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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, 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
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HEALTHSOUTH CORPORATION
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(Exact Name of Registrant as Specified in its Charter)
DELAWARE 63-0860407
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(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
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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.
|X|
State the aggregate market value of the voting stock held by
non-affiliates of the Registrant as of March 29, 1999:
Common Stock, par value $.01 per share -- $4,588,651,643
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 25, 1999
- - - --------------------------- ------------------------------
COMMON STOCK, PAR VALUE
$.01 PER SHARE 415,214,088 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
inpatient and outpatient healthcare facilities, including inpatient and
outpatient rehabilitation facilities, outpatient surgery centers, diagnostic
centers, occupational health 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, 1998, the
Company had nearly 1,900 locations in 50 states, the United Kingdom and
Australia, exclusive of locations being closed, consolidated or held for sale.
See Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations".
The Company's healthcare services are provided through inpatient
healthcare facilities and facilities providing other clinical services
(including inpatient rehabilitation facilities and specialty medical centers ,
as well as certain physician practices and other services) and outpatient
healthcare facilities (including outpatient rehabilitation centers, outpatient
surgery centers, outpatient diagnostic centers and occupational health centers).
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.
A patient referred to one of the Company's rehabilitation facilities
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 to restore them to as productive, active
and independent a lifestyle as possible.
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 health centers in the United States. Most of
the Company's diagnostic centers and occupational health 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 healthcare services in a particular geographic market makes the Company
more attractive to both patients and payors in such market. The Company focuses
on marketing its services in an integrated system to patients and payors in such
geographic markets.
Over the last four years, the Company has completed several significant
acquisitions in both inpatient and outpatient rehabilitation services and has
expanded into the outpatient surgery center, diagnostic and occupational health
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,
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diagnostic and occupational health businesses provides it with platforms for
future growth. The Company is continually evaluating potential acquisitions that
complement its existing operations.
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
throughout the United States for patients, physicians and payors alike for the
outpatient and inpatient and other clinical healthcare services that it
provides. The Company's growth strategy is based upon four primary elements: (i)
the implementation of the 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 and other
clinical services, outpatient 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 as
its long-term goal to expand the model into the 300 leading markets in
the United States.
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. These relationships also expose the
Company to pressure from payors to limit pricing for the Company's
services, and the Company endeavors to manage and monitor such
relationships in an effort to ensure both competitive pricing and
patient volumes for its facilities.
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 one of the largest providers of
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. 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.
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RISK FACTORS
HEALTHSOUTH's business, operations and financial condition are subject
to certain risks. Some of these risks are described below, and readers of this
Annual Report on Form 10-K should take such risks into account in evaluating
HEALTHSOUTH or any investment decision involving HEALTHSOUTH. This section does
not describe all risks applicable to HEALTHSOUTH, and it is intended only as a
summary of certain material factors. More detailed information concerning the
factors described below is contained in other sections of this Annual Report on
Form 10-K.
HEALTHSOUTH Depends Upon Reimbursement by Third-Party Payors.
Substantially all of HEALTHSOUTH's revenues are derived from private and
governmental third-party payors (in 1998, approximately 35.9% from Medicare and
approximately 64.1% from commercial insurers, managed care plans, workers'
compensation payors and other private pay revenue sources). 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
assurances that payments from government or private payors will remain at levels
comparable to present levels. In attempts to limit the federal budget deficit,
there have been, and HEALTHSOUTH expects that there will continue to be, a
number of proposals to limit Medicare reimbursement for certain services.
HEALTHSOUTH cannot now predict whether any of these pending proposals will be
adopted or what effect the adoption of such proposals would have on HEALTHSOUTH.
HEALTHSOUTH's Operations Are Subject to Extensive Regulation.
HEALTHSOUTH is subject to various other types of regulation by federal and state
governments, including licensure and certification laws, Certificate of Need
laws and laws relating to financial relationships among providers of healthcare
services, Medicare fraud and abuse and physician self-referral.
The operation of HEALTHSOUTH's facilities and the provision of
healthcare services are subject to federal, state and local licensure and
certification laws. These facilities and services are subject to periodic
inspection by governmental and other authorities to assure compliance with the
various standards established for continued licensure under state law,
certification under the Medicare and Medicaid programs and participation in the
Veteran's Administration program. Additionally, in many states, Certificates of
Need or other similar approvals are required for expansion of HEALTHSOUTH's
operations. HEALTHSOUTH could be adversely affected if it cannot obtain such
approvals, by changes in the standards applicable to approvals and by possible
delays and expenses associated with obtaining approvals. HEALTHSOUTH's failure
to obtain, retain or renew any required regulatory approvals, licenses or
certificates could prevent HEALTHSOUTH from being reimbursed for its services or
from offering some of its services, or could adversely affect its results of
operations.
A wide array of Medicare/Medicaid fraud and abuse provisions apply to
the operations of HEALTHSOUTH. HEALTHSOUTH is subject to extensive federal and
state regulation with respect to financial relationships among healthcare
providers, physician self-referral arrangements and other fraud and abuse
issues. Penalties for violation of federal and state laws and regulation include
exclusion from participation in the Medicare/Medicaid programs, asset
forfeiture, civil penalties and criminal penalties. The Office of Inspector
General of the Department of Health and Human Services, the Department of
Justice and other federal agencies interpret healthcare fraud and abuse
provisions liberally and enforce them aggressively.
Healthcare Reform Legislation May Affect HEALTHSOUTH's Business. In
recent years, many legislative proposals have been introduced or proposed in
Congress and in some state legislatures that would effect major changes in the
healthcare system, either nationally or at the state level. Among the proposals
which are currently being, or which recently have been, considered are cost
controls on hospitals, insurance market reforms to increase the availability of
group health insurance to small businesses, requirements that all businesses
offer health insurance coverage to their employees and the creation of a single
government health insurance plan that would cover all citizens. The costs of
certain proposals would be funded in significant part by reductions in payment
by governmental programs, including Medicare and Medicaid, to healthcare
providers. There continue to be federal and state proposals that would, and
actions that do, impose more limitations on government and private payments to
healthcare providers such as HEALTHSOUTH and proposals to increase copayments
and deductibles from programs and private patients. At the federal level, both
Congress and the current Administration have continued to propose healthcare
budgets that substantially reduce payments under the Medicare and Medicaid
programs. In addition, many states are considering the enactment of initiatives
designed to reduce their Medicaid expenditures, to provide universal coverage or
additional levels of care and/or to impose additional taxes on healthcare
providers to help finance or expend the states' Medicaid systems. There can be
no assurance as to the ultimate content, timing or effect of any healthcare
reform legislation, nor is it possible at this time to estimate the impact of
potential legislation, which may be material, on HEALTHSOUTH.
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HEALTHSOUTH Must Successfully Meet Year 2000 Compliance Risks.
HEALTHSOUTH 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 HEALTHSOUTH's mission-critical applications and if
that code will produce accurate information to date-sensitive calculations after
the turn of the century. As described under Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations", HEALTHSOUTH has
undertaken assessment activities to attempt to determine its year 2000
compliance status.
In that connection, it should be noted that substantially all of
HEALTHSOUTH's revenues are derived from reimbursement by governmental and
private third-party payors, and that HEALTHSOUTH 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 HEALTHSOUTH,
the effects of which could be material to HEALTHSOUTH.
Based on the information currently available, HEALTHSOUTH 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 HEALTHSOUTH's assessment is necessarily
based on information from third-party vendors, payors and suppliers, there can
be no assurance that HEALTHSOUTH's assessment is correct. HEALTHSOUTH will
continue with the assessment process described elsewhere in this Annual Report
on Form 10-K and, to the extent that changes in such assessment require it, will
attempt to develop alternatives or modifications to its compliance plan. 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.
HEALTHSOUTH Faces National, Regional and Local Competition. HEALTHSOUTH
operates in a highly competitive industry. HEALTHSOUTH generally operates its
facilities in communities that also are served by similar facilities operated by
its competitors. Although HEALTHSOUTH is the largest provider of its range of
inpatient and outpatient healthcare services on a nationwide basis, in any
particular market it may encounter competition from local or national entities
with longer operating histories or other superior competitive advantages. There
can be no assurance that such competition, or other competition which
HEALTHSOUTH may encounter in the future, will not adversely affect HEALTHSOUTH's
results of operations.
HEALTHSOUTH Is Subject to Material Litigation. HEALTHSOUTH is, and may
in the future be, subject to litigation which, if determined adversely to
HEALTHSOUTH, could have a material adverse affect on HEALTHSOUTH. In addition,
some of the companies and businesses acquired by HEALTHSOUTH have been subject
to such litigation. While HEALTHSOUTH attempts to conduct its operations in such
a way as to reduce the risk that adverse results in litigation could have a
material adverse affect on HEALTHSOUTH, there can be no assurance that pending
or future litigation, whether or not described in this Annual Report on Form
10-K, will not have such a material adverse affect. See Item 3, "Legal
Proceedings".
HEALTHSOUTH's Stock Price May Be Volatile. Healthcare stocks in
general, including HEALTHSOUTH's common stock, are subject to frequent changes
in stock price and trading volume, some of which may be large. These changes may
be influenced by the market's perceptions of the healthcare sector in general,
of other companies believed to be similar to HEALTHSOUTH, or of HEALTHSOUTH's
results of operations and future prospects. In addition, these perceptions may
be greatly affected not only by information provided by HEALTHSOUTH but also by
opinions and reports created by investment analysts and other third parties
which do not necessarily reflect information provided by HEALTHSOUTH. Adverse
movement in the Company's stock price, particularly as a result of factors over
which it has no control, may adversely affect the Company's access to capital
and the ability to consummate acquisitions using its stock.
GROWTH THROUGH ACQUISITIONS AND RELATED DIVESTITURES
Beginning in 1994, the Company has consummated a series of significant
acquisitions. The following paragraphs describe certain of such acquisitions
consummated during the period covered by the consolidated financial statements
contained in this Annual Report on Form 10-K, as well as related divestitures
and facility closings and consolidations in connection with the Company's
strategic plan.
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
5
Management, Inc. ("PSCM"; 36 outpatient rehabilitation facilities in New York,
New Jersey and Connecticut) and ReadiCare, Inc. ("ReadiCare"; 37 occupational
health 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"). During 1998, the Company acquired National Surgery Centers, Inc.
("NSC"; 40 surgery centers in 14 states), as well as 34 surgery centers
(including centers under management arrangements) from Columbia/HCA Healthcare
Corporation ("Columbia/HCA"). These transactions, along with the Company's other
significant acquisitions since 1993, have further enhanced the Company's
position as the nation's largest provider of inpatient and outpatient
rehabilitative services and outpatient surgery services and its position as one
of the largest providers of occupational health and diagnostic imaging services.
The Company believes that the geographic dispersion of the nearly 1,900
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.
In the course of its major acquisitions, the Company has from time to
time acquired ancillary businesses, such as healthcare staffing and home health
services, which are not part of the Company's strategic lines of business, and
has also acquired facilities which are duplicative of certain existing
facilities or which do not meet the Company's operating and performance
standards. Accordingly, the Company has from time to time determined to sell,
close or consolidate certain acquired facilities and businesses in order to
focus its resources on those facilities and businesses which are most consistent
with its strategic plan and core operations. The most significant divestiture by
the Company was its divestiture of the long-term care assets of Horizon/CMS to
IHS in 1997, described above. In addition, in the third quarter of 1998, the
Company adopted a plan to close substantially all of its home health operations,
which had been obtained as minor components of larger strategic acquisitions,
and in the fourth quarter of 1998 the Company adopted a plan to close,
consolidate or hold for sale certain other non-strategic businesses and
duplicative facilities, as well as facilities which the Company had determined
could not be brought up to the Company's operating and performance standards
without undue expenditure of resources. Unless the context otherwise indicates,
descriptions of the Company's patient care services locations in this Annual
Report on Form 10-K do not include those facilities which, as of December 31,
1998, had been or were being closed, consolidated or sold.
See Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" for additional information concerning the
Company's acquisitions, divestitures and plans with respect to facility closings
and consolidations.
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.
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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 was a 75%
increase in the number of treatments in all ambulatory settings from 1986 to
1996, with over 70% of the total number of surgeries in the United States
currently 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.
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 health services and that provide
independent platforms for growth. The Company's acquisitions and internal growth
have enabled it to become one of the largest providers of healthcare services in
the United States. The following sections discuss the range of services offered
by the Company in its inpatient and other clinical services and outpatient
services business segments.
Inpatient and Other Clinical Services
The Company's inpatient and other clinical services business segment
includes the operations of its inpatient rehabilitation facilities and medical
centers, as well as the operations of certain physician practices and other
clinical services which are managerially aligned with the Company's inpatient
services.
INPATIENT REHABILITATION FACILITIES. At December 31, 1998, the Company
operated 124 inpatient rehabilitation facilities with 7,690 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 are utilized by these facilities.
A number of the Company's rehabilitation hospitals were developed in
conjunction with local tertiary-care facilities, including major teaching
hospitals such as those at Vanderbilt University, the University of Missouri and
the University of Virginia. This strategy of developing effective referral and
service networks prior to opening results in improved operating efficiencies for
the new facilities and provides a more coordinated continuum of care for the
constituencies served by the tertiary-care facilities. In addition to those
facilities so developed by the Company, the Company has entered into or is
pursuing similar affiliations with a number of its rehabilitation hospitals
which were obtained through the Company's major acquisitions.
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MEDICAL CENTERS. At December 31, 1998, the Company operated four
medical centers with 810 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
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".
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, 1998, the Company's inpatient facilities
achieved an overall utilization, based on patient days and available beds, of
76.25%.
Outpatient Services
The Company's outpatient services business segment includes the
Company's outpatient rehabilitation facilities, its outpatient surgery centers,
its outpatient diagnostic centers and its occupational health centers.
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, 1998, the Company
provided outpatient rehabilitative healthcare services through approximately
1,187 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 administrative services.
8
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.
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.
SURGERY CENTERS. The Company is currently the largest operator of
outpatient surgery centers in the United States. At December 31, 1998, it
operated 221 freestanding surgery centers, including eight mobile lithotripsy
units, in 41 states. Over 80% of these facilities are located in markets served
by the Company's rehabilitation facilities, enabling the Company to pursue
opportunities for cross-referrals between surgery and rehabilitation 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 at 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, 1998, the Company operated 118
diagnostic centers in 25 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.
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 HEALTH SERVICES. At December 31, 1998, the Company
operated 119 occupational health centers in 28 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 health 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 health
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
9
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 health primary care services are a strategic
component of its business, and that the physicians in its occupational health
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 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. These services are included within the
business segment of the Company with which they are most closely aligned in the
particular local market.
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 local or area-based marketing personnel, whereas
large-scale regional and national efforts are coordinated by corporate-based
personnel. In Integrated Service Model markets, area marketing activities are
coordinated by an ISM Advisory Committee reflecting the Company's range of
services in each market.
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 First Health,
Hospital Network of America and Multiplan, with national case management
companies, such as INTRACORP and Crawford & Co., and with national employers,
such as Wal-Mart, Georgia-Pacific Corporation, Federated Department Stores,
Goodyear Tire & Rubber and Winn-Dixie. In addition, since many of the facilities
acquired by the Company during the past four 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 name recognition and association with amateur and professional athletics.
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 Professional Golfers Association, the Senior Professional Golfers
Association, 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 2,000 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 and its employees are able to support charitable organizations and
activities within their communities.
10
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, 1997 DECEMBER 31, 1998
- - - --------------------------- ----------------- -----------------
Medicare ....................................................36.9% 35.9%
Commercial (1)......................................................35.1 37.0
Workers' Compensation...............................................11.1 10.8
All Other Payors (2)................................................16.9 16.3
---- ----
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 NSC facilities for periods or
portions thereof prior to the effective date of the NSC acquisition. 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'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
Company's rehabilitation components of the Company's inpatient and outpatient
business segments are quality of services, projected patient outcomes, charges
for services, responsiveness to the needs of the patients, community and
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.
