed as Exhibit (2)-1 to the
Company's Registration Statement on Form S-4 (Registration No.
333-08449), is hereby incorporated by reference.
(2)-9 Plan and Agreement of Merger, dated September 11, 1996, among
HEALTHSOUTH Corporation, Warwick Acquisition Corporation and
ReadiCare, Inc., filed as Exhibit (2)-1 to the Company's Registration
Statement on Form S-4 (Registration No. 333-14697), is hereby
incorporated by reference.
(2)-10 Plan and Agreement of Merger, dated December 2, 1996, among
HEALTHSOUTH Corporation, Hammer Acquisition Corporation and Health
Images, Inc., filed as Exhibit (2)-1 to the Company's Registration
Statement on Form S-4 (Registration No. 333-19439), is hereby
incorporated by reference.
(2)-11 Plan and Agreement of Merger, dated February 17, 1997, among
HEALTHSOUTH Corporation, Reid Acquisition Corporation and Horizon/CMS
Healthcare Corporation, as amended, filed as Exhibit 2 to the
Company's Registration Statement on Form S-4 (Registration No.
333-36419), is hereby incorporated by reference.
(2)-12 Purchase and Sale Agreement, dated November 3, 1997, among HEALTHSOUTH
Corporation, Horizon/CMS Healthcare Corporation and Integrated Health
Services, Inc., filed as Exhibit 2.1 to the Company's Current Report
on Form 8-K, dated December 31, 1997, is hereby incorporated by
reference.
(2)-13 Amendment to Purchase and Sale Agreement, dated December 31, 1997,
among HEALTHSOUTH Corporation, Horizon/CMS Healthcare Corporation and
Integrated Health Services, Inc., filed as Exhibit 2.2 to the
Company's Current Report on Form 8-K, dated December 31, 1997, is
hereby incorporated by reference.
(2)-14* Second Amendment to Purchase and Sale Agreement, dated March 4, 1998,
among HEALTHSOUTH Corporation, Horizon/CMS Healthcare Corporation and
Integrated Health Services, Inc.
(3)-1 Restated Certificate of Incorporation of HEALTHSOUTH Corporation, as
filed in the Office of the Secretary of State of the State of Delaware
on March 13, 1997, filed as Exhibit (3)-1 to the Company's Annual
Report on Form 10-K for the Fiscal Year Ended December 31, 1996, is
hereby incorporated by reference.
(3)-2 Bylaws of HEALTHSOUTH Rehabilitation Corporation, filed as Exhibit
(3)-2 to the Company's Annual Report on Form 10-K for the Fiscal Year
Ended December 31, 1991, are hereby incorporated by reference.
(4)-1 Indenture, dated March 24, 1994, between HEALTHSOUTH Rehabilitation
Corporation and NationsBank of Georgia, National Association, relating
to the Company's 9.5% Senior Subordinated Notes
due 2001, filed as Exhibit (4)-1 to the Company's Annual Report on
Form 10-K for the Fiscal Year Ended December 31, 1994, is hereby
incorporated by reference.
(4)-2* Subordinated Indenture, dated March 20, 1998, between HEALTHSOUTH
Corporation and The Bank of Nova Scotia Trust Company of New York, as
Trustee.
(4)-3* Officer's Certificate pursuant to Sections 2.3 and 11.5 of the
Subordinated Indenture, dated March 20, 1998, between HEALTHSOUTH
Corporation and The Bank of Nova Scotia Trust Company of New York, as
Trustee, relating to the Company's 3.25% Convertible Subordinated
Debentures due 2003.
(4)-4* Registration Rights Agreement, dated March 17, 1998, among HEALTHSOUTH
Corporation and Smith Barney Inc., Bear, Stearns & Co. Inc., Cowen &
Company, Credit Suisse First Boston Corporation, J.P. Morgan
Securities Inc., Morgan Stanley & Co. Incorporated, NationsBanc
Montgomery Securities LLC and PaineWebber Incorporated, relating to
the Company's 3.25% Convertible Subordinated Debentures due 2003.
(10)-1 1984 Incentive Stock Option Plan, as amended, filed as Exhibit (10)-1
to the Company's Annual Report on Form 10-K for the Fiscal Year Ended
December 31, 1987, is hereby incorporated herein by reference.
