SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
AMENDMENT NO. 1
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended September 30, 1998;
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 of (I.R.S. Employer
Incorporation or Organization) Identification No.)
ONE HEALTHSOUTH PARKWAY, BIRMINGHAM, ALABAMA 35243
--------------------------------------------------
(Address of Principal Executive Offices)
(Zip Code)
(205) 967-7116
-------------
(Registrant's Telephone Number, Including Area Code)
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 and 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 the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at November 11, 1998
- - ----------------------- --------------------------------
COMMON STOCK, PAR VALUE 423,057,045 SHARES
$.01 PER SHARE
Page 1
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
AMENDMENT NO. 1 TO
QUARTERLY REPORT ON FORM 10-Q
INTRODUCTORY NOTE: On July 22, 1998, a subsidiary of HEALTHSOUTH Corporation
merged with National Surgery Centers, Inc. in a transaction accounting for as a
pooling of interests. Based upon an analysis of its effect upon HEALTHSOUTH's
trend of earnings, financial condition and similar factors, in accordance with
then-current practice under APB 16, the transaction was not material to the
results of operations of HEALTHSOUTH. Accordingly, HEALTHSOUTH did not restate
prior period financial statements, and HEALTHSOUTH's stockholders' equity at
July 1, 1998 was increased by $146,284,000 to reflect the effects of the merger
when HEALTHSOUTH's original Quarterly Report on Form 10-Q for the three months
ended September 30, 1998 was filed. However, new guidance from the Securities
and Exchange Commission subsequent to the original filing of such Quarterly
Report on Form 10-Q indicated that, in the SEC's view, prior period statements
should be revised to reflect the effect of pooling transactions where such
transactions would have an effect on any financial statement line item of 3% or
more. HEALTHSOUTH therefore files this Amendment No. 1 to Quarterly Report on
Form 10-Q to reflect the effects of the National Surgery Centers acquisition on
all prior periods presented.
INDEX
PART 1 -- FINANCIAL INFORMATION
Page
----
Item 1. Financial Statements
Consolidated Balance Sheets (Unaudited) -- September 30, 1998 3
and December 31, 1997
Consolidated Statements of Income (Unaudited) -- Three Months and Nine
Months Ended September 30, 1998 and 1997 4
Consolidated Statements of Cash Flows (Unaudited) -- Nine Months
Ended September 30, 1998 and 1997 5
Notes to Consolidated Financial Statements (Unaudited) -- Three
Months and Nine Months Ended September 30, 1998 and 1997 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings 17
Item 2. Changes in Securities 17
Item 6. Exhibits and Reports on Form 8-K 18
Page 2
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED - IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31,
1998 1997
----------- -----------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 206,393 $ 162,992
Other marketable securities 3,716 22,026
Accounts receivable 1,041,487 765,335
Inventories, prepaid expenses, and
other current assets 266,155 190,335
----------- -----------
TOTAL CURRENT ASSETS 1,517,751 1,140,688
OTHER ASSETS 247,121 222,536
PROPERTY, PLANT AND EQUIPMENT--NET 2,296,074 1,890,110
INTANGIBLE ASSETS--NET 2,992,757 2,312,990
----------- -----------
TOTAL ASSETS $ 7,053,703 $ 5,566,324
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 37,290 $ 125,824
Salaries and wages payable 110,042 124,823
Income taxes payable 1,506 92,507
Deferred income taxes 45,821 34,119
Accrued interest payable and other liabilities 165,519 101,338
Current portion of long-term debt 48,326 49,160
----------- -----------
TOTAL CURRENT LIABILITIES 408,504 527,771
LONG-TERM DEBT 2,780,234 1,565,801
DEFERRED INCOME TAXES 71,276 75,533
DEFERRED REVENUE AND OTHER LONG-TERM LIABILITIES 8,275 2,224
MINORITY INTERESTS--LIMITED PARTNERSHIPS 151,736 104,372
STOCKHOLDERS' EQUITY:
Preferred Stock, $.10 par value--1,500,000
shares authorized; issued and outstanding--
none 0 0
Common Stock, $.01 par value--600,000,000
shares authorized; 422,963,000 and 415,537,000
shares issued at September 30, 1998 and
December 31, 1997, respectively 4,230 4,155
Additional paid-in capital 2,576,630 2,474,726
Retained earnings 1,072,074 833,328
Treasury stock (3,923) (3,923)
Receivable from Employee Stock Ownership Plan (10,169) (12,247)
Notes receivable from stockholders (5,164) (5,416)
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 3,633,678 3,290,623
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 7,053,703 $ 5,566,324
=========== ===========
See accompanying notes.