11
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 national or regional companies or from local hospitals or other
providers 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 or outpatient surgery centers. Outpatient rehabilitation, occupational
health and diagnostic facilities and services do not require such approvals in a
majority of states.
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. Diagnostic and
occupational health facilities are not required to be licensed in a majority of
states.
12
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 1,065 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 are certified (or awaiting
certification) under the Medicare program. Diagnostic and occupational health
facilities are not certified by 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.
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. 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 873 are Medicare-certified rehabilitation agencies or satellites thereof.
Additionally, the Company has certification applications pending for four CORF
sites and 176 rehabilitation agency sites (including satellites.) Through
December 31, 1998, CORFs were reimbursed reasonable costs (subject to certain
limits) for services provided to Medicare beneficiaries, and outpatient
rehabilitation facilities certified by Medicare as rehabilitation agencies were
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. From January 1,
1999, CORFs and rehabilitation agencies are reimbursed on a fee screen basis as
well. 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.
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 hospitals 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 continuing operations. See Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations" for a
discussion of the impact of the Balanced Budget Act on certain businesses
discontinued by the Company in 1998.
13
In June 1998, the Health Care Financing Administration issued proposed
rules setting forth new payment classifications which would significantly change
Medicare reimbursement for outpatient surgery centers. However, the comment
period for such proposed rules has now been extended for the third time, until
June 30, 1999, and the Company cannot currently predict when final rules, if
any, will be adopted or the content or effect on the Company's operations of
such rules.
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
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
14
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 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. The Proposed Stark
Regulations would implement, amplify and clarify the Stark II statute. Final
regulations are not expected to be promulgated until after 1999. 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.
15
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 program. 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, 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, 1998, 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 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.
In connection with the risk transfer, the carrier has questioned the
availability of coverage for punitive damages. The Company and Horizon/CMS have
filed a declaratory judgment action in the United States District Court for the
District of New Mexico seeking a declaration that such damages are required to
be covered (HEALTHSOUTH Corporation, et al. v. St. Paul Fire and Marine
Insurance Company, et al., Civ. No. 98-800 BB/DIS-ACE). Thereafter, the carrier
filed an action seeking a contrary declaration in the United States District
Court for the
16
Northern District of Texas (St. Paul Fire and Marine Insurance Company, et al.
v. Horizon/CMS Healthcare Corporation, et al., Civil Action No. 4-98CV-575-Y).
The parties have filed preliminary motions in both actions, and the Company
cannot now predict the outcome or effect of these actions or the length of time
it will take to resolve them.
EMPLOYEES
As of December 31, 1998, the Company employed approximately 51,901
persons, of whom 32,558 were full-time employees and 19,343 were part-time
employees. Of the above employees, 821 were employed at the Company's
headquarters in Birmingham, Alabama. Except for approximately 77 employees at
one rehabilitation hospital (about 14.6% 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 a headquarters
building of approximately 200,000 square feet 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
health operations are carried out in leased facilities. The Company owns 29 of
its inpatient rehabilitation facilities and leases or operates under management
contracts the remainder of its inpatient rehabilitation facilities. The Company
also owns 62 of its surgery centers and 35 of its diagnostic centers and leases
or operates under management arrangements the remainder. The Company constructed
its rehabilitation hospitals in Florence and Columbia, South Carolina, Kingsport
and Nashville, Tennessee, Concord, New Hampshire, Dothan, Alabama, Columbia,
Missouri, and Charlottesville, Virginia 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.
17
The following table sets forth a listing of the Company's primary domestic
patient care services locations (including both facilities owned or leased by
the Company and facilities under management agreements or similar arrangements)
at December 31, 1998, exclusive of those facilities to be closed, consolidated
or sold pursuant to plans adopted in 1998:
INPATIENT OCCUPATIONAL OUTPATIENT
REHABILITATION MEDICAL HEALTH REHABILITATION SURGERY DIAGNOSTIC
STATE FACILITIES (BEDS)(1) CENTERS (BEDS)(1) CENTERS CENTERS(2) CENTERS CENTERS
- - - ----- -------------------- ----------------- ------- ---------- ------- -------
Alabama 8 (404) 1 (219) 32 7 4
Alaska 4 7 1 1
Arizona 4 (243) 8 27 2 1
Arkansas 6 (309) 5 25 2
California 1 (60) 27 51 50 3
Colorado 1 (64) 1 35 5 5
Connecticut 1 (26) 2 18 6
Delaware 6 1
District of Columbia 1 1
Florida 9 (631) 1 (285) 6 83 18 8
Georgia 1 (50) 4 29 4 11
Hawaii 10 1
Idaho 4 1
Illinois 1 55 7 10
Indiana 3 (200) 2 14 5 1
Iowa 1 3 2
Kansas 4 (224) 11
Kentucky 2 (80) 2 4 6
Louisiana 5 (287) 3 5 2 3
Maine 2 (125) 11
Maryland 1 (44) 28 9 6
Massachusetts 11 (921) 1 52 1 2
Michigan 1 (30) 3 12
Minnesota 15 2
Mississippi 8 3
Missouri 2 (160) 1 55 8 1
Montana 4 1
Nebraska 1 5
Nevada 2 (130) 22 3
New Hampshire 3 (98) 9
New Jersey 1 (155) 1 66 3 3
New Mexico 1 (61) 1 6 1 1
New York 1 (27) 47 1 3
North Carolina 22 10 1
North Dakota 4
Ohio 1 (30) 3 36 7
Oklahoma 3 (155) 1 18 5 1
Oregon 31 1
Pennsylvania 14 (1,049) 3 57 6 8
Rhode Island 2 2
South Carolina 3 (216) 8 2 5
South Dakota 4 1
Tennessee 7 (407) 25 5 4
Texas 19 (1,114) 1 (106) 10 108 18 22
Utah 1 (86) 2 10 2
Vermont 1 2
Virginia 2 (90) 1 (200) 4 25 1 6
Washington 17 72 5 1
West Virginia 4 (214) 3 1
Wisconsin 1 4
Wyoming 2
-----------------------
(1) "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.
18
(2) Includes freestanding outpatient centers and their satellites,
outpatient satellites of inpatient rehabilitation facilities and
outpatient facilities managed under contract.
In addition, at December 31, 1998, the Company operated six diagnostic
centers in the United Kingdom and one rehabilitation hospital in Australia, as
well as numerous locations in various states providing other services.
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.
SECURITIES LITIGATION
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. Seven such 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, Twin Plus LLC, et al. v. HEALTHSOUTH Corporation, et
al., Civil Action No. 98-PWG-2695-S, Irene Rigas, et al. v. HEALTHSOUTH
Corporation, et al., Civil Action No. 98-RRA-2777-S, Harry Schipper v.
HEALTHSOUTH Corporation, et al., Civil Action No. 98-N-2779-S, Ryan McCormick v.
HEALTHSOUTH Corporation, et al., Civil Action No. 98-RRA-2831-S, United Food &
Commercial Workers Union Local 100-A Pension Fund v. HEALTHSOUTH Corporation, et
al., Civil Action No. 98-BU-2869-S, and Vinod Parikh v. HEALTHSOUTH Corporation,
et al., Civil Action No. 98-BU-2869-S. These are substantially 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. Certain of the named plaintiffs in some of the complaints also
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. In January 1999, these complaints were ordered to be
consolidated, with a consolidated amended complaint due to be filed on April 5,
1999 (after a one-month extension requested by the plaintiffs' counsel). Another
suit, Peter J. Petrunya v. HEALTHSOUTH Corporation, et al., Civil Action No.
98-05931, was filed in the Circuit Court for Jefferson County, Alabama, alleging
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 Section
8-6-17 and 8-6-19 of the Alabama Securities Act. The Petrunya complaint was
voluntarily dismissed by the plaintiff without prejudice in January 1999.
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 plaintiff in that case has forborne pursuing its claim
thus far pending further progress in the federal actions, and the Company has
not yet been required to file a responsive pleading in the case.
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 predict the outcome
of any such suits or the magnitude of any potential loss if the Company's
defense is unsuccessful.
19
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 has for some time been
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 Company and Horizon/CMS have no knowledge of the current status
of the investigation, 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 or 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 has no knowledge of the current status of such reviews.
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.
Neither the Company nor Horizon/CMS has received any further inquiries
from the SEC or the NYSE with respect to the matters described above since
mid-1997, and the Company is unaware of the current status of such
investigations or reviews. The Company does not intend to describe these matters
in future reports unless it becomes aware of new developments with respect to
them.
Michigan Attorney General Litigation Regarding 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.
20
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. The litigation has continued at the pretrial hearing phase
for several months, including numerous adjournments, and such pretrial hearing
phase is not expected to conclude until April 1999, after which time the court
will determine which, if any, charges may be brought to trial. Because of the
preliminary status of this litigation, 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.
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 a procedurally 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.
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. ss.ss. 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 remains at a
procedurally early stage, the Company cannot predict the length of time it will
take to resolve the litigation or the outcome of the litigation.
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
21
efficacy of the jury's verdict and has appealed the judgment. The judgment was
left unchanged by the intermediate appellate court and is now being appealed to
the Texas Supreme Court.
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 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 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. See Item 1, "Business --
Insurance".
HEALTH IMAGES/FONAR LITIGATION
On February 2, 1998, Fonar Corporation ("Fonar") filed an action
against HEALTHSOUTH in the United States District Court for the Eastern District
of New York styled Fonar Corporation v. HEALTHSOUTH, Inc., Civil Action No.
98-CV-679 (LDW)(ARL). In the complaint, Fonar alleges that HEALTHSOUTH infringed
United States Patent Number 4,871,966 (the "'966 patent") which pertains to the
operation of the Multi-Angle Oblique ("MAO") feature in MRI machines. The MAO
feature enables the MRI machine to scan multiple differing angles in a single
MAO scan. Fonar seeks damages in an unspecified amount, along with enhanced
damages for alleged willful infringement. Fonar's allegations of infringement
and willful infringement are based largely on the actions of Health Images prior
to its acquisition by HEALTHSOUTH in March 3, 1997. Health Images, and
subsequently HEALTHSOUTH, are alleged to have infringed the '966 patent through
the manufacture and use of MRI equipment that contains the MAO feature.
HEALTHSOUTH has answered Fonar's complaint denying the allegations of
infringement, and filed a third-party complaint against Picker International,
Inc., which seeks indemnity for those machines purchased by Health Images and
HEALTHSOUTH from Picker alleged to infringe the '966 patent. At this time, since
discovery has not yet commenced, HEALTHSOUTH cannot predict the outcome or
effect of this litigation or the length of time it will take to resolve this
litigation. The court has set the matter for a final pretrial conference on
September 15, 2000.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
22
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
-------- ------
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
1998
----
First Quarter.............................................................. $ 30.44 $ 21.69
Second Quarter............................................................. 30.81 25.75
Third Quarter.............................................................. 30.12 8.88
Fourth Quarter............................................................. 15.88 7.69
-------------------------
The closing price for the Company's common stock on the New York Stock
Exchange on March 29, 1999, was $11.125.
There were approximately 6,924 holders of record of the Company's
common stock as of March 25, 1999, 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
All unregistered sales of equity securities by the Company in 1998 have
been previously reported on Form 10-Q or Form 8-K, as applicable.
23
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
acquisitions of Surgical Health Corporation ("SHC") and Sutter Surgery Centers,
Inc. ("SSCI"), the 1996 SCA and Advantage Health acquisitions, the 1997 Health
Images acquisition and the 1998 NSC acquisition, each of which was accounted for
as a pooling of interests.
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------------------
1994 1995 1996 1997 1998
------------- ------------- ------------ ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
INCOME STATEMENT DATA:
Revenues $ 1,769,095 $ 2,173,012 $ 2,648,188 $ 3,123,176 $ 4,006,074
Operating unit expenses 1,237,750 1,478,208 1,718,108 1,952,189 2,491,914
Corporate general and administrative expenses 69,718 67,789 82,953 87,512 112,800
Provision for doubtful accounts 36,807 43,471 61,311 74,743 112,202
Depreciation and amortization 128,721 164,482 212,967 257,136 344,591
Merger and acquisition related expenses (1) 6,520 19,553 41,515 15,875 25,630
Impairment and restructuring charges (2) 10,500 53,549 37,390 --- 483,455
Loss on abandonment of computer project 4,500 --- --- --- ---
Loss on disposal of surgery centers 13,197 --- --- --- ---
Loss on sale of assets (2) --- --- --- --- 31,232
Interest expense 79,081 109,656 101,367 112,529 148,163
Interest income (6,838) (8,287) (6,749) (6,004) (11,286)
Gain on sale of MCA Stock (7,727) --- --- --- ---
-------------- ------------- ------------ ------------- -------------
1,572,229 1,928,421 2,248,862 2,493,980 3,738,701
------------- ------------- ------------ ------------- -------------
Income from continuing operations
before income taxes, minority interests
and extraordinary item 196,866 244,591 399,326 629,196 267,373
Provision for income taxes 69,578 88,142 148,545 213,668 143,347
------------- ------------- ------------ ------------- -------------
127,288 156,449 250,781 415,528 124,026
Minority interests 32,692 45,135 54,003 72,469 77,468
------------- ------------- ------------ ------------- -------------
Income from continuing operations
before extraordinary item 94,596 111,314 196,778 343,059 46,558
Income from discontinued operations (6,528) (1,162) --- --- ---
Extraordinary item --- (9,056) --- --- ---
------------- -------------- ------------ ------------- -------------
Net income $ 88,068 $ 101,096 $ 196,778 $ 343,059 $ 46,558
============= ============= ============ ============= =============
Weighted average common shares
outstanding (3) 280,506 298,462 336,603 366,768 421,462
============= ============= ============ ============= =============
Net income per common share: (3)
Continuing operations $ 0.34 $ 0.37 $ 0.58 $ 0.94 $ 0.11
Discontinued operations (0.02) --- --- --- ---
Extraordinary item --- (0.03) --- --- ---
------------- -------------- ------------ ------------- -------------
$ 0.32 $ 0.34 $ 0.58 $ 0.94 $ 0.11
============= ============= ============ ============= =============
Weighted average common shares
outstanding-- assuming dilution(3)(4) 307,784 329,000 365,715 386,211 432,275
============= ============= ============== ============= =============
Net income per common share --
assuming dilution: (3)(4)
Continuing operations $ 0.32 $ 0.35 $ 0.55 $ 0.89 $ 0.11
Discontinued operations (0.02) --- --- --- ---
Extraordinary item --- (0.03) --- --- ---
------------- -------------- ------------ ------------- -------------
$ 0.30 $ 0.32 $ 0.55 $ 0.89 $ 0.11
============= ============= ============ ============= =============
24
DECEMBER 31,
------------------------------------------------------------------------------------------
1994 1995 1996 1997 1998
------------- ------------- ------------ ------------- -------------
BALANCE SHEET DATA: (In thousands)
Cash and marketable securities $ 138,518 $ 182,636 $ 205,166 $ 185,018 $ 142,513
Working capital 315,070 428,746 624,497 612,917 945,927
Total assets 2,412,874 3,190,095 3,671,958 5,566,324 6,773,008
Long-term debt (5) 1,206,846 1,477,092 1,570,597 1,614,961 2,830,926
Stockholders' equity 843,884 1,317,878 1,686,770 3,290,623 3,423,004
- - - --------------
(1) Expenses related to the ReLife acquisition and SHC's Heritage Surgical
acquisition in 1994, the SHC, SSCI and NovaCare Rehabilitation Hospitals
acquisitions in 1995, the SCA, Advantage Health, PSCM and ReadiCare
acquisitions in 1996, the Health Images acquisition in 1997 and the NSC
acquisition in 1998.