(10)-2 1988 Non-Qualified Stock Option Plan, filed as Exhibit 4(a) to the
Company's Registration Statement on Form S-8 (Registration No.
33-23642), is hereby incorporated herein by reference.
(10)-3 1989 Stock Option Plan, filed as Exhibit (10)-6 to the Company's
Annual Report on Form 10-K for the Fiscal Year Ended December 31,
1989, is hereby incorporated by reference.
(10)-4 1990 Stock Option Plan, filed as Exhibit (10)-13 to the Company's
Annual Report on Form 10-K for the Fiscal Year ended December 31,
1990, is hereby incorporated by reference.
(10)-5 1991 Stock Option Plan, as amended, filed as Exhibit (10)-15 to the
Company's Annual Report on Form 10-K for the Fiscal Year ended
December 31, 1991, is hereby incorporated herein by reference.
(10)-6 1992 Stock Option Plan, filed as Exhibit (10)-8 to the Company's
Annual Report on Form 10-K for the Fiscal Year Ended December 31,
1992, is hereby incorporated by reference.
(10)-7 1993 Stock Option Plan, filed as Exhibit (10)-10 to the Company's
Annual Report on Form 10-K for the Fiscal Year Ended December 31,
1993, is hereby incorporated by reference.
(10)-8 Amended and Restated 1993 Consultants Stock Option Plan, filed as
Exhibit 4 to the Company's Registration Statement on Form S-8
(Commission File No. 333-42305), is hereby incorporated by reference.
(10)-9 1995 Stock Option Plan, filed as Exhibit (10)-14 to the Company's
Annual Report on Form 10-K for the Fiscal Year Ended December 31,
1995, is hereby incorporated by reference.
(10)-10 Employment Agreement, dated July 23, 1986, between HEALTHSOUTH
Rehabilitation Corporation and Richard M. Scrushy, as amended, filed
as Exhibit (10)-16 to the Company's Annual Report on Form 10-K for the
Fiscal Year Ended December 31, 1995, is hereby incorporated by
reference.
(10)-11 Third Amended and Restated Credit Agreement, dated as of April 11,
1996, between HEALTHSOUTH Corporation and NationsBank, N.A., filed as
Exhibit (10)-17 to the Company's Annual Report on Form 10-K for the
Fiscal Year Ended December 31, 1996, is hereby incorporated by
reference.
(10)-12 Form of Indemnity Agreement entered into between HEALTHSOUTH
Rehabilitation Corporation and each of its Directors, filed as Exhibit
(10)-13 to the Company's Annual Report on Form 10-K for the Fiscal
Year Ended December 31, 1991, is hereby incorporated by reference.
(10)-13 Surgical Health Corporation 1992 Stock Option Plan, filed as Exhibit
10(aa) to Surgical Health Corporation's Registration Statement on Form
S-4 (Commission File No. 33-70582), is hereby incorporated by
reference.
(10)-14 Surgical Health Corporation 1993 Stock Option Plan, filed as Exhibit
10(bb) to Surgical Health Corporation's Registration Statement on Form
S-4 (Commission File No. 33-70582), is hereby incorporated by
reference.
(10)-15 Surgical Health Corporation 1994 Stock Option Plan, filed as Exhibit
10(pp) to Surgical Health Corporation's Quarterly Report on Form 10-Q
for the Quarter Ended September 30, 1994, is hereby incorporated by
reference.
(10)-16 Heritage Surgical Corporation 1992 Stock Option Plan, filed as Exhibit
4(d) to the Company's Registration Statement on Form S-8 (Commission
File No. 33-60231), is hereby incorporated by reference.
(10)-17 Heritage Surgical Corporation 1993 Stock Option Plan, filed as Exhibit
4(e) to the Company's Registration Statement on Form S-8 (Commission
File No. 33-60231), is hereby incorporated by reference.
(10)-18 Sutter Surgery Centers, Inc. 1993 Stock Option Plan, Non-Qualified
Stock Option Plan and Agreement (Saibeni), Non-Qualified Stock Option
Plan and Agreement (Shah), Non-Qualified Stock Option Plan and
Agreement (Akella), Non-Qualified Stock Option Plan and Agreement
(Kelly) and Non-Qualified Stock Option Plan and Agreement (May), filed
as Exhibits 4(a) - 4(f) to the Company's Registration Statement on
Form S-8 (Commission File No. 33-64615), are hereby incorporated by
reference.