Page 3
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- --------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
Revenues $ 1,047,422 $ 776,062 $ 2,965,265 $ 2,238,628
Operating unit expenses 673,392 480,816 1,853,062 1,399,817
Corporate general and administrative expenses 27,503 20,782 83,021 59,286
Provision for doubtful accounts 24,015 19,782 69,577 54,126
Depreciation and amortization 88,888 65,658 246,925 186,502
Merger costs 25,630 0 25,630 15,875
Loss on impairment of home health assets 77,571 0 77,571 0
Interest expense 46,126 28,107 103,702 81,868
Interest income (3,450) (1,799) (8,589) (4,984)
----------- ----------- ----------- -----------
959,675 613,346 2,450,899 1,792,490
----------- ----------- ----------- -----------
Income before income taxes and
minority interests 87,747 162,716 514,366 446,138
Provision for income taxes 63,907 54,762 214,485 150,716
----------- ----------- ----------- -----------
Income before minority interests 23,840 107,954 299,881 295,422
Minority interests (18,170) (18,901) (59,478) (54,592)
----------- ----------- ----------- -----------
Net income $ 5,670 $ 89,053 $ 240,403 $ 240,830
=========== =========== =========== ===========
Weighted average common shares outstanding 422,649 361,543 420,957 356,907
=========== =========== =========== ===========
Net income per common share $ 0.01 $ 0.25 $ 0.57 $ 0.67
=========== =========== =========== ===========
Weighted average common shares
outstanding -- assuming dilution 433,033 377,458 433,913 376,404
=========== =========== =========== ===========
Net income per common share--
assuming dilution $ 0.01 $ 0.24 $ 0.55 $ 0.64
=========== =========== =========== ===========
See accompanying notes.
Page 4
HEALTHSOUTH CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
---------- ----------
1998 1997
---------- ----------
OPERATING ACTIVITIES
Net income $ 240,403 $ 240,830
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 246,925 186,502
Provision for doubtful accounts 69,577 54,126
Income applicable to minority interests of
limited partnerships 59,478 54,592
Merger costs 25,630 15,875
Loss on impairment of home health assets 77,571 --
Provision for deferred income taxes 13,145 10,932
Provision for deferred revenue -- (390)
Changes in operating assets and liabilities, net of effects of
acquisitions:
Accounts receivable (314,418) (152,847)
Inventories, prepaid expenses and other current
assets (73,714) (46,199)
Accounts payable and accrued expenses 14,164 (71,632)
----------- -----------
NET CASH PROVIDED BY
OPERATING ACTIVITIES 358,761 291,789
INVESTING ACTIVITIES
Purchases of property, plant and equipment (473,344) (264,852)
Additions to intangible assets, net of effects of
acquisitions (33,690) (66,641)
Assets obtained through acquisitions, net of liabilities
assumed (707,011) (273,204)
Payments on purchase accounting accruals related to 1997 acquisitions
and dispositions (295,508) --
Changes in other assets (23,711) (25,849)
Proceeds received on sale of other marketable
securities 18,310 28,506
Investment in other marketable securities -- (139)
----------- -----------
NET CASH USED IN
INVESTING ACTIVITIES (1,514,954) (602,179)
FINANCING ACTIVITIES
Proceeds from borrowings 2,389,272 569,978
Principal payments on long-term debt (1,194,016) (186,635)
Proceeds from exercise of options 60,779 22,760
Reduction in receivable from Employee Stock
Ownership Plan 2,078 1,901
Decrease in loans to stockholders 252 7
Proceeds from investment by minority interests 2,061 1,907
Payment of cash distributions to limited partners (60,832) (55,917)
----------- -----------
NET CASH PROVIDED BY
FINANCING ACTIVITIES 1,199,594 354,001
----------- -----------
INCREASE IN CASH AND
CASH EQUIVALENTS 43,401 43,611
Cash and cash equivalents at beginning of period 162,992 159,792
----------- -----------
CASH AND CASH EQUIVALENTS
AT END OF PERIOD $ 206,393 $ 203,403
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest $ 81,406 $ 77,820
Income taxes 286,401 109,339
Page 5
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(UNAUDITED - IN THOUSANDS)
Non-cash investing activities:
During 1998, the Company issued 699,000 shares of its common stock with a
market value of $19,397,000 as consideration for acquisitions accounted for
as purchases.
Non-cash financing activities:
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
at various dates during 1997.
During 1997, the Company had a two-for-one stock split on its common stock,
which was effected in the form of a 100% stock dividend.
The Company received a tax benefit from the disqualifying disposition of
incentive stock options of $21,804,000 for the nine months ended September
30, 1998.
See accompanying notes.
Page 6
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
NOTE 1 -- The accompanying consolidated financial statements include the
accounts of HEALTHSOUTH Corporation (the "Company") and its
subsidiaries. This information should be read in conjunction
with the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1997. It is management's opinion that
the accompanying consolidated financial statements reflect all
adjustments (which are normal recurring adjustments, except as
otherwise indicated) necessary for a fair presentation of the
results for the interim period and the comparable period
presented.