(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.
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 a stock split effected
in the form of a 100% stock dividend paid on March 17, 1997):
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. (the "Health
Images Acquisition"). 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.
(the "NIA Acquisition"). 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.
25
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.
o On July 1, 1998, the Company acquired Columbia/HCA Healthcare Corporation's
interest in (or entered into interim management arrangements with respect to) 34
outpatient surgery centers located in 13 states (the "Columbia/HCA
Acquisition"). The cash purchase price was approximately $550,402,000.
o On July 22, 1998, the Company acquired National Surgery Centers, Inc. (the
"NSC Acquisition"). A total of 20,426,261 shares of the Company's Common Stock
were issued in connection with the transaction, representing a value of
approximately $574,489,000. At that time, NSC operated 40 outpatient surgery
centers in 14 states.
Each of the ASC Acquisition, the Horizon/CMS Acquisition, the NIA
Acquisition and the Columbia/HCA Acquisition was accounted for under the
purchase method of accounting and, accordingly, the acquired operations are
included in the Company's consolidated financial statements from their
respective dates of acquisition. Each of the SCA Acquisition, the Advantage
Health Acquisition, the Health Images Acquisition and the NSC 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.
SCA, Advantage Health, Health Images and NSC 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
consolidated 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. In connection with recent developments, including changes
in the reimbursement environment in the healthcare industry, the closing or
consolidation of certain of its locations, and the integration of some of its
purchased facilities in connection with implementation of its Integrated Service
Model strategy, the Company is undertaking a comprehensive review of its
amortization policies with respect to the excess of cost over net asset value of
purchased facilities. This review may result in future changes in certain of the
Company's accounting estimates following completion of such review. With respect
to the carrying value of the excess of cost over net asset value of individual
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
26
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.
In 1998, the Company adopted the provisions of Statement of Financial
Accounting Standards ("SFAS") No. 131, "Disclosures about Segments of an
Enterprise and Related Information". SFAS 131 requires an enterprise to report
operating segments based upon the way its operations are managed. This approach
defines operating segments along the lines used by management to assess
performance and make operating and resource allocation decisions. Based on the
Company's management and reporting structure, segment information has been
presented for inpatient and other clinical services and outpatient services.
The inpatient and other clinical services segments includes the operations
of its inpatient rehabilitation facilities and medical centers, as well as the
operations of certain physician practices and other clinical services which are
managerially aligned with the Company's inpatient services. The Company has
aggregated the financial results of its outpatient rehabilitation facilities
(including occupational health centers), outpatient surgery centers and
outpatient diagnostic centers into the outpatient services segment. These three
types of facilities have common economic characteristics, provide similar
services, serve a similar class of customers, cross-utilize administrative
services and operate in a similar regulatory environment. In addition, the
Company's Integrated Service Model strategy combines these services in a
seamless environment for the delivery of patient care on an episodic basis.
See Note 14 of "Notes to Consolidated Financial Statements" for financial
data for each of the Company's operating segments.
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.
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 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.
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
27
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.
RESULTS OF OPERATIONS OF THE COMPANY
Twelve-Month Periods Ended December 31, 1996 and 1997
The Company's operations generated revenues of $3,123,176,000 in 1997, an
increase of $474,988,000, or 17.9%, as compared to 1996 revenues. Same store
revenues for the twelve months ended December 31, 1997 were $2,921,684,000, an
increase of $273,496,000, or 10.3%, as compared to the same period in 1996. New
store revenues for 1997 were $201,492,000. New store revenues reflect primarily
the addition of facilities through the Horizon/CMS Acquisition and the ASC
Acquisition and the acquisition of outpatient rehabilitation operations in new
markets through internal development (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 inpatient days, outpatient visits, surgical cases and
diagnostic cases increased 10.8%, 20.6%, 8.8% and 12.3%, respectively. Revenue
per inpatient day, outpatient visit, surgical case and diagnostic case for same
store operations increased (decreased) by 1.6%, 4.6%, (0.9)% and (0.3) %,
respectively.
Operating expenses, at the operating unit level, were $1,952,189,000, or
62.5% 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 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 $1,804,674,000, or 61.8% of related revenues.
New store operating expenses were $147,515,000, or 73.2% 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 were significantly higher as a percentage of related revenues
than in the Company's other facilities. Corporate general and administrative
expenses increased from $82,953,000 in 1996 to $87,512,000 in 1997. As a
percentage of revenues, corporate general and administrative expenses decreased
from 3.1% in 1996 to 2.8% in 1997. Total operating expenses were $2,039,701,000,
or 65.3% of revenues, for 1997, compared to $1,801,061,000, or 68.0% of
revenues, for 1996. The provision for doubtful accounts was $74,743,000, or 2.4%
of revenues, for 1997, compared to $61,311,000, or 2.3% of revenues, for 1996.
Depreciation and amortization expense was $257,136,000 for 1997, compared
to $212,967,000 for 1996. The increase resulted from the investment in
additional assets by the Company. Interest expense increased to $112,529,000 in
1997, compared to $101,367,000 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 $6,004,000, compared to
$6,749,000 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
$629,196,000, compared to $399,326,000 for 1996. Minority interests reduced
income before income taxes by $72,469,000 in 1997, compared to $54,003,000 for
1996. The provision for income taxes for 1997 was $213,668,000, compared to
$148,545,000 for 1996, resulting in effective tax rates of 38.4% for 1997 and
43.0% for
28
1996. Net income for 1997 was $343,059,000.
Twelve-Month Periods Ended December 31, 1997 and 1998
The Company's operations generated revenues of $4,006,074,000 in 1998, an
increase of $882,898,000, or 28.3%, as compared to 1997 revenues. Same store
revenues for the twelve months ended December 31, 1998 were $3,755,413,000, an
increase of $632,237,000, or 20.2%, as compared to the same period in 1997. New
store revenues for 1998 were $250,661,000. Same store revenues reflect the first
full year of operations of the Horizon/CMS facilities and the ASC Network
facilities acquired in October 1997. New store revenues reflect primarily the
addition of facilities from the Columbia/HCA Acquisition and the Company's
single facility acquisitions through internal development (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 35.9% and 2.7% of total revenues for 1998,
compared to 36.9% and 2.3% of total revenues for 1997. Revenues from any other
single third-party payor were not significant in relation to the Company's total
revenues. During 1998, same store inpatient days, outpatient visits, surgical
cases and diagnostic cases increased 32.5%, 27.7%, 20.8% and 18.0%,
respectively. Revenue per inpatient day, outpatient visit, surgical case and
diagnostic case for same store operations decreased by (5.8)%, (0.2)%, (2.8)%
and (0.3)%, respectively.
Operating expenses, at the operating unit level, were $2,491,914,000, or
62.2% of revenues, for 1998, compared to 62.5% of revenues for 1997. Included in
operating expenses, at the operating unit level, for the year ended December 31,
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 $2,464,146,000, or
61.5% of revenues for the year ended December 31, 1998. The decrease in
operating expenses as a percentage of revenues is primarily attributable to the
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
1998, excluding the non-recurring expense item noted above, were $2,296,802,000
or 61.2% of related revenues. New store operating expenses were $167,344,000, or
66.8% of related revenues. Corporate general and administrative expenses
increased from $87,512,000 in 1997 to $112,800,000 in 1998. As a percentage of
revenues, corporate general and administrative expenses remained constant at
2.8% in 1997 and 1998. Total operating expenses were $2,604,714,000, or 65.0% of
revenues, for 1998, compared to $2,039,701,000, or 65.3% of revenues, for 1997.
The provision for doubtful accounts was $112,202,000, or 2.8% of revenues, for
1998, compared to $74,743,000, or 2.4% of revenues, for 1997. Included in the
provision for doubtful accounts for the year ended December 31, 1998, is a
non-recurring expense item of approximately $19,228,000 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 item, the provision
for doubtful accounts was $92,974,000 or 2.3% of revenues for 1998.
Depreciation and amortization expense was $344,591,000 for 1998, compared
to $257,136,000 for 1997. The increase resulted from the investment in
additional assets by the Company. Interest expense increased to $148,163,000 in
1998, compared to $112,529,000 for 1997, primarily because of the increased
amount outstanding under the Company's credit facilities (see "Liquidity and
Capital Resources"). For 1998, interest income was $11,286,000, compared to
$6,004,000 for 1997. The increase in interest income resulted primarily from an
increase in the average amount outstanding in interest-bearing investments.
Merger expenses in 1998 of $25,630,000 represent costs incurred or accrued
in connection with completing the NSC Acquisition. For further discussion, see
Note 2 of "Notes to Consolidated Financial Statements".
During the third quarter of 1998, the Company adopted a plan to dispose of
or otherwise discontinue substantially all of its home health operations. The
decision to adopt the plan was prompted in large part
29
by the negative impact of the 1997 Balanced Budget Act (the "BBA"), which placed
reimbursement limits on home health businesses. The limits were announced in
March 1998 and the Company thereafter began to see the adverse affect on home
health margins. The negative trends that occurred as a result in the reduction
in reimbursement brought about by the BBA caused the Company to re-evaluate its
view of the home health product line. The plan was approved by the Board of
Directors on September 16, 1998 and all home health operations covered by the
plan were closed by December 31, 1998.
The Company recorded impairment and restructuring charges of approximately
$72,000,000 related to the home health plan. In addition, the Company determined
that approximately $27,768,000 in notes receivable and approximately $19,228,000
in accounts receivable would not be collectible as a result of the closing of
its home health operations. These non-recurring amounts have been recognized in
operating unit expenses and the provision for doubtful accounts, respectively.
The total non-recurring charges and expenses included in the results of
operations for the year ended December 31, 1998 related to the home health plan
was approximately $118,996,000.
During the fourth quarter of 1998, the Company adopted a plan to dispose of
or otherwise substantially discontinue the operations of certain facilities that
did not fit with the Company's Integrated Service Model strategy (see Item 1,
"Business - Company Strategy"), underperforming facilities and facilities not
located in target markets. The Board of Directors approved the plan on December
10, 1998 and as of March 12, 1999, 73% of the identified facilities had been
closed. The Company recorded impairment and restructuring charges of
approximately $404,000,000 related to the fourth quarter restructuring plan.
In addition, the Company recorded an impairment charge of approximately
$8,000,000 related to a rehabilitation hospital it had closed and recorded a
$31,232,000 loss on the sale of its physical therapy staffing business.
Total non-recurring charges and expenses included in the results of
operations for the year ended December 31, 1998 were approximately $587,000,000.
For further discussion, see Notes 2, 9 and 13 of "Notes to Consolidated
Financial Statements".
Income before minority interests and income taxes for 1998 was
$267,373,000, compared to $629,196,000 for 1997. Minority interests reduced
income before income taxes by $77,468,000 in 1998, compared to $72,469,000 for
1997. The provision for income taxes for 1998 was $143,347,000, compared to
$213,668,000 for 1997. Excluding the tax effects of the impairment and
restructuring charges, the merger costs, and the loss on sale of assets, the
effective tax rate for 1998 was 39.0%, compared to 38.4% for 1997 ( see Note 10
of "Notes to Consolidated Financial Statements" for further discussion). Net
income for 1998 was $46,558,000.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1998, the Company had working capital of $945,927,000,
including cash and marketable securities of $142,513,000. Working capital at
December 31, 1997 was $612,917,000, including cash and marketable securities of
$185,018,000. For 1998, cash provided by operations was $636,132,000, compared
to $446,937,000 for 1997. For 1998, investing activities used $1,781,459,000,
compared to providing $346,778,000 for 1997. The change is primarily due to the
proceeds from sale of non-strategic assets in 1997. Additions to property, plant
and equipment and acquisitions accounted for $714,212,000 and $729,440,000,
respectively, during 1998. Those same investing activities accounted for
$349,861,000 and $309,548,000, respectively, in 1997. Financing activities
provided $1,121,162,000 and used $790,515,000 during 1998 and 1997,
respectively. The change is primarily due to the Company's use of the proceeds
from the sale of non-strategic assets to pay down outstanding indebtedness in
1997. Net borrowing proceeds (reductions) for 1998 and 1997 were $1,177,311,000
and $(774,303,000), respectively.
30
Net accounts receivable were $897,901,000 at December 31, 1998, compared to
$765,335,000 at December 31, 1997. The number of days of average annual revenues
in ending receivables was 81.8 at December 31, 1998, compared to 79.9 at
December 31, 1997. See Note 1 of "Notes to Consolidated Financial Statements"
for concentration of net accounts receivable from patients, third-party payors,
insurance companies and others at December 31, 1998 and 1997.
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. 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. The effective interest rate on
the average outstanding balance under the 1998 Credit Agreement was 6.1% for the
twelve months ended December 31, 1998, compared to the average prime rate of
8.4% during the same period. At December 31, 1998, the Company had drawn
$1,325,000,000 under the 1998 Credit Agreement. For further discussion, see Note
7 of "Notes to Consolidated Financial Statements".
The Company also has a Short Term Credit Agreement with NationsBank (as
amended, the "Short Term Credit Agreement"), providing for a $500,000,000 short
term revolving credit facility. The terms of the Short Term Credit Agreement are
substantially consistent with those of the 1998 Credit Agreement. Interest on
the Short Term Credit Agreement is paid based on LIBOR plus a predetermined
margin or a base rate. The Company is required to pay a fee on the unused
portion of the credit facility ranging from 0.09% to 0.25%, depending on certain
defined ratios. The principal amount is payable in full on February 15, 2000,
with an earlier repayment required in the event that the Company consummates any
public offering or private placement of debt securities. At December 31, 1998,
the Company had not drawn down any amounts under the Short Term 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.
On February 8, 1999, the Company announced a plan to repurchase up to
70,000,000 shares of its common stock over the next 36 months through open
market purchases, block trades or privately negotiated transactions.
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 other complementary 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 $100,000,000 to $200,000,000 on maintenance and expansion of its
31
existing facilities and approximately $300,000,000 to $500,000,000 to repurchase
outstanding shares of its common stock, depending on market conditions, and on
continued 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 existing
credit facilities 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.
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 $3,686,000 at
December 31, 1998, compared to $22,026,000 at December 31, 1997. The investment
represents less than 1% of total assets at December 31, 1998 and 1997. 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 December 31, 1998 is subject to variable
rates of interest, while the remaining balance in long-term debt of
$1,505,926,000 is subject to fixed rates of interest. This compares to
$1,175,000,000 in long-term debt subject to variable rates of interest and
$439,961,000 in long-term debt subject to fixed rates of interest at December
31, 1997 (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 and, except for the 3.25% Convertible Debentures, at December 31, 1998. The
fair value of the 3.25% Convertible Debentures at December 31, 1998 was
approximately $483,000,000. Based on a hypothetical 1% increase in interest
rates, the potential losses in future 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.
32
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
tested. Implementation will be completed during the first quarter of 1999. The
budget for this project is approximately $150,000.
The Company's general business applications are licensed from and
maintained by the same vendor. All such applications are already year 2000
compliant. The coding and testing of all of the Company's other externally
maintained mission-critical applications for year 2000 compliance was completed
during 1998. Installation of certain applications is still in process and will
be completed by June 30, 1999. The total cost of such installation is estimated
to be approximately $1,500,000.
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 an independent contractor to inventory and test all
of its computer hardware for year 2000 compliance at an estimated cost of
$800,000 to $1,000,000. The contractor has completed site visits to each of the
Company's locations with over five processors. The Company has received the data
from the site visits and is currently determining an appropriate remediation
plan. The preliminary estimate of the range of cost to complete a remediation
plan is approximately $25,000,000 to $30,000,000. The contractor has sent
diskettes containing test programs to each of the Company's locations with five
or fewer processors. The data from those locations will be available by April
30, 1999. The cost of remediation for those facilities with five or fewer
processors cannot be estimated until the data is complete.
