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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997; OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO
Commission File Number 1-10315
HEALTHSOUTH CORPORATION
--------------------------------
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 63-0860407
- - --------------------------------------- ----------
(State or Other Jurisdiction (I.R.S. Employer Identification No.)
of Incorporation or Organization)
ONE HEALTHSOUTH PARKWAY
BIRMINGHAM, ALABAMA 35243
- - -------------------------------------------- ----------
(Address of Principal Executive (Zip Code)
Offices)
Registrant's Telephone Number, Including Area Code: (205) 967-7116
Securities Registered Pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on which Registered
- - --------------------------------------- ------------------------
COMMON STOCK, PAR VALUE NEW YORK STOCK EXCHANGE
$.01 per share
9.5% SENIOR SUBORDINATED NEW YORK STOCK EXCHANGE
NOTES DUE 2001
Securities Registered Pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the Registrant (1) has filed all Reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such Reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
State the aggregate market value of the voting stock held by non-affiliates
of the Registrant as of March 13, 1998:
Common Stock, par value $.01 per share -- $11,890,990,000
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of the latest practicable date.
Class Outstanding at March 13, 1998
- - ------------------------------------ ------------------------------
COMMON STOCK, PAR VALUE
$.01 PER SHARE 398,285,974 SHARES
DOCUMENTS INCORPORATED BY REFERENCE
No documents are incorporated by reference into this Annual Report on Form 10-K.
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PART I
ITEM 1. BUSINESS.
GENERAL
HEALTHSOUTH Corporation ("HEALTHSOUTH" or the "Company") is the nation's
largest provider of outpatient surgery and rehabilitative healthcare services.
The Company provides these services through its national network of outpatient
and inpatient rehabilitation facilities, outpatient surgery centers, diagnostic
centers, occupational medicine centers, medical centers and other healthcare
facilities. The Company believes that it provides patients, physicians and
payors with high-quality healthcare services at significantly lower costs than
traditional inpatient hospitals. Additionally, the Company's national network,
reputation for quality and focus on outcomes has enabled it to secure contracts
with national and regional managed care payors. At December 31, 1997, the
Company had over 1,750 patient care locations in 50 states, the United Kingdom
and Australia.
In its outpatient and inpatient rehabilitation facilities, the Company
provides interdisciplinary programs for the rehabilitation of patients
experiencing disability due to a wide variety of physical conditions, such as
stroke, head injury, orthopaedic problems, neuromuscular disease and
sports-related injuries. The Company's rehabilitation services include physical
therapy, sports medicine, work hardening, neurorehabilitation, occupational
therapy, respiratory therapy, speech-language pathology and rehabilitation
nursing. Independent studies have shown that rehabilitation services like those
provided by the Company can save money for payors and employers.
In addition to its rehabilitation facilities, the Company operates the
largest network of freestanding outpatient surgery centers in the United States.
The Company's outpatient surgery centers provide the facilities and medical
support staff necessary for physicians to perform non-emergency surgical
procedures. While outpatient surgery is widely recognized as generally less
expensive than surgery performed in a hospital, the Company believes that
outpatient surgery performed at a freestanding outpatient surgery center is
generally less expensive than hospital-based outpatient surgery. Over 80% of the
Company's surgery center facilities are located in markets served by its
rehabilitative service facilities, enabling the Company to pursue opportunities
for cross-referrals.
The Company is also among the largest operators of outpatient diagnostic
centers and occupational medicine centers in the United States. Most of the
Company's diagnostic centers and occupational medicine centers operate in
markets where the Company also provides rehabilitative healthcare and outpatient
surgery services. The Company believes that its ability to offer a comprehensive
range of its services in a particular geographic market makes the Company more
attractive to both patients and payors in such market.
Over the last three years, the Company has completed several significant
acquisitions in the rehabilitation business and has expanded into the surgery
center, diagnostic and occupational medicine businesses. The Company believes
that these acquisitions complement its historical operations and enhance its
market position. The Company further believes that its expansion into the
outpatient surgery, diagnostic and occupational medicine businesses provides it
with platforms for future growth. The Company is continually evaluating
potential acquisitions in the outpatient and rehabilitative healthcare services
industry.
The Company was organized as a Delaware corporation in February 1984. The
Company's principal executive offices are located at One HealthSouth Parkway,
Birmingham, Alabama 35243, and its telephone number is (205) 967-7116.
COMPANY STRATEGY
The Company's principal objective is to be the provider of choice for
patients, physicians and payors alike for outpatient surgery and rehabilitative
healthcare services throughout the United States. The Company's growth strategy
is based upon four primary elements: (i) the implementation of the
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Company's integrated service model in appropriate markets, (ii) successful
marketing to managed care organizations and other payors, (iii) the provision of
high-quality, cost-effective healthcare services, and (iv) the expansion of its
national network.
o Integrated Service Model. The Company seeks, where appropriate, to provide an
integrated system of healthcare services, including outpatient rehabilitation
services, inpatient rehabilitation services, ambulatory surgery services and
outpatient diagnostic services. The Company believes that its integrated
system offers payors the convenience of dealing with a single provider for
multiple services. Additionally, it believes that its facilities can provide
extensive cross-referral opportunities. For example, the Company estimates
that approximately one-third of its outpatient rehabilitation patients have
had outpatient surgery, virtually all inpatient rehabilitation patients will
require some form of outpatient rehabilitation, and virtually all inpatient
rehabilitation patients have had some type of diagnostic procedure. The
Company has implemented its Integrated Service Model in certain of its
markets, and intends to expand the model into other appropriate markets.
o Marketing to Managed Care Organizations and Other Payors. Since the late
1980s, the Company has focused on the development of contractual
relationships with managed care organizations, major insurance companies,
large regional and national employer groups and provider alliances and
networks. The Company's documented outcomes and experience with several
hundred thousand patients in delivering quality healthcare services at
reasonable prices has enhanced its attractiveness to such entities and has
given the Company a competitive advantage over smaller and regional
competitors. These relationships have increased patient flow to the Company's
facilities and contributed to the Company's same-store growth.
o Cost-Effective Services. The Company's goal is to provide high-quality
healthcare services in cost-effective settings. To that end, the Company has
developed standardized clinical protocols for the treatment of its patients.