NOTE 2 -- The Company has a $1,750,000,000 revolving credit facility with
NationsBank, N.A. ("NationsBank") and other participating banks
(the "1998 Credit Agreement"). The 1998 Credit Agreement
replaced a previous $1,250,000,000 revolving credit agreement,
also with NationsBank, consisting of a $350,000,000 two-year
amortizing term note maturing on December 31, 1999, and a
$900,000,000 revolving credit facility. In conjunction with the
1998 Credit Agreement, the Company also canceled its
$350,000,000 364-day interim revolving credit facility with
NationsBank. Interest on the 1998 Credit Agreement 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 based on the unused portion of
the revolving credit facility ranging from 0.09% to 0.25%,
depending on certain defined ratios. The principal amount is
payable in full on June 22, 2003. The Company has provided a
negative pledge on all assets under the 1998 Credit Agreement.
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. The net proceeds from the issuance of the Notes
were used by the Company to pay down indebtedness outstanding
under its existing credit facilities.
On March 20, 1998, the Company issued $500,000,000 in 3.25%
Convertible Subordinated Debentures due 2003 (the "3.25%
Convertible Debentures") in a private placement. An additional
$67,750,000 principal amount of the 3.25% Convertible Debentures
was issued on March 31, 1998 to cover underwriters'
overallotments. Interest is payable on April 1 and October 1.
The 3.25% Convertible Debentures 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 net proceeds from the issuance
of the 3.25% Convertible Debentures were used by the Company to
pay down indebtedness outstanding under its existing credit
facilities.
On June 22, 1998, the Company issued $250,000,000 in 6.875%
Senior Notes due 2005 and $250,000,000 in 7.0% Senior Notes due
2008 (collectively, the "Senior Notes"). Interest is payable on
June 15 and December 15 of each year, commencing on December 15,
1998. The Senior Notes are unsecured, unsubordinated obligations
of the Company. The net proceeds from the issuance of the Senior
Notes were used by the Company to pay down indebtedness
outstanding under its existing credit facilities.
Page 7
At September 30, 1998, and December 31, 1997, long-term debt
consisted of the following:
September 30, December 31,
1998 1997
----------------- -----------------
(in thousands)
Advances under the 1998 Credit Agreement $ 1,325,000 $ 1,175,000
9.5% Senior Subordinated Notes due 2001 250,000 250,000
3.25% Convertible Subordinated Debentures
due 2003 567,750 0
6.875% Senior Notes due 2005 250,000 0
7.0% Senior Notes due 2008 250,000 0
Other long-term debt 185,810 189,961
----------------- -----------------
2,828,560 1,614,961
Less amounts due within one year 48,326 49,160
----------------- -----------------
$ 2,780,234 $1,565,801
================= =================
NOTE 3 -- Effective July 1, 1998, the Company acquired Columbia/HCA
Healthcare Corporation's interests in 33 ambulatory surgery
centers in a transaction accounted for as a purchase. Effective
July 31, 1998, the Company entered into certain other
arrangements to acquire substantially all of the economic
benefit of Columbia/HCA's interests in one additional ambulatory
surgery center. The transaction was valued at approximately
$550,594,000. Also, during the first nine months of 1998, the
Company acquired 97 outpatient rehabilitation facilities, one
inpatient rehabilitation hospital, three outpatient surgery
centers and 26 diagnostic imaging centers. The total purchase
price of these acquired facilities was approximately
$156,417,000. The Company also entered into non-compete
agreements totaling approximately $22,502,000 in connection with
these transactions. The cost in excess of the acquired
facilities' net asset value was approximately $698,353,000. The
results of operations (not material individually or in the
aggregate) of these acquisitions are included in the
consolidated financial statements from their respective
acquisition dates.
NOTE 4 -- On July 22, 1998, a wholly-owned subsidiary of the Company
merged with National Surgery Centers, Inc. ("NSC"). A total of
20,426,261 shares of the Company's Common Stock were issued in
connection with the transaction. At the time of the merger, NSC
operated 40 outpatient surgery centers in 14 states. The NSC
merger was accounted for as a pooling of interests. Accordingly,
the Company's consolidated financial statements have been
restated to include the results of NSC for all periods
presented.
Costs and expenses of $25,630,000, primarily representing
accounting, legal and financial advisory services, incurred by
the Company in connection with the merger were recorded in
operations during the quarter ending September 30, 1998, and
reported as Merger Costs in the accompanying consolidated
statements of income. The effects of conforming the accounting
policies of the Company and NSC were not material.