The Company has completed its review of embedded applications which control
certain medical and other equipment. As expected, the review revealed that 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.
33
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 89% of those
suppliers, and no significant problems have been identified. Third 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 85% of the Company's
revenues. Such responses indicate that these payors' systems will be year 2000
compliant. Third requests have been mailed to non-respondents. 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.
Each of the Company's facilities is required, by Company policy, to
maintain a disaster recovery plan. The management of each facility has been
instructed to review and update such facility's specific disaster recovery plan
in light of potential local area problems that may occur as a result of year
2000 computer failures. Such potential problems include, but are not limited to,
interruption and/or loss of electrical power and water, breakdowns in
telecommunications systems and the inability to transport supplies and/or
personnel. The Company's primary exposure resides in its inpatient locations,
where patients will be in residence during the time that such potential problems
may occur. Execution of each facility's disaster recovery plan should mitigate
this exposure for a period of ten to fourteen days. If such potential problems
continue to occur after that period of time, the Company will have to take
actions that are not currently contemplated in the various disaster recovery
plans. It is not currently possible to estimate the cost or scope of such
actions.
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 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.
34
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, involve a
number of risks and uncertainties and are made pursuant to the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995. There can be
no assurance that other factors will not affect the accuracy of such
forward-looking statements or that HEALTHSOUTH's actual results will not differ
materially from the results anticipated in 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 or delays 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.
35
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 Auditor 37
Consolidated Balance Sheets as of December 31, 1997 and 1998 38
Consolidated Statements of Income for the Years Ended
December 31, 1996, 1997 and 1998 40
Consolidated Statements of Stockholders' Equity for the
Years Ended December 31, 1996, 1997 and 1998 41
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1996, 1997 and 1998 43
Notes to Consolidated Financial Statements 46
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 1997 acquisition of Health Images and the 1998
acquisition of NSC, both 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.
1997
- - - -------------------------------------------------------------------------------------------------------------------
1ST 2ND 3RD 4TH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenues $ 714,534 $ 748,032 $ 776,062 $ 884,548
Net income 67,191 84,586 89,053 102,229
Net income per common share 0.19 0.24 0.25 0.26
Net income per common share --
assuming dilution 0.18 0.22 0.24 0.25
1998
- - - -------------------------------------------------------------------------------------------------------------------
1ST 2ND 3RD 4TH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenues $ 938,779 $ 979,064 $ 1,047,422 $ 1,040,809
Net income 113,132 121,600 5,670 (193,844)
Net income per common share 0.27 0.29 0.01 (0.46)
Net income per common share --
assuming dilution 0.26 0.28 0.01 (0.46)
36
Report of 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, 1997 and 1998, and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the three years in the period ended December 31, 1998. 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, 1997 and 1998, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1998, 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 aspects the
information set forth therein.
ERNST & YOUNG LLP
Birmingham, Alabama
March 19, 1999
37
HEALTHSOUTH Corporation and Subsidiaries
Consolidated Balance Sheets
DECEMBER 31,
---------------------------------------------
1997 1998
---------------------------------------------
(In thousands)
Assets
Current assets:
Cash and cash equivalents (Note 3) $ 162,992 $ 138,827
Other marketable securities (Note 3) 22,026 3,686
Accounts receivable, net of allowances for doubtful
accounts of $127,572,000 in 1997 and $143,689,000 in
1998 765,335 897,901
Inventories 67,867 77,840
Prepaid expenses and other current assets 122,468 169,899
Income tax refund receivable - 58,832
---------------------------------------------
Total current assets 1,140,688 1,346,985
Other assets:
Loans to officers 1,007 3,263
Assets held for sale (Notes 9 and 13) 60,400 27,430
Other (Note 4) 161,129 147,158
---------------------------------------------
222,536 177,851
Property, plant and equipment, net (Note 5) 1,890,110 2,288,262
Intangible assets, net (Note 6) 2,312,990 2,959,910
---------------------------------------------
Total assets $ 5,566,324 $ 6,773,008
=============================================
38
DECEMBER 31,
---------------------------------------------
1997 1998
---------------------------------------------
(In thousands)
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 125,824 $ 76,099
Salaries and wages payable 124,823 111,243
Accrued interest payable and other liabilities 101,112 126,110
Income taxes payable 92,507 -
Deferred income taxes (Note 10) 34,345 37,612
Current portion of long-term debt (Note 7) 49,160 49,994
---------------------------------------------
Total current liabilities 527,771 401,058
Long-term debt (Note 7) 1,565,801 2,780,932
Deferred income taxes (Note 10) 75,533 28,856
Deferred revenue and other long-term liabilities 2,224 11,940
Minority interests-limited partnerships (Note 1) 104,372 127,218
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--600,000,000 shares
authorized; issued--415,537,000 in 1997 and
423,178,000 in 1998 4,155 4,232
Additional paid-in capital 2,474,726 2,577,647
Retained earnings 833,328 878,228
Treasury stock, at cost (552,000 shares in 1997 and
2,042,000 shares in 1998) (3,923) (21,813)
Receivable from Employee Stock Ownership
Plan (12,247) (10,169)
Notes receivable from stockholders (5,416) (5,121)
---------------------------------------------
Total stockholders' equity 3,290,623 3,423,004
---------------------------------------------
Total liabilities and stockholders' equity $ 5,566,324 $ 6,773,008
=============================================
See accompanying notes.
39
HEALTHSOUTH Corporation and Subsidiaries
Consolidated Statements of Income
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------
1996 1997 1998
---------------------------------------------------------------
(In thousands, except for per share amounts)
Revenues $ 2,648,188 $ 3,123,176 $ 4,006,074
Operating unit expenses 1,718,108 1,952,189 2,491,914
Corporate general and
administrative expenses 82,953 87,512 112,800
Provision for doubtful accounts 61,311 74,743 112,202
Depreciation and amortization 212,967 257,136 344,591
Merger and acquisition related expenses
(Notes 2 and 9) 41,515 15,875 25,630
Loss on sale of assets (Note 9) - - 31,232
Impairment and restructuring charges
(Note 13) 37,390 - 483,455
Interest expense 101,367 112,529 148,163
Interest income (6,749) (6,004) (11,286)
---------------------------------------------------------------
2,248,862 2,493,980 3,738,701
---------------------------------------------------------------
Income before income taxes and minority
interests 399,326 629,196 267,373
Provision for income taxes (Note 10) 148,545 213,668 143,347
---------------------------------------------------------------
250,781 415,528 124,026
Minority interests 54,003 72,469 77,468
---------------------------------------------------------------
Net income $ 196,778 $ 343,059 $ 46,558
===============================================================
Weighted average common shares outstanding 336,603 366,768 421,462
===============================================================
Net income per common share $ 0.58 $ 0.94 $ 0.11
===============================================================
Weighted average common shares
outstanding - assuming dilution 365,715 386,211 432,275
===============================================================
Net income per common share -
assuming dilution $ 0.55 $ 0.89 $ 0.11
===============================================================
See accompanying notes.
40
HEALTHSOUTH Corporation and Subsidiaries
Consolidated Statements of Stockholders' Equity
Years ended December 31, 1996, 1997 and 1998
Additional
Common Stock Paid-In Retained Treasury Stock
Shares Amount Capital Earnings Shares Amount
---------------------------------------------------------------------------------
(In thousands)
Balance at December 31, 1995 170,301 $ 1,703 $1,053,713 $ 315,683 3,070 $ (30,864)
Adjustment for Advantage Health Merger - - - (17,638) - -
Adjustment for 1996 mergers (Note 2) 4,047 40 68,785 (1,256) - -
Proceeds from exercise of options (Note 8) 4,135 42 35,289 - - -
Proceeds from issuance of common shares 2,650 26 54,923 - - -
Common shares issued upon conversion of
convertible debt 562 6 6,693 - - -
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 - - - (83) - -
Purchase of treasury stock - - - - 89 (736)
Retirement of treasury stock (1,835) (18) (31,259) - (3,068) 31,277
Net income - - - 196,778 - -
Translation adjustment - - - 692 - -
Dividends paid - - - (1,222) - -
Stock split 159,727 1,597 (1,597) - 91 -
---------------------------------------------------------------------------------
Balance at December 31, 1996 339,587 3,396 1,210,314 492,954 182 (323)
Common shares issued in connection with
acquisitions (Note 9) 46,412 464 999,587 - - -
Value of options exchanged in connection with
the Horizon/CMS acquisition (Note 9) - - 23,191 - - -
Common shares issued upon conversion of
convertible debt 12,324 123 114,390 - - -
Proceeds from exercise of options (Note 8) 10,525 105 60,221 - - -
Income tax benefits related to incentive stock
options (Note 8) - - 67,090 - - -
Reduction in receivable from ESOP - - - - - -
Payments received on stockholders' notes
receivable - - - - - -
Purchase of limited partnership units - - - (2,465) - -
Purchase of treasury stock - - - - 370 (3,600)
Net income - - - 343,059 - -
Translation adjustment - - - (220) - -
Stock dividend 6,689 67 (67) - - -
---------------------------------------------------------------------------------
Balance at December 31, 1997 415,537 4,155 2,474,726 833,328 552 (3,923)
Proceeds from exercise of options (Note 8) 6,885 69 60,135 - - -
Common shares issued in connection with
acquisitions (Note 9) 699 7 19,390 - - -
Common shares issued in connection with lease
buyout 57 1 1,592 - - -
Income tax benefits related to incentive stock
options (Note 8) - - 21,804 - - -
Purchase of treasury shares - - - - 1,490 (17,890)
Reduction in receivable from ESOP - - - - - -
Payments received on stockholders' notes
receivable - - - - - -
Purchase of limited partnership units - - - (1,634) - -
Net income - - - 46,558 - -
Translation adjustment - - - (24) - -
---------------------------------------------------------------------------------
Balance at December 31, 1998 423,178 $ 4,232 $2,577,647 $ 878,228 2,042 $(21,813)
=================================================================================
41
Notes
Receivable Total
Receivable from Stockholders'
from ESOP Stockholders Equity
---------------------------------------------
Balance at December 31, 1995 $(15,886) $ (6,471) $ 1,317,878
Adjustment for Advantage Health Merger - - (17,638)
Adjustment for 1996 mergers (Note 2) - - 67,569
Proceeds from exercise of options (Note 8) - - 35,331
Proceeds from issuance of common shares - - 54,949
Common shares issued upon conversion of
convertible debt - - 6,699
Income tax benefits related to incentive stock
options (Note 8) - - 23,767
Reduction in receivable from ESOP 1,738 - 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 - - 196,778
Translation adjustment - - 692
Dividends paid - - (1,222)
Stock split - - -
-----------------------------------------------
Balance at December 31, 1996 (14,148) (5,423) 1,686,770
Common shares issued in connection with
acquisitions (Note 9) - - 1,000,051
Value of options exchanged in connection with
the Horizon/CMS acquisition (Note 9) - - 23,191
Common shares issued upon conversion of
convertible debt - - 114,513
Proceeds from exercise of options (Note 8) - - 60,326
Income tax benefits related to incentive stock
options (Note 8) - - 67,090
Reduction in receivable from ESOP 1,901 - 1,901
Payments received on stockholders' notes
receivable - 7 7
Purchase of limited partnership units - - (2,465)
Purchase of treasury stock - - (3,600)
Net income - - 343,059
Translation adjustment - - (220)
Stock dividend - - -
-----------------------------------------------
Balance at December 31, 1997 (12,247) (5,416) 3,290,623
Proceeds from exercise of options (Note 8) - - 60,204
Common shares issued in connection with
acquisitions (Note 9) - - 19,397
Common shares issued in connection with lease
buyout - - 1,593
Income tax benefits related to incentive stock
options (Note 8) - - 21,804
Purchase of treasury shares - - (17,890)
Reduction in receivable from ESOP 2,078 - 2,078
Payments received on stockholders' notes
receivable - 295 295
Purchase of limited partnership units - - (1,634)
Net income - - 46,558
Translation adjustment - - (24)
-----------------------------------------------
Balance at December 31, 1998 $(10,169) $(5,121) $ 3,423,004
===============================================
See accompanying notes.
42
HEALTHSOUTH Corporation and Subsidiaries
Consolidated Statements of Cash Flows
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1996 1997 1998
------------------------------------------------------
(In thousands)
OPERATING ACTIVITIES
Net income $ 196,778 $ 343,059 $ 46,558
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 212,967 257,136 344,591
Provision for doubtful accounts 61,311 74,743 112,202
Impairment and restructuring charges 37,390 - 483,455
Merger and acquisition related expenses 41,515 15,875 25,630
Loss on sale of assets - - 31,232
Income applicable to minority interests of
limited partnerships 54,003 72,469 77,468
Provision for deferred income taxes 15,818 15,237 (43,410)
Provision for deferred revenue (1,255) (406) -
Changes in operating assets and liabilities,
net of effects of acquisitions:
Accounts receivable (145,837) (200,778) (250,468)
Inventories, prepaid expenses and other
current assets (37,567) 21,803 (132,280)
Accounts payable and accrued expenses (34,548) (152,201) (58,846)
------------------------------------------------------
Net cash provided by operating activities 400,575 446,937 636,132
INVESTING ACTIVITIES
Purchases of property, plant and equipment (208,908) (349,861) (714,212)
Proceeds from sale of non-strategic assets - 1,136,571 34,100
Additions to intangible assets, net of effects of
acquisitions (175,380) (61,887) (48,415)
Assets obtained through acquisitions, net of
liabilities assumed (109,334) (309,548) (729,440)
Payments on purchase accounting accruals - - (292,949)
Changes in other assets (57,328) (108,245) (48,883)
Proceeds received on sale of other marketable
securities 8,774 41,087 18,340
Investments in other marketable securities - (1,339) -
------------------------------------------------------
Net cash (used in) provided by investing activities (542,176) 346,778 (1,781,459)
43
HEALTHSOUTH Corporation and Subsidiaries
Consolidated Statements of Cash Flows (continued)
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1996 1997 1998
------------------------------------------------------
(In thousands)
FINANCING ACTIVITIES
Proceeds from borrowings $ 205,873 $ 1,763,317 $ 3,486,474
Principal payments on long-term debt (117,700) (2,537,620) (2,309,163)
Proceeds from exercise of options 35,331 60,326 60,204
Proceeds from issuance of common stock 55,628 70 -
Purchase of treasury stock (736) - (17,890)
Reduction in receivable from ESOP 1,738 1,901 2,078
Payments received from stockholders 1,048 7 295
Dividends paid (1,222) - -
Proceeds from investment by minority interests 83 4,096 4,471
Purchase of limited partnership units (3,064) (2,685) (1,658)
Payment of cash distributions to limited partners (42,051) (79,927) (103,649)
------------------------------------------------------
Net cash provided by (used in) financing
activities 134,928 (790,515) 1,121,162
------------------------------------------------------
(Decrease) increase in cash and cash equivalents (6,673) 3,200 (24,165)
Cash and cash equivalents at beginning of year 170,102 159,792 162,992
Cash flows related to mergers (3,637) - -
------------------------------------------------------
Cash and cash equivalents at end of year $ 159,792 $ 162,992 $ 138,827
======================================================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION
Cash paid during the year for:
Interest $ 99,684 $ 113,241 $ 143,606
Income taxes 72,212 140,715 315,028
Non-cash investing activities:
The Company assumed liabilities of $30,608,000, $1,163,913,000 and $107,091,000
during the years ended December 31, 1996, 1997 and 1998, 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 46,480,000 common
shares with a market value of $1,000,051,000 as consideration for acquisitions
accounted for as purchases.