(10)-19 Surgical Care Affiliates Incentive Stock Plan of 1986, filed as
Exhibit 10(g) to Surgical Care Affiliates Inc.'s Annual Report on Form
10-K for the Fiscal Year Ended December 31, 1993, is hereby
incorporated by reference.
(10)-20 Surgical Care Affiliates 1990 Non-Qualified Stock Option Plan for Non-
Employee Directors, filed as Exhibit 10(i) to Surgical Care
Affiliates, Inc.'s Annual Report on Form 10-K for the Fiscal Year
Ended December 31, 1990, is hereby incorporated by reference.
(10)-21 Professional Sports Care Management, Inc. 1992 Stock Option Plan, as
amended, filed as Exhibits 10.1 - 10.3 to Professional Sports Care
Management, Inc.'s Registration Statement on Form S-1 (Commission File
No. 33-81654), is hereby incorporated by reference.
(10)-22 Professional Sports Care Management, Inc. 1994 Stock Incentive Plan,
filed as Exhibit 10.4 to Professional Sports Care Management, Inc.'s
Registration Statement on Form S-1 (Commission File No. 33-81654), is
hereby incorporated by reference.
(10)-23 Professional Sports Care Management, Inc. 1994 Directors' Stock Option
Plan, filed as Exhibit 10.5 to Professional Sports Care Management,
Inc.'s Registration Statement on Form S-1 (Commission File No. 33-
81654), is hereby incorporated by reference.
(10)-24 ReadiCare, Inc. 1991 Stock Option Plan, filed as an exhibit to
ReadiCare, Inc.'s Annual Report on Form 10-K for the Fiscal Year Ended
February 29, 1992, is hereby incorporated by reference.
(10)-25 ReadiCare, Inc. Stock Option Plan for Non-Employee Directors, as
amended, filed as an exhibit to ReadiCare, Inc's Annual Report on Form
10-K for the Fiscal Year Ended February 29, 1992 and as an exhibit to
ReadiCare, Inc.'s Annual Report on Form 10-K for the Fiscal Year Ended
February 28, 1994, is hereby incorporated by reference.
(10)-26 1997 Stock Option Plan, filed as Exhibit 4 to the Company's
Registration Statement on Form S-8 (Registration No. 333-42307) is
hereby incorporated by reference.
(10)-27* Bridge Credit Agreement, dated October 22, 1997, between HEALTHSOUTH
Corporation and NationsBank, National Association.
(10)-28 Health Images, Inc. Non-Qualified Stock Option Plan, filed as Exhibit
10(d)(i) to Health Images, Inc.'s Annual Report on Form 10-K for the
Fiscal Year Ended December 31, 1995, is hereby incorporated by
reference.
(10)-29 Amended and Restated Employee Incentive Stock Option Plan, as amended,
of Health Images, Inc., filed as Exhibits 10(c)(i), 10(c)(ii),
10(c)(iii) and 10(c)(iv) to Health Images, Inc.'s Annual Report on
Form 10-K for the Fiscal Year Ended December 31, 1995, is hereby
incorporated herein by reference.
(10)-30 Form of Health Images, Inc. 1995 Formula Stock Option Plan, filed as
Exhibit 10(d)(iv) to Health Images, Inc.'s Annual Report on Form 10-K
for the Fiscal Year Ended December 31, 1995, is hereby incorporated
herein by reference.
(10)-31 1996 Employee Incentive Stock Option Plan of Health Images, Inc.,
filed as Exhibit 4(v) to the Company's Registration Statement on Form
S-8 (Registration No. 333-24429), is hereby incorporated by reference.
(10)-32 Employee Stock Option Plan of Horizon/CMS Healthcare Corporation,
filed as Exhibit 10.5 to Horizon/CMS Healthcare Corporation's Annual
Report on Form 10-K for the Fiscal Year Ended May 31, 1994, is hereby
incorporated by reference.
(10)-33 First Amendment to Employee Stock Option Plan of Horizon/CMS
Healthcare Corporation, filed as Exhibit 10.6 to Horizon/CMS
Healthcare Corporation's Annual Report on Form 10-K for the Fiscal
Year Ended May 31, 1994, is hereby incorporated by reference.