NOTE 5 -- During the third quarter of 1998, the Company adopted a plan to
dispose of or otherwise discontinue substantially all of its
home health operations, effective November 1, 1998. Such
operations, which were acquired by the Company as portions of
larger strategic acquisitions, are inconsistent with the
Company's core business and growth strategy. Accordingly, the
Company recorded an impairment loss of approximately $77,571,000
during the quarter ending September 30, 1998. The loss
represents the write-down of the home health assets, including
goodwill, to their estimated fair value less the estimated costs
to sell or otherwise dispose of the assets. Revenues related to
the home health assets to be
Page 8
disposed of were approximately $73,071,000 and $63,407,000 for
the nine months ending September 30, 1998 and 1997,
respectively.
NOTE 6 -- During the first nine months of 1998, the Company granted
incentive and nonqualified stock options to certain Directors,
employees and others for 574,000 shares of Common Stock at
exercise prices ranging from $26.94 to $29.75 per share.
Page 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company provides outpatient and rehabilitative healthcare services
through its inpatient and outpatient rehabilitation facilities, surgery centers,
diagnostic centers and medical centers. The Company has expanded its operations
through the acquisition or opening of new facilities and satellite locations and
by enhancing its existing operations. As of September 30, 1998, the Company had
over 2,000 locations in 50 states, the United Kingdom and Australia, including
approximately 1,290 outpatient rehabilitation locations, 131 inpatient
rehabilitation facilities, four medical centers, 250 surgery centers, 139
diagnostic centers and approximately 200 locations providing other patient care
services.
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 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.
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. The
Company may, from time to time, close or consolidate similar locations in
multi-site markets to obtain efficiencies and respond to changes in demand.
Substantially all of the Company's revenues are derived from private
and governmental third-party payors. The Company's reimbursement from
governmental third-party payors is based upon cost reports and other
reimbursement mechanisms which require the application and interpretation of
complex regulations and policies, and such reimbursement is subject to various
levels of review and adjustment by fiscal intermediaries and others, which may
affect the final determination of reimbursement. In addition, there are
increasing pressures from many payor sources to control healthcare costs and to
reduce or limit increases in reimbursement rates for medical services. There can
be no assurance that payments under
Page 10
governmental and third-party payor programs will remain at levels comparable to
present levels. In addition, there have been, and the Company expects that there
will continue to be, a number of proposals to limit Medicare reimbursement for
certain services. The Company cannot now predict whether any of these proposals
will be adopted or, if adopted and implemented, what effect such proposals would
have on the Company. Changes in reimbursement policies or rates by private or
governmental payors could have an adverse effect on the future results of
operations of the Company.
RESULTS OF OPERATIONS -- THREE MONTHS ENDED SEPTEMBER 30, 1998
The Company operated approximately 1,290 outpatient locations (which
includes base facilities and satellites) at September 30, 1998, compared to
approximately 880 outpatient locations at September 30, 1997. In addition, the
Company operated 131 inpatient rehabilitation facilities, four medical centers,
250 surgery centers, and 139 diagnostic centers at September 30, 1998, compared
with 99 inpatient facilities, four medical centers, 210 surgery centers and 77
diagnostic centers at September 30, 1997.
The Company's operations generated revenues of $1,047,422,000 for the
quarter ended September 30, 1998, an increase of $271,360,000, or 35.0%, as
compared to the same period in 1997. The increase in revenues is primarily
attributable to increases in patient volume and the addition of new outpatient,
inpatient, diagnostic and surgery centers. Same store revenues for the quarter
ended September 30, 1998, were $806,959,000, an increase of $30,897,000, or
4.0%, as compared to the same period in 1997. New store revenues were
$240,463,000. Revenues generated from patients under Medicare and Medicaid plans
respectively accounted for 35.1% and 2.9% of revenue for the third quarter of
1998, compared to 36.4% and 2.3% for the same period in 1997. Revenues from any
other single third-party payor were not significant in relation to the Company's
revenues. During the third quarter of 1998, same store outpatient visits,
inpatient days, surgical cases and diagnostic cases increased 15.5%, 6.7%, 4.2%
and 10.9%, respectively. Revenue per outpatient visit, inpatient day, surgical
case and diagnostic case for same store operations increased (decreased) by
(0.2)%, 0.1%, (0.8)% and (0.5)%, respectively.
Operating expenses, at the operating unit level, were $673,392,000, or
64.3% of revenues, for the quarter ended September 30, 1998, compared to 62.0%
of revenues for the third quarter of 1997. Included in operating expenses, at
the operating unit level, for the quarter ended September 30, 1998, is a
non-recurring expense item of approximately $27,768,000 related to the Company's
plan to dispose of or otherwise discontinue substantially all of its home health
operations, as described below. Excluding the non-recurring expense, operating
expenses, at the operating unit level, were $645,624,000, or 61.6% of revenues
for the quarter ended September 30, 1998. Same store operating expenses,
excluding the non-recurring expense item noted above, were $496,279,000, or
61.5% of comparable revenue. New store operating expenses were $149,345,000, or
62.1% of comparable revenue. Corporate general and administrative expenses
increased from $20,782,000 during the 1997 quarter to $27,503,000 during the
1998 quarter. As a percentage of revenue, corporate general and administrative
expenses decreased from 2.7% during the 1997 quarter to 2.6% in 1998 quarter.