During the year ended December 31, 1998, the Company issued 699,000 common
shares with a market value of $19,397,000 as consideration for acquisitions
accounted for as purchases.
44
HEALTHSOUTH Corporation and Subsidiaries
Consolidated Statements of Cash Flows (continued)
Non-cash financing activities:
During 1997, the Company effected a two-for-one stock split of 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 $23,767,000, $67,090,000 and $21,804,000 for the
years ended December 31, 1996, 1997 and 1998, 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 12,324,000 shares of the Company's
Common Stock.
See accompanying notes.
45
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 1998
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.
NATURE OF OPERATIONS
HEALTHSOUTH is engaged in the business of providing healthcare services through
two business segments: inpatient and other clinical services and outpatient
services. Inpatient and other clinical services consist of services provided
through inpatient rehabilitation facilities, specialty medical centers and
certain physician practices and other clinical services. Outpatient services
consist of services provided through outpatient rehabilitation facilities
(including occupational health centers), outpatient surgery centers and
outpatient diagnostic centers.
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.
OPERATING SEGMENTS
The Company has adopted the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 131, "Disclosures about Segments of an Enterprise and
Related Information". SFAS 131 requires the utilization of a "management
approach" to define and report the financial results of operating segments. The
management approach defines operating segments along the lines used by
management to assess performance and make operating and resource allocation
decisions. The Company has aggregated the financial results of its outpatient
rehabilitation facilities, outpatient surgery centers and outpatient diagnostic
centers into the outpatient services segment. These three types of facilities
have common economic characteristics, provide similar services, serve a similar
class of customers, cross-utilize administrative services and operate in a
similar regulatory environment. In addition, the Company's integrated service
model strategy combines these services in a seamless environment for the
delivery of patient care on an episodic basis.
46
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The adoption of SFAS 131 did not affect results of operations or financial
position, but did require the disclosure of segment information (see Note 14).
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 $36,759,000 and $9,277,000 at December 31, 1997 and 1998,
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.
47
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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,
---------------------------------------
1997 1998
=======================================
Medicare 25% 21%
Medicaid 4 4
Other 71 75
---------------------------------------
100% 100%
=======================================
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 costs of $105,310,000, $115,020,000 and $148,793,000,
of which $3,943,000, $2,491,000 and $630,000 was capitalized, during 1996, 1997
and 1998, 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.
48
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INTANGIBLE ASSETS
Cost in excess of net asset value of purchased facilities is amortized over 20
to 40 years using the straight-line method, with the majority of such cost being
amortized over 40 years. 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, 1997 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, 1998), the effect of which is
removed from the results of operations of the Company.
49
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.
50
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME PER COMMON SHARE
The following table sets forth the computation of basic and diluted earnings per
share:
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1996 1997 1998
----------------- ------------------ -----------------
(In thousands, except per share amounts)
Numerator:
Net income $196,778 $343,059 $46,558
----------------- ------------------ -----------------
Numerator for basic earnings per
share--income available to
common stockholders 196,778 343,059 46,558
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 3,839 968 -
----------------- ------------------ -----------------
Numerator for diluted earnings per share-income
available to common stockholders after
assumed conversion $200,617 $344,027 $ 46,558
================= ================== =================
Denominator:
Denominator for basic earnings per share -
weighted-average shares 336,603 366,768 421,462
----------------- ------------------ -----------------
Effect of dilutive securities:
Net effect of dilutive stock options 16,362 16,374 10,813
Assumed conversion of 5% Convertible
Subordinated Debentures due 2001 12,226 3,057 -
Assumed conversion of other dilutive
convertible debt 524 12 -
----------------- ------------------ -----------------
Dilutive potential common shares 29,112 19,443 10,813
----------------- ------------------ -----------------
Denominator of diluted earnings per share -
adjusted weighted-average shares and
assumed conversions 365,715 386,211 432,275
================= ================== =================
Basic earnings per share $ 0.58 $ 0.94 $ 0.11
================= ================== =================
Diluted earnings per share $ 0.55 $ 0.89 $ 0.11
================= ================== =================
51
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 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, 1997 and 1998, are included with accrued interest payable and other
liabilities in the accompanying consolidated balance sheets.
RECLASSIFICATIONS
Certain amounts in 1996 and 1997 financial statements have been reclassified to
conform with the 1998 presentation. Such reclassifications had no effect on
previously reported consolidated financial position and consolidated net income.
52
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
2. MERGERS
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,
53
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. MERGERS (CONTINUED)
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.
Effective July 22, 1998, a wholly-owned subsidiary of the Company merged with
National Surgery Centers, Inc. ("NSC"), and in connection therewith the Company
issued 20,426,261 shares of its common stock in exchange for all of NSC's
outstanding common stock. Prior to the merger, NSC operated 40 outpatient
surgery centers in 14 states. Costs and expenses of approximately $25,630,000,
primarily legal, accounting and financial advisory fees, incurred by the Company
in connection with the NSC merger have been recorded in operations during 1998
and reported as merger expenses in the accompanying consolidated statements of
income.
The mergers of the Company with SCA, Advantage Health, Health Images and NSC
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, SCA, Advantage Health, Health Images and NSC
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 NSC are as follows (in
thousands):
HEALTHSOUTH NSC Combined
---------------------- ----------------- --------------------
Year ended December 31, 1996
Revenues $ 2,568,155 $ 80,033 $ 2,648,188
Net income 189,864 6,914 196,778
Year ended December 31, 1997
Revenues $ 3,017,269 $ 105,907 $ 3,123,176
Net income 330,608 12,451 343,059
Year ended December 31, 1998
Revenues $ 3,938,376 $ 67,698 $ 4,006,074
Net income 38,421 8,137 46,558
Separate 1998 results for NSC include only the period January 1 through June 30,
1998.
54
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. MERGERS (CONTINUED)
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
consolidated 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.
3. CASH, CASH EQUIVALENTS AND OTHER MARKETABLE SECURITIES
Cash, cash equivalents and other marketable securities consisted of the
following:
DECEMBER 31,
--------------------------------------
1997 1998
------------------- ------------------
(In thousands)
Cash $ 150,318 $ 131,709
Cash equivalents 12,674 7,118
------------------- ----------------
Total cash and cash equivalents 162,992 138,827
Certificates of deposit 1,256 1,256
Municipal put bonds 1,570 1,430
Municipal put bond mutual funds 500 -
Other debt securities 17,700 -
Collateralized mortgage obligations 1,000 1,000
------------------- ----------------
Total other marketable securities 22,026 3,686
------------------- ----------------
Total cash, cash equivalents and other
marketable securities (approximates
market value) $ 185,018 $ 142,513
=================== ================
55
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
3. CASH, CASH EQUIVALENTS AND OTHER MARKETABLE SECURITIES (CONTINUED)
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,
-------------------------------------------
1997 1998
--------------------- ---------------------
(In thousands)
Notes receivable $ 70,655 $ 59,992
Prepaid long-term lease 9,190 7,829
Investments accounted for on equity method 9,794 16,548
Investments accounted for at cost 28,427 52,004
Real estate investments 21,911 2,820
Trusteed funds 921 4,218
Other 20,231 3,747
--------------------- --------------------
$ 161,129 $ 147,158
===================== =====================
The Company has various investments, with ownership percentages ranging from 24%
to 49%, which are accounted for using the equity method of accounting. The
Company's equity in earnings of these investments was not material to the
Company's consolidated results of operations for the years ended 1996, 1997 and
1998. At December 31, 1998, the investment balance on the Company's books was
not materially different than the underlying equity in net assets of the
unconsolidated entities.
Investments accounted for at cost are comprised of investments in companies
involved in operations similar to those of the Company. For those investments
with a quoted market price, the Company's investment balance is not materially
different than the quoted market price. For all other investments in this
category, it was not practicable to estimate the fair value because of the lack
of a quoted market price and the inability to estimate the fair value without
incurring excessive costs. The carrying amount at December 31, 1998 represents
the original cost of the investments, which management believes is not impaired.
56
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,
---------------------------------------
1997 1998
--------------------- -----------------
(In thousands)
Land $ 115,117 $ 123,076
Buildings 1,039,523 1,153,845
Leasehold improvements 196,934 348,205
Furniture, fixtures and equipment 1,077,538 1,266,185
Construction-in-progress 32,876 29,212
--------------------- -----------------
2,461,988 2,920,523
Less accumulated depreciation and amortization 571,878 632,261
--------------------- -----------------
$ 1,890,110 $ 2,288,262
===================== =================
6. INTANGIBLE ASSETS
Intangible assets consisted of the following:
DECEMBER 31,
-------------------------------------------
1997 1998
--------------------- --------------------
(In thousands)
Organizational, partnership formation and
start-up costs (see Note 1) $ 255,810 $ 200,160
Debt issue costs 33,114 56,068
Noncompete agreements 121,581 130,776
Cost in excess of net asset value of
purchased facilities 2,176,127 2,919,187
--------------------- ---------------------
2,586,632 3,306,191
Less accumulated amortization 273,642 346,281
--------------------- ---------------------
$ 2,312,990 $ 2,959,910
===================== =====================
57
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. LONG-TERM DEBT
Long-term debt consisted of the following:
DECEMBER 31,
-------------------------------------------
1997 1998
--------------------- ---------------------
(In thousands)
Notes and bonds payable:
Advances under a $1,750,000,000 credit agreement with banks $ - $ 1,325,000
Advances under a $1,250,000,000 credit agreement with banks 1,175,000 -
9.5% Senior Subordinated Notes due 2001 250,000 250,000
3.25% Convertible Subordinated Debentures due 2003 - 567,750
6.875% Senior Notes due 2005 - 250,000
7.0% Senior Notes due 2008 - 250,000
Notes payable to banks and various other notes payable, at
interest rates from 5.5% to 14.9% 128,036 113,755
Hospital revenue bonds payable 14,836 13,712
Noncompete agreements payable with payments due at intervals
ranging through December 2004 47,089 60,709
--------------------- ---------------------
1,614,961 2,830,926
Less amounts due within one year 49,160 49,994
--------------------- ---------------------
$ 1,565,801 $ 2,780,932
===================== =====================
The fair value of the total long-term debt approximates book value at December
31, 1997 and, except for the 3.25% Convertible Subordinated Debentures due 2003,
at December 31, 1998. The fair value of the 3.25% Convertible Subordinated
Debentures due 2003 was approximately $483,000,000 at December 31, 1998. 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.
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. 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
58
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. LONG-TERM DEBT (CONTINUED)
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 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. At December 31, 1998, the
effective interest rate associated with the 1998 Credit Agreement was
approximately 5.9%.
The Company also has a Short Term Credit Agreement with NationsBank (as amended,
the "Short Term Credit Agreement"), providing for a $500,000,000 short term
revolving credit facility. The terms of the Short Term Credit Agreement are
substantially consistent with those of the 1998 Credit Agreement. Interest on
the Short Term Credit Agreement is paid based on LIBOR plus a predetermined
margin or a base rate. The Company is required to pay a fee on the unused
portion of the credit facility ranging from 0.09% to 0.25%, depending on certain
defined ratios. The principal amount is payable in full on February 15, 2000,
with an earlier repayment required in the event that the Company consummates any
public offering or private placement of debt securities. At December 31, 1998,
the Company had not drawn down any amounts under the Short Term 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, and also are effectively subordinated to all existing and future
liabilities of the Company's subsidiaries and partnerships. The Notes mature on
April 1, 2001.
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 then-existing credit facilities.
59
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. LONG-TERM DEBT (CONTINUED)
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.
Principal maturities of long-term debt are as follows:
YEAR ENDING DECEMBER 31, (IN THOUSANDS)
- - - ------------------------ --------------
1999 $ 49,994
2000 36,564
2001 277,805
2002 17,221
2003 1,904,692
After 2003 544,650
--------------
$ 2,830,926
===============
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
60
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
8. STOCK OPTIONS (CONTINUED)
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, 1997 and 1998 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 1996,
1997 and 1998, respectively: risk-free interest rates of 6.01%, 6.12% and 6.10%;
dividend yield of 0%; volatility factors of the expected market price of the
Company's common stock of .37, .37 and .76; and a weighted-average expected life
of the options of 4.3 years, 6.2 years and 5.5 years.
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.
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,
------------------------------------------------------------
1996 1997 1998
--------------------- --------------------- ----------------
(In thousands, except per share amounts)
Pro forma net income $ 168,390 $ 301,467 $ 31,009
Pro forma earnings per share:
Basic $ 0.50 $ 0.82 $ 0.07
Diluted 0.46 0.78 0.07
61
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
8. STOCK OPTIONS (CONTINUED)
The effect of compensation expense from stock options on 1996 pro forma net
income reflects the second year of vesting of 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 is full effect of
recognizing compensation expense for stock options 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:
1996 1997 1998
--------------------- --------------------- ---------------------
Weighted Weighted Weighted
Average Average Average
Options Exercise Options Exercise Options Exercise
(000) Price (000) Price (000) Price
----- ----- ----- ----- ----- -----
Options outstanding January 1 36,102 $ 5 34,736 $ 7 34,771 $12
Granted 5,730 17 11,286 22 6,020 12
Exercised (6,751) 5 (10,075) 7 (5,035) 12
Canceled (345) 6 (1,176) 19 (1,319) 21
------- ------- -------- ----- ---------- ------
Options outstanding at December 31 34,736 $ 7 34,771 $12 34,437 $12
Options exercisable at December 31 27,978 $ 6 28,703 $11 29,156 $11
Weighted average fair value of
options granted during the
year $ 7.13 $ 10.59 $ 7.50
The following table summarizes information about stock options outstanding at
December 31, 1998:
Options Outstanding Options Exercisable
---------------------------------------- ----------------------------
Weighted Weighted Weighted
Average Average Average
December 31, Remaining Exercise December 31, Exercise
1998 Life Price 1998 Price
---- ---- ----- ---- -----
(In thousands) (Years) (In thousands)
Under $10.00 21,808 5.76 $ 6.59 18,775 $ 6.08
$10.00 - $23.63 7,760 6.66 17.99 7,113 18.02
$23.63 and above 4,869 8.65 24.12 3,268 24.06
62
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
9. ACQUISITIONS
The Company evaluates each of its acquisitions independently to determine the
appropriate amortization period for the cost in excess of net asset value of
purchased facilities. Each evaluation includes an analysis of historic and
projected financial performance, evaluation of the estimated useful lives of
buildings and fixed assets acquired, the indefinite lives of certificates of
need and licenses acquired, the competition within local markets, lease terms
where applicable, and the legal term of partnerships where applicable.
1996 ACQUISITIONS
At various dates during 1996, the Company acquired 80 outpatient rehabilitation
facilities, 19 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 $122,264,000. The form of consideration
constituting the total purchase prices was approximately $110,262,000 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.
The fair value of the total net assets relating to the 1996 acquisitions
described above was approximately $42,459,000. The total cost of the 1996
acquisitions exceeded the fair value of the net assets acquired by approximately
$79,805,000. 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.
63
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
9. ACQUISITIONS (CONTINUED)
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 Company also planned 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 was completed during the
fourth quarter of 1998. Accordingly, a portion of the Horizon/CMS purchase price
was allocated to the Physician Placement Services Subsidiary and this amount was
classified as assets held for sale in the accompanying December 31, 1997
consolidated balance sheet. The allocated amount of $60,400,000 represented 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 actual net proceeds realized by the
64
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
9. ACQUISITIONS (CONTINUED)
Company upon the sale of the Physician Placement Services Subsidiary was
approximately $34,100,000. The difference between the original amount allocated
and the net proceeds realized by the Company has been accounted for in 1998 as
an adjustment to the Horizon/CMS purchase price allocation. The results of
operations of the Physician Placement Services Subsidiary from the Horizon/CMS
acquisition date to December 31, 1998, including a net loss of $10,065,000, have
been excluded from the Company's results of operations in the accompanying
financial statement in accordance with EITF 87-11.