(10)-34 Corrected Second Amendment to Employee Stock Option Plan of
Horizon/CMS Healthcare Corporation, filed as Exhibit 10.7 to
Horizon/CMS Healthcare Corporation's Annual Report on Form 10-K for
the Fiscal Year Ended May 31, 1994, is hereby incorporated by
reference.
(10)-35 Amendment No. 3 to Employee Stock Option Plan of Horizon/CMS
Healthcare Corporation, filed as Exhibit 10.12 to Horizon/CMS
Healthcare Corporation's Annual Report on Form 10-K for the Fiscal
Year Ended May 31, 1995, is hereby incorporated by reference.
(10)-36 Horizon Healthcare Corporation Stock Option Plan for Non-Employee
Directors, filed as Exhibit 10.6 to Horizon/CMS Healthcare
Corporation's Annual Report on Form 10-K for the Fiscal Year Ended May
31, 1994, is hereby incorporated by reference.
(10)-37 Amendment No. 1 to Horizon Healthcare Corporation Stock Option Plan
for Non-Employee Directors, filed as Exhibit 10.14 to Horizon/CMS
Healthcare Corporation's Annual Report on Form 10-K for the Fiscal
Year Ended May 31, 1996, is hereby incorporated by reference.
(10)-38 Horizon/CMS Healthcare Corporation 1995 Incentive Plan, filed as
Exhibit 4.1 to Horizon/CMS Healthcare Corporation's Registration
Statement on Form S-8 (Registration No. 33-63199), is hereby
incorporated by reference.
(10)-39 Horiozn/CMS Healthcare Corporation 1995 Non-Employee Directors' Stock
Option Plan, filed as Exhibit 4.2 to Horizon/CMS Healthcare
Corporation's Registration Statement on Form S-8 (Registration No. 33-
63199), is hereby incorporated by reference.
(10)-40 First Amendment to Horizon Healthcare Corporation Employee Stock
Purchase Plan, filed as Exhibit 10.18 to Horizon/CMS Healthcare
Corporation's Annual Report on Form 10-K for the Fiscal Year Ended May
31, 1996, is hereby incorporated by reference.
(10)-41 Continental Medical Systems, Inc. 1994 Stock Option Plan (as amended
and restated effective December 1, 1991), Amendment No. 1 to
Continental Medical Systems, Inc. 1986 Stock Option Plan and Amendment
No. 2 to Continental Medical Systems, Inc. 1986 Stock Option Plan,
filed as Exhibit 4.1 to Horizon/CMS Healthcare Corporation's
Registration Statement on Form S-8 (Registration No. 33- 61697), is
hereby incorporated by reference.
(10)-42 Continental Medical Systems, Inc. 1989 Non-Employee Directors' Stock
Option Plan (as amended and restated effective December 1, 1991),
filed as Exhibit 4.2 to Horizon/CMS Healthcare Corporation's
Registration Statement on Form S-8 (Registration No. 33-61697), is
hereby incorporated by reference.
(10)-43 Continental Medical Systems, Inc. 1992 CEO Stock Option Plan and
Amendment No. 1 to Continental Medical Systems, Inc. 1992 CEO Stock
Option Plan, filed as Exhibit 4.3 to Horizon/CMS Healthcare
Corporation's Registration Statement on Form S-8 (Registration No. 33-
61697), is hereby incorporated by reference.
(10)-44 Continental Medical Systems, Inc. 1993 Nonqualified Stock Option Plan,
Amendment No. 1 to Continental Medical Systems, Inc. 1993 Nonqualified
Stock Option Plan and Amendment No. 2 to Continental Medical Systems,
Inc. 1993 Nonqualified Stock Option Plan, filed as Exhibit 4.4 to
Horizon/CMS Healthcare Corporation's Registration Statement on Form
S-8 (Registration No. 33-61697), is hereby incorporated by reference.
(10)-45 Continental Medical Systems, Inc. 1994 Stock Option Plan, filed as
Exhibit 4.5 to Horizon/CMS Healthcare Corporation's Registration
Statement on Form S-8 (Registration No. 33-61697), is hereby
incorporated by reference.
(21)* Subsidiaries of HEALTHSOUTH Corporation.
(23)* Consent of Ernst & Young LLP.
(27)* Financial Data Schedule.
* -- Filed herewith.