The provision for doubtful accounts was $24,015,000, or 2.3% of revenues, for
the third quarter of 1998, compared to $19,782,000, or 2.5% of revenues, for the
same period in 1997. Management believes that this provision is adequate to
cover any uncollectible revenues.
Depreciation and amortization expense was $88,888,000 for the quarter
ended September 30, 1998, compared to $65,658,000 for the same period in 1997.
The increase represents the investment in additional assets by the Company.
Interest expense was $46,126,000 for the quarter ended September 30, 1998,
compared to $28,107,000 for the quarter ended September 30, 1997. For the third
quarter of 1998, interest income was $3,450,000, compared to $1,799,000 for the
third quarter of 1997.
As a result of the National Surgery Centers, Inc. acquisition, the
Company recognized $25,630,000, primarily representing accounting, legal and
financial advisory services, in merger costs during the quarter ending September
30, 1998.
During the third quarter of 1998, the Company adopted a plan to dispose
of or otherwise discontinue substantially all of its home health operations,
effective November 1, 1998. Such operations,
Page 11
which were acquired by the Company as portions of larger strategic acquisitions,
are inconsistent with the Company's core business and growth strategy.
Accordingly, the Company recorded an impairment loss of approximately
$77,571,000 during the quarter ending September 30, 1998. The loss represents
the write-down of the home health assets, including goodwill, to their estimated
fair value less the estimated costs to sell or otherwise dispose of the assets.
Including the $27,768,000 non-recurring expense item recognized in operating
expenses, as described above, the total non-recurring charge recognized in the
third quarter of 1998 related to the plan to dispose of or otherwise
substantially discontinue the home health operations was approximately
$105,339,000.
Income before minority interests and income taxes for the third quarter
of 1998 was $87,747,000, compared to $162,716,000 for the same period in 1997.
Minority interests decreased income before income taxes by $18,170,000 for the
quarter ended September 30, 1998, compared to decreasing income before income
taxes by $18,901,000 for the third quarter of 1997. The provision for income
taxes for the third quarter of 1998 was $63,907,000, compared to $54,672,000 for
the same period in 1997. Excluding the tax effects of the merger costs and
impairment loss described above, the effective tax rates for the quarters ending
September 30, 1998 and 1997 were 39.1% and 38.1%, respectively. Net income for
the third quarter of 1998 was $5,670,000, compared to $89,053,000 for the third
quarter of 1997.
RESULTS OF OPERATIONS -- NINE MONTHS ENDED SEPTEMBER 30, 1998
Revenues for the nine months ended September 30, 1998, were
$2,965,265,000, an increase of $726,637,000, or 32.5%, over the nine months
ended September 30, 1997. Same store revenues were $2,435,813,000, an increase
of $197,185,000, or 8.8%, as compared to the same period in 1997. New store
revenues were $529,452,000. Revenues generated from patients under Medicare and
Medicaid plans respectively accounted for 35.9% and 2.8% of revenue for the
first nine months of 1998, compared to 37.4% and 2.3% for the same period in
1997. Revenues from any other single third-party payor were not significant in
relation to the Company's revenues. During the first nine months of 1998, same
store outpatient visits, inpatient days, surgical cases and diagnostic cases
increased 16.0%, 8.9%, 7.2% and 11.0%, respectively. Revenue per outpatient
visit, inpatient day, surgical case and diagnostic case for same store
operations increased (decreased) by 0.7%, 0.3%, (0.9)% and (0.5)%, respectively.
Operating expenses, at the operating unit level, were $1,853,062,000,
or 62.5% of revenues, for the nine months ended September 30, 1998, as compared
to $1,399,817,000, or 62.5% of revenues, for the first nine months of 1997.
Excluding the $27,768,000 non-recurring expense item related to the disposition
or discontinuation of home health operations described above, operating expenses
at the operating unit level were $1,825,294,000, or 61.6% of comparable revenue.
New store operating expenses were $335,092,000, or 63.3% of comparable revenue.
As a result of its acquisition of Health Images, Inc., the Company recognized
$15,875,000, primarily representing accounting, legal and financial advisory
services, in merger costs during the first quarter of 1997. Net income for the
nine months ended September 30, 1998, was $240,403,000, compared to $240,830,000
for the same period in 1997.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 1998, the Company had working capital of
$1,109,247,000, including cash and marketable securities of $210,109,000.