In connection with the sale of the Physician Placement Services Subsidiary, the
Company also sold its physical therapy staffing business, which had been
acquired by the Company as part of a larger strategic acquisition in 1994. The
loss on the sale of the physical therapy staffing business was $31,232,000 and
was recorded by the Company in the fourth quarter of 1998.
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, ten 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 $179,749,000. The form of consideration constituting the total
purchase prices was $173,519,000 in cash, $2,674,000 in notes payable and the
issuance of approximately 235,000 shares of the Company's common stock, valued
at $3,521,000.
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.
65
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
9. ACQUISITIONS (CONTINUED)
As of December 31, 1997, the Company had estimated the fair value of the total
net assets relating to the 1997 acquisitions described above to be approximately
$237,369,000. During 1998, the Company made certain adjustments to reduce the
fair value of the Horizon/CMS net assets acquired by approximately $136,065,000.
These adjustments relate primarily to the valuation of accounts and notes
receivable acquired, the valuation of fixed assets acquired, final working
capital settlements with IHS and the payment of pre-acquisition liabilities in
excess of amounts accrued in the original purchase price allocation. After
considering the effects of the adjustments recorded in 1998, the total cost of
the 1997 acquisitions exceeded the fair value of the net assets acquired by
approximately $1,228,993,000. 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 25 to 40 years on a
straight-line basis.
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.
1998 ACQUISITIONS
Effective July 1, 1998, the Company acquired Columbia/HCA Healthcare
Corporation's interests in 33 ambulatory surgery centers (subject to certain
outstanding consents and approvals with respect to three of the centers, as to
which the parties entered into management agreements) 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
purchase price was approximately $550,402,000 in cash.
At various dates and in separate transactions throughout 1998, the Company
acquired 112 outpatient rehabilitation facilities, four outpatient surgery
centers, one inpatient rehabilitation hospital and 27 diagnostic imaging
centers. The acquired operations are located throughout the United States. The
total purchase price of the acquired operations was approximately $216,305,000.
The form of consideration constituting the total purchase prices was
approximately $179,038,000 in cash and $17,870,000 in notes payable and the
issuance of approximately 699,000 shares of the Company's common stock, valued
at $19,397,000.
66
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
9. ACQUISITIONS (CONTINUED)
In connection with these transactions, the Company entered into noncompete
agreements with former owners totaling $25,926,000. 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 1998 acquisitions
described above was approximately $15,570,000. The total cost of the 1998
acquisitions exceeded the fair value of the net assets acquired by approximately
$751,137,000. 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 1998 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. At December 31, 1998, the purchase price allocation associated with the
1998 acquisitions is preliminary in nature. During 1999 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 1998 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.
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.
67
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 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, 1997 are as follows:
CURRENT NONCURRENT TOTAL
------------------- ------------------- -------------------
(In thousands)
Deferred tax assets:
Accruals $ 19,564 $ - $ 19,564
Net operating loss - 11,334 11,334
Other - 4,618 4,618
------------------- ------------------- -------------------
Total deferred tax assets 19,564 15,952 35,516
Deferred tax liabilities:
Depreciation and amortization - 91,485 91,485
Capitalized costs 9,038 - 9,038
Allowance for bad debts 40,520 - 40,520
Other 4,351 - 4,351
------------------- ------------------- -------------------
Total deferred tax liabilities 53,909 91,485 145,394
------------------- ------------------- -------------------
Net deferred tax liabilities $ (34,345) $ (75,533) $ (109,878)
=================== =================== ===================
68
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
10. INCOME TAXES (CONTINUED)
Significant components of the Company's deferred tax assets and liabilities as
of December 31, 1998 are as follows:
CURRENT NONCURRENT TOTAL
------------------- ------------------- -------------------
(In thousands)
Deferred tax assets:
Net operating loss $ - $ 3,504 $ 3,504
Accruals 19,482 - 19,482
Impairment & restructuring charges - 136,470 136,470
------------------- ------------------- -------------------
Total deferred tax assets 19,482 139,974 159,456
Deferred tax liabilities:
Depreciation and amortization - (90,753) (90,753)
Bad debts (53,642) - (53,642)
Capitalized costs - (78,077) (78,077)
Other (3,452) - (3,452)
------------------- ------------------- -------------------
Total deferred tax liabilities (57,094) (168,830) (225,924)
------------------- ------------------- -------------------
Net deferred tax liabilities $ (37,612) $ (28,856) $ (66,468)
=================== =================== ===================
At December 31, 1998, the Company has net operating loss carryforwards of
approximately $9,829,000 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.
The provision for income taxes was as follows:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------
1996 1997 1998
--------------------- --------------------- ---------------------
(In thousands)
Currently payable:
Federal $ 118,448 $ 171,029 $ 162,433
State 14,279 27,402 24,324
--------------------- --------------------- ---------------------
132,727 198,431 186,757
Deferred expense :
Federal 14,742 13,186 (37,756)
State 1,076 2,051 (5,654)
--------------------- --------------------- ---------------------
15,818 15,237 (43,410)
--------------------- --------------------- ---------------------
$ 148,545 $ 213,668 $ 143,347
===================== ===================== =====================
69
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
10. INCOME TAXES (CONTINUED)
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,
--------------------------------------------------------
1996 1997 1998
----------------- ----------------- ------------------
(In thousands)
Federal taxes at statutory rates $ 139,764 $ 220,219 $ 93,581
Add (deduct):
State income taxes, net of federal tax
benefit 9,981 19,144 12,136
Minority interests (18,901) (25,364) (27,114)
Nondeductible goodwill - - 7,630
Disposal/impairment charges 6,563 1,576 57,873
Other 11,138 (1,907) (759)
----------------- ------------------ ------------------
$ 148,545 $ 213,668 $ 143,347
================= ================== ==================
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,
1998 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
70
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
11. COMMITMENTS AND CONTINGENCIES (CONTINUED)
claims 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" was
conducted which converted 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, 1998, 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 consolidated financial
position.
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. Seven such suits have been filed in the
United States District Court for the Northern District of Alabama, comprising
substantially 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. Certain of the named plaintiffs in some of the complaints also
purport to represent separate subclasses consisting of former stockholders of
corporations acquired by the Company in 1997 and 1998 who received shares of the
Company's Common Stock in connection with such acquisitions and who assert
additional claims under Section 11 of the Securities Act of 1933. In January
1999, these complaints were ordered to be consolidated, with a consolidated
amended complaint due to be filed by April 5, 1999.
71
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
11. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Additionally, another suit has been filed in the Circuit Court of Jefferson
County, Alabama, purportedly as a derivative action on behalf of the Company.
This 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 plaintiff in that case has forborne pursuing its claim thus far pending
further progress in the federal actions, and the Company has not yet been
required to file a responsive pleading in the case. Another non-derivative state
court action was voluntarily dismissed by the plaintiff, without prejudice.
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 predict the outcome of any
such suits or the magnitude of any potential loss if the Company's defense is
unsuccessful.
At December 31, 1998, committed capital expenditures for the next twelve months
are $27,458,000.
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 $138,098,000, $167,749,000 and
$238,937,000 for the years ended December 31, 1996, 1997 and 1998, respectively.
72
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
11. COMMITMENTS AND CONTINGENCIES (CONTINUED)
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)
- - - ---------------------------- ---------------------
1999 $ 199,903
2000 171,245
2001 142,874
2002 110,545
2003 85,697
After 2003 285,008
--------------------
Total minimum payments required $ 995,272
====================
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 $2,420,000,
$2,628,000 and $4,121,000 in 1996, 1997 and 1998, 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 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 $3,198,000, $3,249,000 and $3,195,000 in
1996,
73
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
12. EMPLOYEE BENEFIT PLANS (CONTINUED)
1997 and 1998, respectively. Interest incurred on the ESOP Loans was
approximately $1,298,000, $1,121,000 and $927,000 in 1996, 1997 and 1998,
respectively. Approximately 1,875,000 shares owned by the ESOP have been
allocated to participants at December 31, 1998.
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 AND RESTRUCTURING CHARGES
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.
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 HI Standard and HI STAR MRI systems. The Company's evaluation revealed
that due to improvements in technology, high-field 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. 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. Since the MRI
system was not fully developed, the Company has not been able to find a buyer
for any of the assets, nor are there any alternative uses. 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.
74
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
13. IMPAIRMENT AND RESTRUCTURING CHARGES (CONTINUED)
During the third quarter of 1998, the Company recorded impairment and
restructuring charges of approximately $72,000,000 related to the Company's
decision to dispose of or otherwise discontinue substantially all of its home
health operations. The decision was prompted in large part by the negative
impact of the 1997 Balanced Budget Act, which placed reimbursement limits on
home health businesses. The limits were announced in March 1998 and the Company
began to see the adverse affect on home health margins. Based on this
unfavorable trend, management prepared a plan to exit the home health operations
described above. The plan was approved by the Board of Directors on September
16, 1998. Revenues and income before income taxes and minority interests for the
home health operations were $71,163,000 and $(4,261,000), respectively. The home
health operations have been included in the inpatient and other clinical
services segment.
75
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
13. IMPAIRMENT AND RESTRUCTURING CHARGES (CONTINUED)
The Company has developed a strategic plan to provide integrated services in
major markets throughout the United States. In the fourth quarter of 1998, the
Company recorded a restructuring charge of approximately $404,000,000 as a
result of its decision to close certain facilities that do not fit with the
Company's strategic vision, underperforming facilities and facilities not
located in target markets. The identified facilities contributed $140,087,000 to
the Company's revenue and $(9,907,000) to the Company's income before income
taxes and minority interests during 1998.
The home health operations covered by the plan were closed by December 31, 1998.
At March 12, 1999, approximately 73% of the locations identified in the fourth
quarter restructuring plan had been closed. The Company expects the actions
associated with the fourth quarter restructuring plan to be substantially
completed during the first half of 1999. Assets that are no longer in use were
abandoned or written down to their fair value and either have been disposed of
or are being held for sale.
The total number of employees terminated in conjunction with the restructuring
plans was 7,900, with 7,879 having left the Company as of December 31, 1998. The
remaining employees will leave the Company during the first half of 1999.
The restructuring activities (shown below in tabular form) primarily relate to
asset write-downs, lease abandonments and the elimination of job
responsibilities resulting in costs incurred to sever employees.
Details of the impairment and restructuring charges are as follows:
RESTRUCTURING BALANCE AT
DESCRIPTION CHARGE ACTIVITY 12/31/98
- - - ----------------------------------- --------------------- ----------------- --------------------
(In thousands)
Impairment of assets:
Property, plant and equipment $ 146,243 $ 126,863 $ 19,380
Intangible assets 221,129 221,129 -
Lease abandonment costs 52,094 2,618 49,476
Other assets 24,765 24,765 -
Severance packages 6,027 4,753 1,274
Other incremental costs 25,524 9,120 16,404
---------------------- ----------------- --------------------
$ 475,782 $ 389,248 $ 86,534
====================== ================= ====================
Of the remaining balance at December 31, 1998, $19,380,000 is included as assets
held for sale and the remaining $67,154,000 is included in accrued interest
payable and other liabilities in the accompanying consolidated balance sheet.
76
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
13. IMPAIRMENT AND RESTRUCTURING CHARGES (CONTINUED)
In addition, the Company recorded an impairment charge of approximately
$8,000,000 related to a rehabilitation hospital it had closed. The write-down
was based on a recently obtained independent appraisal.
The Company intends to abandon certain equipment and to sell certain properties
and equipment associated with the closed facilities. The fair value of assets to
be sold is approximately $27,000,000. The Company expects to have all properties
sold by the end of 1999. The effect of suspending depreciation is immaterial.
For assets that will not be abandoned, the fair values were based on independent
appraisals or estimates of recoverability for similar closings. Lease
abandonment costs were based on the lease terms remaining. Other incremental
costs consist primarily of costs to close the facilities, refurbish facilities
in accordance with lease requirements, security, legal and similar costs.
14. OPERATING SEGMENTS
The Company adopted SFAS 131 in 1998. Prior years' information has been restated
to present information for the Company's two business segments described in Note
1.
The accounting policies of the segments are the same as those for the Company
described in Note 1, Significant Accounting Policies. Intrasegment revenues are
not significant. The Company's Chief Operating Decision Maker evaluates the
performance of its segments and allocates resources to them based on income
before minority interests and income taxes and earnings before interest, income
taxes, depreciation and amortization ("EBITDA"). In addition, certain revenue
producing functions are managed directly from the Corporate office and are not
included in operating results for management reporting. Unallocated assets
represent those assets under the direct management of Corporate office
personnel.
77
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
14. OPERATING SEGMENTS (CONTINUED)
Operating results and other financial data are presented for the principal
operating segments as follows:
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------
1996 1997 1998
---------------------------------------------------------------
(In thousands)
Revenues:
Inpatient and other clinical services $ 1,405,877 $ 1,624,848 $ 1,909,462
Outpatient services 1,207,611 1,467,005 2,042,952
---------------------------------------------------------------
2,613,488 3,091,853 3,952,414
Unallocated corporate office 34,700 31,323 53,660
---------------------------------------------------------------
Consolidated revenues $ 2,648,188 $ 3,123,176 $ 4,006,074
===============================================================
Income before income taxes and minority
interests:
Inpatient and other clinical services $ 251,798 $ 356,978 $ 168,503
Outpatient services 240,618 420,567 331,790
---------------------------------------------------------------
492,416 777,545 500,293
Unallocated corporate office (93,090) (148,349) (232,920)
---------------------------------------------------------------
Consolidated income before income taxes and
minority interests $ 399,326 $ 629,196 $ 267,373
===============================================================
Depreciation and amortization:
Inpatient and other clinical services $ 76,225 $ 78,208 $ 90,251
Outpatient services 100,091 120,867 164,409
---------------------------------------------------------------
176,316 199,075 254,660
Unallocated corporate office 36,651 58,061 89,931
---------------------------------------------------------------
Consolidated depreciation and
amortization $ 212,967 $ 257,136 $ 344,591
===============================================================
Interest expense:
Inpatient and other clinical services $ 65,439 $ 68,393 $ 68,600
Outpatient services 10,068 3,731 2,176
---------------------------------------------------------------
75,507 72,124 70,776
Unallocated corporate office 25,860 40,405 77,387
---------------------------------------------------------------
Consolidated interest expense $ 101,367 $ 112,529 $ 148,163
===============================================================
78
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
YEAR ENDED DECEMBER 31,
1996 1997 1998
-----------------------------------------------------------
(In thousands)
Interest income:
Inpatient and other clinical services $ 187 $ 1,153 $ 4,399
Outpatient services 1,816 3,879 4,145
-----------------------------------------------------------
2,003 5,032 8,544
Unallocated corporate office 4,746 972 2,742
-----------------------------------------------------------
Consolidated interest income $ 6,749 $ 6,004 $ 11,286
=============================================================
EBITDA:
Inpatient and other clinical services $ 393,275 $ 502,426 $ 322,955
Outpatient services 348,961 541,286 494,230
-----------------------------------------------------------
742,236 1,043,712 817,185
Unallocated corporate office (35,325) (50,855) (68,344)
-----------------------------------------------------------
Consolidated EBITDA $ 706,911 $ 992,857 $ 748,841
=============================================================
Merger and acquisition related expenses,
loss on sale of assets and impairment and
restructuring charge:
Inpatient and other clinical services $ - $ - $ 224,710
Outpatient services 78,905 15,875 303,979
-----------------------------------------------------------
78,905 15,875 528,689
Unallocated corporate office - - 11,628
-----------------------------------------------------------
Consolidated merger and acquisition
related expenses, loss on sale of assets
and impairment and restructuring charge $ 78,905 $ 15,875 $ 540,317
=============================================================
Assets:
Inpatient and other clinical services $ 2,894,135 $ 2,590,677
Outpatient services 2,331,326 3,642,825
----------------------------------------
5,225,461 6,233,502
Unallocated corporate office 340,863 539,506
----------------------------------------
Total assets $ 5,566,324 $ 6,773,008
========================================
79
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, 1998.