Working capital at December 31, 1997, was $612,917,000, including cash and
marketable securities of $185,018,000. For the first nine months of 1998, cash
provided by operations was $358,761,000, compared to $291,789,000 for the same
period in 1997. Additions to property, plant, and equipment and acquisitions
accounted for $473,344,000 and $707,011,000, respectively, during the first nine
months of 1998. Those same investing activities accounted for $264,852,000 and
$273,204,000, respectively, in the same period in 1997. Financing activities
provided $1,199,594,000 and $354,001,000 during the first nine months of 1998
and 1997, respectively. Net borrowing proceeds (borrowing less principal
reductions) for the first nine months of 1998 and 1997 were $1,195,256,000 and
$383,343,000, respectively.
Accounts receivable were $1,041,487,000 at September 30, 1998, compared
to $765,335,000 at December 31, 1997. The number of days of average revenues in
average receivables at September 30,
Page 12
1998, was 79.4, compared to 77.1 days of average revenues in average receivables
at December 31, 1997. The concentration of net accounts receivable from
patients, third-party payors, insurance companies and others at September 30,
1998, is consistent with the related concentration of revenues for the period
then ended.
The Company has a $1,750,000,000 revolving credit facility with
NationsBank, N.A. ("NationsBank") and other participating banks (the "1998
Credit Agreement"). The 1998 Credit Agreement replaced a previous $1,250,000,000
revolving credit agreement, also with NationsBank, consisting of a $350,000,000
two-year amortizing term note maturing on December 31, 1999, and a $900,000,000
revolving credit facility. In conjunction with the 1998 Credit Agreement, the
Company also canceled its $350,000,000 364-day interim revolving credit facility
with NationsBank. Interest on the 1998 Credit Agreement 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 based on the unused
portion of the revolving credit facility ranging from 0.09% to 0.25%, depending
on certain defined ratios. The principal amount is payable in full on September
22, 2003. The Company has provided a negative pledge on all assets under the
1998 Credit Agreement. The effective interest rate on the average outstanding
balance under the 1998 Credit Agreement was 6.18% for the nine months ended
September 30, 1998, compared to the average prime rate of 8.50% during the same
period. At September 30, 1998, the Company had drawn $1,325,000,000 under the
1998 Credit Agreement.
On March 20, 1998, the Company issued $500,000,000 in 3.25% Convertible
Subordinated Debentures due 2003 (the "3.25% Convertible Debentures") in a
private placement. An additional $67,750,000 principal amount of the 3.25%
Convertible Debentures was issued on March 31, 1998 to cover underwriters'
overallotments. Interest is payable on April 1 and October 1 of each year,
commencing on October 1, 1998. The Convertible Debentures 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 the adjustment upon the occurrence of certain
events. The net proceeds from the issuance of the Convertible Debentures were
used by the Company to pay down indebtedness outstanding under its other
existing credit facilities.
On June 22, 1998, the Company issued $250,000,000 in 6.875% Senior
Notes due 2005 and $250,000,000 in 7.0% Senior Notes due 2008 (collectively, the
"Senior Notes"). Interest is payable on June 15 and December 15 of each year,
commencing on December 15, 1998. The Senior Notes are unsecured, unsubordinated
obligations of the Company. The net proceeds from the issuance of the Senior
Notes were used by the Company to pay down indebtedness outstanding under its
existing credit facilities.
The Company intends to pursue the acquisition or development of
additional healthcare operations, including comprehensive outpatient
rehabilitation facilities, ambulatory surgery centers, inpatient rehabilitation
facilities and companies engaged in the provision of outpatient surgery and
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 next twelve months, it will spend approximately $150,000,000 on
maintenance and expansion of its existing facilities and approximately
$300,000,000 on development of the Integrated Service Model, pursuant to which
the Company plans to utilize its services in particular markets to provide an
integrated continuum of coordinated care.
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
1998 Credit Agreement will be sufficient to satisfy the Company's estimated cash
requirements for the next twelve months and for the reasonably foreseeable
future.
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.
Page 13
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 $3,716,000 at
September 30, 1998, which represents less than 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
$1,325,000,000 in long-term debt at September 30, 1998 is subject to variable
rates of interest, while the remaining balance in long-term debt of
$1,503,560,000 is subject to fixed rates of interest (see Note 2 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 September 30, 1998. Based on a hypothetical
1% increase in interest rates, the potential losses in future annual pre-tax
earnings would be approximately $13,250,000. 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.
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 to date-sensitive calculations after
the turn of the century.
The Company is involved in an extensive, ongoing program to identify and
correct problems arising from the year 2000 issues. The program is broken down
into the following categories: (1) mission-critical computer applications which
are internally maintained by the Company's information technology department;
(2) mission-critical computer applications which are maintained by third-party
vendors; (3) non-mission-critical applications, whether internally or externally
maintained; (4) hardware; (5) embedded applications which control certain
medical and other equipment; (6) computer applications of its significant
suppliers; and (7) computer applications of its significant payors.
Mission-critical computer applications are those which are integral to the
Company's business mission, which have no reasonable manual alternative for
producing the same information and results, and the failure of which to produce
accurate information and results would have a significant adverse impact on the
Company. Such applications include the Company's general business systems and
its patient billing systems. Most of the Company's clinical applications are not
considered mission-critical, because reasonable manual alternatives are
available to produce the same information and results for as long as necessary.
The Company's review of its internally maintained mission-critical
applications revealed that such applications contained very few date-sensitive
calculations. The revisions to these applications have been completed and
testing is being conducted during November and December, 1998. Implementation is
scheduled for the first quarter of 1999. The budget for this project is
approximately $150,000.
Page 14
The Company's general business applications are all licensed from and
maintained by the same vendor. All such applications are already year 2000
compliant. The Company has received written confirmation from the vendors of its
other externally maintained mission-critical applications that such applications
are currently year 2000 compliant or will be made year 2000 compliant by the end
of 1998. The cost to be incurred by the Company related to externally maintained
applications is not currently expected to be material.
The Company has reviewed all of its non-mission-critical applications and
determined that some of these applications are not year 2000 compliant and will
not be made to be compliant. In such cases, the Company has developed manual
alternatives to produce the information that such systems currently produce. The
incremental cost of the manual systems is not currently estimated to be
material. The Company plans to evaluate the effectiveness of the manual systems
before any decisions are made on the replacement of the non-compliant
applications.
The Company has engaged a consultant to test all of its computer hardware
for year 2000 compliance at a cost of approximately $800,000. The consultant is
currently testing the computer hardware at nine pilot sites. The results of the
pilot test will be available by November 30, 1998. Testing will begin at the
remainder of the Company's sites in January 1999. Results from their test are
expected to be available by March 31, 1999. The Company has regularly upgraded
its significant servers and hardware platforms. Therefore, it is expected that
the consultant's tests will only reveal that the Company's older personal
computers are not year 2000 compliant. Once the results of the tests are
available, the Company will determine which hardware components are necessary to
replace and will develop a plan to do so. The cost of such replacements cannot
be estimated until the plan is developed.
The Company has not completed its review of embedded applications which
control certain medical and other equipment. The Company expects to complete
this review during the fourth quarter of 1998. 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. In particular, the Company has
focused on reviewing and testing those applications the failure of which would
be likely to cause a significant risk of death or serious injury to patients
under treatment in the Company's facilities, and the Company believes that,
because of the types of services it primarily provides and the nature of its
patient population, there is little likelihood of such an event occurring
because of the failure of an embedded application.
The Company has sent inquiries to its significant suppliers of equipment
and medical supplies concerning the year 2000 compliance of their significant
computer applications. Responses have been received from over 85% of those
suppliers, and no significant problems have been identified. Second requests
have been mailed to all non-respondents.
The Company has also sent inquiries to its significant third-party payors.
Responses have been received from payors representing over 75% of the Company's
revenues. Such responses indicate that these payors' systems will be year 2000
compliant. Second requests were mailed to all non-respondents during October
1998. The Company will continue to evaluate year 2000 risks with respect to such
payors as additional responses are received. In that connection, it should be
noted that substantially all of the Company's revenues are derived from
reimbursement by governmental and private third-party payors, and that the
Company is dependent upon such payors' evaluation of their year 2000 compliance
status to assess such risks. If such payors are incorrect in their evaluation of
their own year 2000 compliance status, this could result in delays or errors in
reimbursement to the Company by such payors, the effects of which could be
material to the Company.
Guidance from the Securities and Exchange Commission requires the
Company to describe its "reasonably likely worst case scenario" in connection
with year 2000 issues. As discussed above, while there is always the potential
risk of serious injury or death resulting from a failure of embedded
applications in medical and other equipment used by the Company, the Company
does not believe that such events are reasonably likely to occur. The Company
believes that the most reasonably likely worst case to which it would be exposed
is that, notwithstanding the Company's attempts to obtain year 2000 compliance
Page 15
assurance from third-party payors, there is a material failure in such payors'
systems which prevents or substantially delays reimbursement to the Company for
its services. In such event, the Company would be forced to rely on cash on hand
and available borrowing capacity to the extent of any shortfall in
reimbursement, and could be forced to incur additional costs for personnel and
other resources necessary to resolve any payment issues. It is not possible at
this time to predict the nature or amount of such costs or the materiality of
any reimbursement issues that may arise as a result of the failure of payors'
payment systems, the effect of which could be substantial. The Company continues
to endeavor to obtain reliable information from its payors as to their
compliance status, and will attempt to adopt and revise its contingency plans
for dealing with payment issues if, as and when such issues become susceptible
of prediction.
Based on the information currently available, the Company believes that its
risk associated with problems arising from year 2000 issues is not significant.