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 46 Chairman of the Board 1984
and Chief Executive Officer
and Director
James P. Bennett 41 President and Chief Operating Officer 1993
and Director
Phillip C. Watkins, M.D. 57 Physician, Birmingham, Alabama, 1984
and Director
George H. Strong 72 Private Investor, Locust, New Jersey, 1984
and Director
C. Sage Givens 42 General Partner, 1985
Acacia Venture Partners
and Director
Charles W. Newhall III 54 Partner, New Enterprise 1985
Associates Limited Partnerships,
and Director
Anthony J. Tanner 50 Executive Vice President-- 1993
Administration and Secretary
and Director
P. Daryl Brown 44 President-- HEALTHSOUTH Outpatient 1995
Centers and Director
80
PRINCIPAL OCCUPATION
AND ALL POSITIONS A DIRECTOR
NAME AGE WITH THE COMPANY SINCE
---- --- ---------------- -----
John S. Chamberlin 70 Private Investor, 1993
Princeton, New Jersey,
and Director
Joel C. Gordon 69 Chairman, Cardiology 1996
Partners of America, Inc.
Consultant to the Company
and Director
Michael D. Martin 38 Executive Vice President 1998
and Chief Financial Officer
and Director
Larry D. Striplin, Jr. 69 Chairman and Chief Executive Officer, 1999
Nelson-Brantley Glass Contractors, Inc.
and Director
81
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 a director 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 as Chairman of the Board from
January 16 through December 1, 1998.
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.
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 Balanced
Care Corporation and Integrated Health Services, Inc., both publicly-traded
healthcare corporations, 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 board of directors of PhyCor,
Inc., a publicly-traded healthcare corporation, 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.
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 Sports Holding Company
and WNS, Inc., and is a director of Imagyn Medical Technologies 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.
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 is Chairman of Cardiology Partners of
America, Inc. and serves on the boards of directors of Genesco, Inc., an apparel
manufacturer, and SunTrust Bank of Nashville, N.A.
82
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. In March
1999, he ceased serving as Treasurer 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 MedPartners, Inc.
Larry D. Striplin, Jr. has been the Chairman and Chief Executive
Officer of Nelson-Brantley Glass Contractors, Inc. and Chairman and Chief
Executive Officer of Clearview Properties, Inc. since December 1995. Until
December 1995, Mr. Striplin had been Chairman of the Board and Chief Executive
Officer of Circle "S" Industries, Inc., a privately owned bonding wire
manufacturer. Mr. Striplin is a member of the boards of directors of Kulicke &
Suffa Industries, Inc., a publicly traded manufacturer of electronic equipment,
The Banc Corporation and MedPartners, Inc.
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 46 Chairman of the Board 1984
and Chief Executive Officer and
Director
James P. Bennett 41 President and Chief Operating Officer 1991
and Director
Anthony J. Tanner 50 Executive Vice President-- Administration 1984
and Secretary and Director
Michael D. Martin 38 Executive Vice President 1989
and Chief Financial Officer
and Director
Thomas W. Carman 47 Executive Vice President-- 1985
Corporate Development
P. Daryl Brown 44 President-- HEALTHSOUTH 1986
Outpatient Centers and Director
Robert E. Thomson 51 President-- HEALTHSOUTH 1987
Inpatient Operations
Patrick A. Foster 52 President-- HEALTHSOUTH 1994
Surgery Centers
William T. Owens 40 Group Senior Vice President-- 1986
Finance and Controller
William W. Horton 39 Senior Vice President and 1994
Corporate Counsel and
Assistant Secretary
83
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.
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.
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 Agreements between the Company and Richard M. Scrushy,
James P. Bennett, Michael D. Martin, Anthony J. Tanner and P. Daryl Brown. (see
Item 11, "Executive Compensation -- Chief Executive Officer Employment
Agreement"; " -- Other Executive Employment Agreements") and except that the
Company initially 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,
1998, through December 31, 1998, all of its officers, Directors and
greater-than-10% beneficial owners complied with all Section 16(a) filing
requirements applicable to them.
84
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 1996, 1997 and 1998.
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 1996 $3,391,775 $ 8,000,000 1,500,000 --- $ 34,286 (2)
Chairman of the Board 1997 3,398,999 10,000,000 1,300,000 --- 21,430
and Chief Executive Officer(3) 1998 2,777,829 --- 1,500,000 --- 72,352
James P. Bennett 1996 496,590 800,000 200,000 --- 32,106 (2)
President and Chief 1997 639,161 1,500,000 700,000 --- 10,158
Operating Officer 1998 670,000 --- 300,000 --- 10,092
Michael D. Martin 1996 281,644 750,000 120,000 --- 31,586 (2)
Executive Vice President 1997 359,672 2,000,000 450,000 --- 9,700
and Chief Financial Officer 1998 415,826 --- 260,000 9,665
P. Daryl Brown 1996 335,825 400,000 100,000 --- 11,181
President-- HEALTHSOUTH 1997 370,673 450,000 250,000 --- 10,737
Outpatient Centers 1998 386,212 --- 75,000 --- 10,981
Anthony J. Tanner 1996 298,078 350,000 100,000 --- 7,763
Executive Vice President-- 1997 371,114 450,000 450,000 --- 9,817
Administration and Secretary 1998 388,422 --- 250,000 --- 11,197
- - - --------------------
(1) Includes car allowances of $500 per month for Mr. Scrushy and $350 per
month for the other Named Executive Officers in 1996 and 1997, use of a
Company-owned automobile by Mr. Scrushy in 1998, and car allowances of
$500 per month for Mr. Scrushy and $450 per month for the other Named
Executive Officers through September 1998. Also includes (a) matching
contributions under the Company's Retirement Investment Plan for 1996,
1997 and 1998, respectively, of: $708, $791 and $1,450 to Mr. Scrushy;
$1,425, $1,425 and $1,499 to Mr. Bennett; $1,371, $1,324 and $1,395 to
Mr. Martin; $1,897 $1,319 and $1,415 to Mr. Brown; and $1,290, $1,215
and $1,308 to Mr. Tanner; (b) awards under the Company's Employee Stock
Benefit Plan for 1996, 1997 and 1998, respectively, of $3,389, $2,889
and $2,882 to Mr. Scrushy; $3,387, $2,889 and $2,882 to Mr. Bennett;
$3,386, $2,889 and $2,882 to Mr. Martin; $3,389, $2,889 and $2,882 to
Mr. Brown; and $1,276, $2,889 and $2,882 to Mr. Tanner; and (c)
split-dollar life insurance premiums paid in 1996, 1997 and 1998 of
$2,312, $11,750 and $45,187 with respect to Mr. Scrushy; $1,217, $1,644
and $1,661 with respect to Mr. Bennett; $752, $1,287 and $1,338 with
respect to Mr. Martin; $1,695, $2,329 and $2,634 with respect to Mr.
Brown; and $997, $1,513 and $2,957 with respect 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 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. Effective
November 1, 1998, Mr. Scrushy voluntarily suspended receipt of his base
salary and monthly incentive compensation. See this Item,"Executive
Compensation -- Chief Executive Officer Employment Agreement".
85
STOCK OPTION GRANTS IN 1998
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 1,500,000 29.9% 10.00 10/22/08 $ 11,355,000
James P. Bennett 300,000 6.0% 10.00 10/22/08 2,271,000
Michael D. Martin 260,000 5.2% 10.00 10/22/08 1,968,200
P. Daryl Brown 75,000 1.5% 10.00 10/22/08 567,750
Anthony J. Tanner 250,000 5.0% 10.00 10/22/08 1,892,500
- - - -----------------
(1) Based on the Black-Scholes option pricing model adapted for use in
valuing 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 76%; (ii) the risk-free rate of return is
assumed to be 6.01%; (iii) dividend yield is assumed to be 0; and (iv)
the time of exercise is assumed to be 7.3 years from the date of grant.
STOCK OPTION EXERCISES IN 1998 AND OPTION VALUES AT DECEMBER 31, 1998
NUMBER VALUE OF UNEXERCISED
OF SHARES NUMBER OF UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS
ACQUIRED AT DECEMBER 31, 1998 (1) AT DECEMBER 31, 1998 (2)
ON VALUE ------------------------------ -----------------------------
NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- -------- -------- ----------- ------------- ----------- -------------
Richard M. Scrushy...... -- -- 12,672,524 -- $97,144,849 --
James P. Bennett........ -- -- 1,610,000 -- 4,945,175 --
Michael D. Martin....... -- -- 860,000 30,000 1,643,750 $ 213,750
P. Daryl Brown.......... 198,000 $2,458,802 915,000 -- 5,386,450 --
Anthony J. Tanner....... -- -- 1,190,000 -- 5,026,325 --
- - - --------------------
(1) Does not reflect any options granted and/or exercised after December 31,
1998. 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,
1998. 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.
86
STOCK OPTION PLANS
Set forth below is information concerning the various stock option
plans of the Company at December 31, 1998. 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 its terms.
As of December 31, 1998, there were outstanding under the ISO Plan options to
purchase 15,202 shares of the Company's Common Stock at $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 had a 1988 Non-Qualified Stock Option Plan (the "NQSO
Plan") covering a maximum of 4,800,000 shares of Common Stock. The NQSO Plan
expired on February 28, 1998, in accordance with its terms. As of December 31,
1998, there were outstanding under the NQSO Plan options to purchase 7,300
shares of the Company's Common Stock at $16.25 per share. Under the NQSO Plan,
which was administered by the Audit and Compensation Committee of the Board of
Directors, provides that Directors, executive officers and other key employees
could be granted options to purchase shares of Common Stock at 100% of fair
market value on the date of grant. The outstanding 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, 18,929,658 (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, 1998, there were outstanding options
to purchase an aggregate of 29,938,700 shares of the Company's Common Stock
under such Plans at exercise prices ranging from $2.52 to $28.0625 per share. An
additional 3,825,091 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.
87
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, 1998, there were
outstanding under the 1993 Consultants' Plan options to purchase 1,620,633
shares of Common Stock at prices ranging from $3.375 to $28.0625 per share. An
additional 120,000 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 certain of its major acquisitions, 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, 1998, there
were outstanding under these assumed plans options to purchase 2,838,710 shares
of the Company's Common Stock at exercise prices ranging from $1.6363 to
$40.7042 per share. No additional options are being granted under any such
assumed plans.
1998 RESTRICTED STOCK PLAN
The Company has a 1998 Restricted Stock Plan (the "Restricted Stock
Plan"), covering a maximum of 3,000,000 shares of the Company's Common Stock.
The Restricted Stock Plan, which is administered by the Audit and Compensation
Committee of the Board of Directors, provides that executives and other key
employees of the Company and its subsidiaries may be granted restricted stock
awards vesting over a period of not less than one year and no more than ten
years, as determined by such Committee. The Restricted Stock Plan terminates on
the earliest of (a) May 28, 2008, (b) the date on which awards covering all
shares of Common Stock reserved for issuance thereunder have been granted and
are fully vested thereunder, or (c) such earlier time as the Board of Directors
of the Company may determine. Awards under the Restricted Stock Plan are
nontransferable except by will or pursuant to the laws of dissent and
distribution (except for certain permitted transfers to family members) are
protected against dilution and are forfeitable upon termination of a
participant's employment to the extent not vested. No awards have been made
under the Restricted Stock Plan.
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 Code. 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 15% of
their annual compensation (subject to nondiscrimination rules under the 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 15% 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 and Chief Financial Officer
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.
88
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 Code. 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.
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.
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 and Chief Financial
Officer 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 and Chief Financial Officer of the Company, and Anthony J.
Tanner, Executive Vice President -- Administration and Secretary of the Company.
89
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 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 party to an Employment Agreement, dated April 1, 1998,
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 expiring on April 1, 2003. Such term is
automatically extended for an additional year on each April 1 unless the
Agreement is terminated as provided therein. 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. The Agreement provides for Mr. Scrushy
to receive an annual base salary of at least $1,200,000, as well as an "Annual
Target Bonus" equal to at least $2,400,000, based upon the Company's success in
meeting certain monthly and annual performance standards determined by the Audit
and Compensation Committee of the Board of Directors. The Annual Target Bonus is
earned at the rate of $200,000 per month if the monthly performance standards
are met, provided that if any monthly performance standards are not met but the
annual performance standards are met, Mr. Scrushy will be entitled to any
payments which were withheld as a result of failure to meet the monthly
performance standards. The Agreement further provides that Mr. Scrushy is
eligible for participation in all other management bonus or incentive plans and
stock option, stock purchase or equity-based incentive compensation plans in
which other senior executives of the Company are eligible to participate. Under
the Agreement, Mr. Scrushy is entitled to receive long-term disability insurance
coverage, a non-qualified retirement plan providing for annual retirement
benefits equal to 60% of his base compensation, use of a Company-owned
automobile, certain personal security services, and certain other retirement,
insurance and fringe benefits, as well as to generally participate in all
employee benefit programs maintained by the Company.
The Agreement may be terminated by Mr. Scrushy for "Good Reason" (as
defined), by the Company for "Cause" (as defined), upon Mr. Scrushy's
"Disability" (as defined) or death, or by either party at any time subject to
the consequences of such termination as described in the Agreement. If the
Agreement is terminated by Mr. Scrushy for Good Reason, the Company is required
to pay him a lump-sum severance payment equal to the discounted value of the sum
of his then-current base salary and Annual Target Bonus over the remaining term
of the Agreement and to continue certain employee and fringe benefits for the
remaining term of the Agreement. If the Agreement is terminated by Mr. Scrushy
otherwise than for Good Reason, the Company is required to pay him a lump-sum
severance amount equal to the discounted value of two times the sum of his
then-current base salary and Annual Target Bonus. If the Agreement is terminated
by the Company for Cause, Mr. Scrushy is not entitled to any severance or
continuation of benefits. If the Agreement is terminated by reason of Mr.
Scrushy's Disability, the Company is required to continue the payment of his
then-current base salary and Annual Target Bonus for three years as if all
relevant performance standards had been met, and if the Agreement is terminated
by Mr. Scrushy's death, the company is required to pay his representatives or
estate a lump-sum payment equal to his then-current base salary and Annual
Target Bonus. In the event of a voluntary termination by Mr. Scrushy following a
Change in Control (as defined) of the Company, other than for Cause, the Company
is required to pay Mr. Scrushy an additional lump-sum severance payment equal to
his then-current base salary and Annual Target Bonus. The Agreement provides for
the Company to indemnify Mr. Scrushy against certain "parachute payment" excise
taxes which may be imposed upon payments under the Agreement. The Agreement
restricts Mr. Scrushy from engaging in certain activities competitive with the
business of the Company during, and for 24 months after termination of, his
employment with the Company, unless such termination occurs after a Change in
Control.
As a result of the impact of the Balanced Budget Act of 1997 on the
Company's reimbursement and the increased pressure from managed care payors, the
Company reduced overhead and otherwise managed expenses. In order to lead by
example, Mr. Scrushy voluntarily chose to forgo receipt of his base salary and
Annual Target Bonus after October 31, 1998. Through that date, all monthly
performance standards required to be met for payment of monthly installments of
his Annual Target Bonus had been met. At some point in the future, Mr. Scrushy
may choose to resume receipt of some portion of his compensation package.