However, 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. The Company will continue with its
assessment process as described above and, to the extent that changes in such
assessment require it, will attempt to develop alternatives or modifications to
its compliance plan described above. There can, however, be no assurance that
such compliance plan, as it may be changed, augmented or modified from time to
time, will be successful.
FORWARD-LOOKING STATEMENTS
Statements contained in this Quarterly Report on Form 10-Q 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 it 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.
Page 16
PART II -- OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS.
The Company has been served with certain lawsuits filed
beginning September 30, 1998 which purport to be class actions
under the federal and Alabama securities laws. Such lawsuits
were filed following a decline in the Company's stock price at
the end of the third quarter of 1998. Three of the suits have
been filed in the United States District Court for the
Northern District of Alabama. Robert M. Gordon, et al., v.
HEALTHSOUTH Corporation, et al., Civil Action No. 98-J-2634-S,
and Twin Plus LLC, et al. v. HEALTHSOUTH Corporation, et al.,
Civil Action No. 98-PWG-2695-S, are identical complaints filed
against the Company and certain of its officers and directors
alleging that, during the period August 12, 1997 through
September 30, 1998, the defendants misrepresented or failed to
disclose certain material facts concerning the Company's
business and financial condition in order to artificially
inflate the price of the Company's Common Stock and issued or
sold shares of such stock during the purported class period,
all allegedly in violation of Section 10(b) of the Securities
Exchange Act of 1934 and Rule 10b-5 thereunder. Irene Rigas,
et al. v. HEALTHSOUTH Corporation, et al., Civil Action No.
98-RRA-2777-S, is substantially identical to the Gordon and
Twin Plus complaints, except that the named plaintiffs therein
purport to represent separate subclasses consisting of former
stockholders of Horizon/CMS Healthcare Corporation and
National Surgery Centers, Inc. who received shares of the
Company's Common Stock in connection with the Company's
acquisition of those entities and assert additional claims
under Section 11 of the Securities Act of 1933 with respect to
the registration of securities issued in those acquisitions. A
fourth suit, Peter J. Petrunya v. HEALTHSOUTH Corporation, et
al., Civil Action No. 98-05931, has been filed in the Circuit
Court for Jefferson County, Alabama, and alleges that during
the period July 16, 1996 through September 30, 1998 the
defendants misrepresented or failed to disclose certain
material facts concerning the Company's business and financial
condition, allegedly in violation of Sections 8-6-17 and
8-6-19 of the Alabama Securities Act. Based upon information
in the media, the Company believes that additional similar
suits may have been filed, but the Company has not been served
with any such suits.
Additionally, a suit styled Dennis Family Trust v. Richard M.
Scrushy, et al., Civil Action No. 98-06592, has been filed in
the Circuit Court for Jefferson County, Alabama, purportedly
as a derivative action on behalf of the Company. That suit
largely replicates the allegations of the federal actions
described in the preceding paragraph and alleges that the
current directors of the Company, certain former directors and
certain officers of the Company breached their fiduciary
duties to the Company and engaged in other allegedly tortious
conduct.
The Company believes that all claims asserted in the above
suits are without merit, and expects to vigorously defend
against such claims. Because such suits have only recently
been filed, the Company cannot currently predict the outcome
of any such suits or the magnitude of any potential loss if
the Company's defense is unsuccessful.
Item 2. CHANGES IN SECURITIES.
(c) Recent Sales of Unregistered Securities
During the three months ended September 30, 1998, the Company
issued 56,624 shares of its Common Stock in a transaction not
registered under the Securities Act of 1933. Such shares were
issued effective July 16, 1998, to RPI, Inc. in connection
with the Company's acquisition by merger of RPI, Inc.'s
subsidiary Sigma Health Properties, Inc., the general partner
of a partnership which owned the building in which the
Company's Tallahassee,
Page 17
Florida rehabilitation hospital operates. Such shares were
issued in reliance upon the exemption provided by Section 4(2)
of the Securities Act, inasmuch as the transaction did not
involve any public offering.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
11. Computation of Income Per Share (unaudited)
27. Financial Data Schedule
(b) Reports on Form 8-K
The Company filed no Current Reports on Form 8-K during the
three months ended September 30, 1998.
No other items of Part II are applicable to the Registrant for the
period covered by this Quarterly Report on Form 10-Q.
Page 18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this Amendment No. 1 to be signed on its behalf
by the undersigned thereunto duly authorized.
HEALTHSOUTH Corporation
(Registrant)
Date: March 25, 1999 /s/ RICHARD M. SCRUSHY
---------------------------
Richard M. Scrushy
Chairman of the Board and
Chief Executive Officer
Date: March 25, 1999 /s/ MICHAEL D. MARTIN
----------------------------
Michael D. Martin
Executive Vice President and
Chief Financial Officer
Page 19