90
OTHER EXECUTIVE EMPLOYMENT AGREEMENTS
The Company is also party to Employment Agreements, dated April 1,
1998, with James P. Bennett, President and Chief Operating Officer, Michael D.
Martin, Executive Vice President and Chief Financial Officer, Anthony J. Tanner,
Executive Vice President -- Administration and Secretary, Thomas W. Carman,
Executive Vice President -- Corporate Development, Robert E. Thomson, President
- - - -- HEALTHSOUTH Inpatient Operations, P. Daryl Brown, President -- HEALTHSOUTH
Outpatient Centers, and Patrick A. Foster, President -- HEALTHSOUTH Surgery
Centers, pursuant to which each of such persons is employed in such capacities
for a three-year term expiring on April 1, 2001. Such terms are automatically
extended for an additional year on each April 1 unless the Agreements are
terminated as provided therein. In addition, the Company has agreed to use its
best efforts to cause Messrs. Bennett, Tanner, Martin and Brown to be elected as
Directors of the Company during the term of their respective Agreements. The
Agreements provide for the payment of an annual base salary of at least $650,000
to Mr. Bennett, $400,000 to Mr. Martin, $375,000 to Mr. Tanner, $325,000 to Mr.
Carman, $300,000 to Mr. Thomson, $370,000 to Mr. Brown, and $240,000 to Mr.
Foster. The Agreements further provide that each such officer is eligible for
participation in all management bonus or incentive plans and stock option, stock
purchase or equity-based incentive compensation plans in which other senior
executives of the Company are eligible to participate, and provide for certain
specified fringe benefits, including car allowances of $500 per month.
If the Agreements are terminated by the Company other than for Cause
(as defined), Disability (as defined) or death, the Company is required to
continue the officers' base salary in effect for a period of two years (in the
case of Messrs. Bennett, Martin, Tanner and Brown) or one year (in each other
case) after termination, as severance compensation. In addition, in the event of
a voluntary termination of employment by the officer within six months after a
Change in Control (as defined), the Company is also required to continue the
officer's salary for the same period. The Agreements restrict the officers from
engaging in certain activities competitive with the business of the Company
during their employment with the Company and for any period during which the
officer is receiving severance compensation, unless such termination occurs
after a Change in Control.
The Company, with the consent of the affected officers, discontinued
payment of the car allowances in October 1998. In addition, each of the affected
officers has voluntarily agreed to a 25% reduction in base salary effective
January 1, 1999 until otherwise agreed between the Company and any such officer.
91
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 15, 1999, (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.
PERCENTAGE
NAME AND NUMBER OF SHARES OF
ADDRESS OF OWNER BENEFICIALLY OWNED (1) COMMON STOCK
---------------- ---------------------- ------------
Richard M. Scrushy 14,187,658 (2) 3.31%
John S. Chamberlin 312,000 (3) *
C. Sage Givens 412,100 (4) *
Charles W. Newhall III 580,846 (5) *
George H. Strong 468,582 (6) *
Phillip C. Watkins, M.D. 644,254 (7) *
James P. Bennett 1,890,500 (8) *
Anthony J. Tanner 1,471,358 (9) *
P. Daryl Brown 1,219,736 (10) *
Joel C. Gordon 2,886,905 (11) *
Michael D. Martin 957,008 (12) *
Larry D. Striplin, Jr. 20,000 *
FMR Corp. 24,397,084 (13) 5.88%
82 Devonshire Street
Boston, Massachusetts 02109
All Executive Officers and Directors as a Group 28,131,863 (14) 6.38%
(17 persons)
- - - -------------------------
(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 6,000 shares held by trusts for Mr. Scrushy's minor children,
10,000 shares held by a charitable foundation of which Mr. Scrushy is an
officer and director and 13,522,524 shares subject to currently
exercisable stock options.
(3) Includes 200,000 shares subject to currently exercisable stock options.
(4) Includes 2,100 shares owned by Ms. Givens's spouse and 410,000 shares
subject to currently exercisable stock options.
(5) Includes 460 shares owned by members of Mr. Newhall's immediate family
and 460,000 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 121,693 shares owned by trusts of which Mr. Strong is a trustee
and claims shared voting and investment power and 300,000 shares subject
to currently exercisable stock options.
(7) Includes 490,000 shares subject to currently exercisable stock options.
(8) Includes 1,810,000 shares subject to currently exercisable stock options.
(9) Includes 60,000 shares held in trust by Mr. Tanner for his children and
1,340,000 shares subject to currently exercisable stock options.
92
(10) Includes 990,000 shares subject to currently exercisable stock options.
(11) Includes 364,340 shares owned by his spouse and 434,520 shares subject to
currently exercisable stock options.
(12) Includes 950,000 shares subject to currently exercisable stock options.
(13) 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 1,012,734 of the shares and sole power to dispose of all of the
shares.
(14) Includes 25,380,844 shares subject to currently exercisable stock options
held by executive officers and Directors.
* Less than 1%
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The Company purchases computer equipment and related technology from a
variety of vendors. During 1998, the Company paid $12,837,000 for the purchase
of new NCR computer equipment from GG Enterprises, a value-added reseller of
computer equipment which is owned by Gerald Scrushy, the father 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.
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 Company and
Michael D. Martin, Executive Vice President and Chief Financial Officer and a
Director of the Company, along with another individual not employed by the
Company, were 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 it was anticipated that the Company and
third-party investors would invest. Investment by the Company in such private
equity fund was 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 bore interest at 1% over the
prime rate announced from time to time by AmSouth Bank of Alabama and were
repayable upon demand by the Company. During 1997 and 1998, 21st Century drew an
aggregate of $2,841,310 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
make an investment in Pathology Partners, 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. 21st Century repaid the principal and the interest allocated to the
purchase of the Summerville stock during 1998. In the first quarter of 1999,
21st Century determined that, due to adverse changes in the markets for private
equity funds specializing in the healthcare industry, it was advisable to
dissolve 21st Century. In connection with the dissolution of the 21st Century,
21st Century transferred to HEALTHSOUTH 675,005 shares of Series A Cumulative
Preferred Stock and 1,440,010 shares of Series B Convertible Preferred Stock of
Pathology Partners, Inc, in satisfaction of the principal and interest allocable
to the loan relating to the Pathology Partners, Inc. investment. The Company
believes that the value of the stock so received is equal to or greater than the
indebtedness of 21st Century to the Company.
93
On December 31, 1998, the Company completed the sale through a
leveraged recapitalization of a majority interest in one of its subsidiaries
which acted as a holding company for its temporary physician staffing and
therapist placement businesses ("CompHealth"). These non-strategic businesses
were acquired by the Company in connection with certain of its major strategic
acquisitions. The Company retained approximately 15% of the equity in such
holding company. Net proceeds to the Company were approximately $34,100,000. The
purchasers comprised a group of venture capital funds, including funds
affiliated with C. Sage Givens and Charles W. Newhall III, both outside
Directors of the Company, as well as venture capital funds controlled by
unaffiliated third parties. The Company solicited offers from third parties to
purchase the business over a period of several months, and the Company believes
that the purchase price and terms of the transaction effected with the venture
capital funds were more favorable to the Company than those available from other
purchasers. In connection with the transaction, the Company entered into certain
"preferred vendor" arrangements with CompHealth, and Michael D. Martin,
Executive Vice President and Chief Financial Officer of the Company, was named
to the Board of Directors of CompHealth.
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, 1998, loans in the following original principal amounts
were outstanding: $460,000 to Larry R. House, a former Director and a former
executive officer, $500,000 to Aaron Beam, Jr., formerly Executive Vice
President and Chief Financial Officer and a Director, and $140,000 and $350,000
to William T. Owens, Group Senior Vice President and Controller. Outstanding
principal balances at December 31, 1998 were $210,000 for Mr. House, $400,000
for Mr. Beam and an aggregate of $476,000 for Mr. Owens. During 1998, the
Company also made loans of $400,000 to P. Daryl Brown, President -- HEALTHSOUTH
Outpatient Centers and a Director, and $750,000 to Russell H. Maddox, then
President -- HEALTHSOUTH Diagnostic Centers, both of which remained outstanding
at December 31, 1998. 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.
94
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.
The Company filed no Current Reports on Form 8-K during the three
months ended December 31, 1998.
(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.
95
(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., filed as
Exhibit (2-14) to the Company's Annual Report on Form 10-K for
the Fiscal Year Ended December 31, 1997, is hereby
incorporated by reference.
(2)-15 Plan and Agreement of Merger, dated May 5, 1998, among
HEALTHSOUTH Corporation, Field Acquisition Corporation and
National Surgery Centers, Inc., filed as Exhibit (2) to the
Company's Registration Statement on Form S-4 (Registration No.
333- 57087), is hereby incorporated by reference.
96
(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 May 21, 1998, filed as Exhibit
(3)-1 to the Company's Current Report on Form 8 dated May 28,
1998, is hereby incorporated by reference.
(3)-2 By-laws of HEALTHSOUTH Corporation, filed as Exhibit (3)-2 to
the Company's Current Report on Form 98-K dated May 28, 1998,
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, filed as Exhibit (4)-2 to the
Company's Annual Report on Form 10-K for the Fiscal Year Ended
December 31, 1997, is hereby incorporated by reference.
(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, filed as
Exhibit (4)-3 to the Company's Annual Report on Form 10-K for
the Fiscal Year Ended December 31, 1997, is hereby
incorporated by reference.
(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, filed as Exhibit
(4)-4 to the Company's Annual Report on Form 10-K for the
Fiscal Year Ended December 31, 1997, is hereby incorporated by
reference.
(4)-5 Indenture, dated June 22, 1998, between HEALTHSOUTH
Corporation and PNC Bank, National Association, as Trustee,
filed as Exhibit 4.1 to the Company's Quarterly Report on Form
10-Q for the Three Months Ended June 30, 1998, is hereby
incorporated by reference.
(4)-6 Form of Officer's Certificate pursuant to Sections 2.3 and
11.5 of the Indenture, dated June 22, 1998, between
HEALTHSOUTH Corporation and PNC Bank, National Association, as
Trustee, relating to the Company's 6.875% Senior Notes due
2005 and 7.0% Senior Notes due 2008, filed as Exhibit (4)-6 to
the Company's Registration Statement on Form S-4 (Registration
No. 333- 61485), is hereby incorporated by reference.
(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 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 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 by
reference.
97
(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 April 1, 1998, between HEALTHSOUTH
Corporation and Richard M. Scrushy.
(10)-11 Credit Agreement, dated as of June 23, 1998, by and among
HEALTHSOUTH Corporation, NationsBank, National Association,
J.P. Morgan Securities, Inc., Deutsche Bank AG, ScotiaBanc,
Inc. and the Lenders party thereto from time to time, filed as
Exhibit 10 to the Company's Quarterly Report on Form for the
Three Months Ended June 30, 1998, 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.
98
(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 1998 Restricted Stock Plan.
(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 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 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.
99
(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.
(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.
(10)-46 The Company Doctor Amended and Restated Omnibus Stock Plan of
1995, filed as Exhibit 4.1 to the Company's Registration
Statement on Form S-8 (Registration No. 333-59895), is hereby
incorporated by reference.
(10)-47 National Surgery Centers, Inc. Amended and Restated 1992 Stock
Option Plan, filed as Exhibit 4.1 to the Company's
Registration Statement on Form S-8 (Registration No.
333-59887), is hereby incorporated by reference.
(10)-48 National Surgery Centers, Inc. 1997 Non-Employee Directors
Stock Option Plan, filed as Exhibit 4.2 to the Company's
Registration Statement on Form S-8 (Registration No.
333-59887), is hereby incorporated by reference.
(10)-49 Employment Agreement, dated April 1, 1998, between HEALTHSOUTH
Corporation and James P. Bennett.
(10)-50 Employment Agreement, dated April 1, 198, between HEALTHSOUTH
Corporation and P. Daryl Brown.
100
(10)-51 Employment Agreement, dated April 1, 1998, between HEALTHSOUTH
Corporation and Thomas W. Carman.
(10)-52 Employment Agreement, dated April 1, 1998, between HEALTHSOUTH
Corporation and Michael D. Martin.
(10)-53 Employment Agreement, dated April 1, 1998, between HEALTHSOUTH
Corporation and Anthony J. Tanner.
(10)-54 Employment Agreement, dated April 1, 1998, between HEALTHSOUTH
Corporation and Patrick A. Foster.
(10)-55 Employment Agreement, dated April 1, 1998 between HEALTHSOUTH
Corporation and Robert E. Thomson.
(10)-56 Lease Agreement, dated December 18, 1998, between First
Security Bank, National Association, as Owner Trustee under
the HEALTHSOUTH Corporation Trust 1998-1, as Lessor, and
HEALTHSOUTH Corporation, as Lessee.
(10)-57 Participation Agreement, dated December 18, 1998, among
HEALTHSOUTH Corporation as Lessee, First Security Bank,
National Association, as Owner Trustee under the HEALTHSOUTH
Corporation Trust 1998-1, the Holders and the Lenders Party
Thereto From Time to Time, Deutsche Bank A.G. New York Branch
and NationsBank, N.A.
(10)-58 Short Term Credit Agreement, among HEALTHSOUTH Corporation,
NationsBank, N.A., NationsBanc Montgomery Securities LLC and
the Lenders Party Thereto From Time to Time, dated September
28, 1998.
(10)-59 Amendment Agreement No. 1 to Short Term Credit Agreement,
dated February 17, 1999, among HEALTHSOUTH Corporation,
NationsBank, N.A. and the Lenders Party Thereto From Time to
Time.
(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
101
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, 1996:
Allowance for doubtful
accounts $ 61,267 $ 61,311 $ 13,737 (1) $ 59,232 (2) $ 77,083
============== ============== ============== ============== ==============
Year ended December 31, 1997:
Allowance for doubtful
accounts $ 77,083 $ 74,743 $ 43,077 (1) $ 67,331 (2) $ 127,572
============== ============== ============== ============== ==============
Year ended December 31, 1998:
Allowance for doubtful
accounts $ 127,572 $ 112,202 $ 18,524 (1) $ 114,609 (2) $ 143,689
============== ============== ============== ============== ==============
- - - -------------------------
(1) Allowances of acquisitions in years 1996, 1997 and 1998, respectively.
(2) Write-offs of uncollectible patient accounts receivable.
102
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 31, 1999
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 31, 1999
- - - -------------------------------------- and Chief Executive Officer
Richard M. Scrushy and Director
MICHAEL D. MARTIN Executive Vice President March 31, 1999
- - - -------------------------------------- and Chief Financial Officer
Michael D. Martin and Director
WILLIAM T. OWENS Group Senior Vice President-Finance March 31, 1999
- - - -------------------------------------- and Controller (Principal Accounting
William T. Owens Officer)
C. SAGE GIVENS Director March 31, 1999
- - - --------------------------------------
C. Sage Givens
CHARLES W. NEWHALL III Director March 31, 1999
- - - --------------------------------------
Charles W. Newhall III
GEORGE H. STRONG Director March 31, 1999
- - - --------------------------------------
George H. Strong
PHILLIP C. WATKINS Director March 31, 1999
- - - --------------------------------------
Phillip C. Watkins
JOHN S. CHAMBERLIN Director March 31, 1999
- - - --------------------------------------
John S. Chamberlin
ANTHONY J. TANNER Director March 31, 1999
- - - --------------------------------------
Anthony J. Tanner
103
JAMES P. BENNETT Director March 31, 1999
- - - --------------------------------------
James P. Bennett
P. DARYL BROWN Director March 31, 1999
- - - --------------------------------------
P. Daryl Brown
JOEL C. GORDON Director March 31, 1999
- - - --------------------------------------
Joel C. Gordon
LARRY D. STRIPLIN, JR. Director March 31, 1999
- - - --------------------------------------
Larry D. Striplin, Jr.
104