This results in "best practices" techniques being utilized at all of the
Company's facilities, allowing the consistent achievement of demonstrable,
cost-effective clinical outcomes. The Company's reputation for its clinical
programs is enhanced through its relationships with major universities
throughout the nation, and its support of clinical research in its facilities.
Further, independent studies estimate that, for every dollar spent on
rehabilitation, $11 to $35 is saved. Finally, surgical procedures typically
are less expensive in outpatient surgery centers than in hospital settings.
The Company believes that outpatient and rehabilitative healthcare services
will assume increasing importance in the healthcare environment as payors
continue to seek to reduce overall costs by shifting patients to more
cost-effective treatment settings.
o Expansion of National Network. As the largest provider of outpatient surgery
and rehabilitative healthcare services in the United States, the Company is
able to realize economies of scale and compete successfully for national
contracts with large payors and employers while retaining the flexibility to
respond to particular needs of local markets. The national network affords
the Company the opportunity to offer large national and regional employers
and payors the convenience of dealing with a single provider, to utilize
greater buying power through centralized purchasing, to achieve more
efficient costs of capital and labor and to more effectively recruit and
retain clinicians. The Company believes that its recent acquisitions in the
outpatient surgery, diagnostic imaging and occupational medicine fields will
further enhance its national presence by broadening the scope of its existing
services and providing new opportunities for growth. These national benefits
are realized without sacrificing local market responsiveness. The Company's
objective is to provide those outpatient and rehabilitative healthcare
services needed within each local market by tailoring its services and
facilities to that market's needs, thus bringing the benefits of nationally
recognized expertise and quality into the local setting.
GROWTH THROUGH ACQUISITIONS
Beginning in 1994, the Company has consummated a series of significant
acquisitions. During 1995, the Company consummated pooling-of-interests mergers
with Surgical Health Corporation ("SHC"; 36 outpatient surgery centers in 11
states) and Sutter Surgery Centers, Inc. ("SSCI"; 12 outpatient surgery centers
in three states), as well as stock purchase acquisitions of the rehabilitation
hospitals division of
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NovaCare, Inc. ("NovaCare"; 11 inpatient rehabilitation facilities, 12 other
healthcare facilities and two Certificates of Need in eight states) and Caremark
Orthopedic Services Inc. ("Caremark"; 120 outpatient rehabilitation facilities
in 13 states). During 1996, the Company acquired Surgical Care Affiliates, Inc.
("SCA"; 67 outpatient surgery centers in 24 states), Advantage Health
Corporation ("Advantage Health"; approximately 136 inpatient and outpatient
rehabilitation facilities in 11 states), Professional Sports Care Management,
Inc. ("PSCM"; 36 outpatient rehabilitation facilities in New York, New Jersey
and Connecticut) and ReadiCare, Inc. ("ReadiCare"; 37 occupational medicine
centers in California and Washington) in pooling-of-interests transactions.
During 1997, the Company acquired Health Images, Inc. ("Health Images"; 55
diagnostic imaging centers in 13 states and the United Kingdom), ASC Network
Corporation ("ASC"; 29 surgery centers in eight states), Horizon/CMS Healthcare
Corporation ("Horizon/CMS"; 30 inpatient rehabilitation facilities and
approximately 275 outpatient rehabilitation centers in 24 states) and National
Imaging Affiliates, Inc. ("NIA"; eight diagnostic imaging centers in six
states). On December 31, 1997, the Company sold the long-term care assets of
Horizon/CMS, consisting of 139 long-term care facilities, 12 specialty
hospitals, 35 institutional pharmacy locations and over 1,000 rehabilitation
therapy contracts with long-term care facilities, to Integrated Health Services,
Inc. ("IHS"). The NovaCare, Caremark, Advantage Health, PSCM and Horizon/CMS
transactions have further enhanced the Company's position as the nation's
largest provider of inpatient and outpatient rehabilitative services, while the
SHC, SSCI, SCA and ASC transactions have made the Company the largest provider
of outpatient surgery services in freestanding centers in the nation and the
ReadiCare, Health Images and NIA transactions have broadened the Company's
services in occupational medicine and diagnostic imaging. The Company believes
that the geographic dispersion of the more than 1,750 locations now operated by
the Company makes it more attractive to managed care networks, major insurance
companies, regional and national employers and regional provider alliances and
enhances the Company's ability to implement its Integrated Service Model in
additional markets. See Item 7, "Management's Discussion and Analysis of
Financial Conditions and Results of Operations".
INDUSTRY BACKGROUND
In 1996, there were an estimated 3,500,000 inpatient hospital discharges in
the United States involving impairments requiring rehabilitative healthcare
services. "Rehabilitative healthcare services" refers to the range of skilled
services provided to individuals in order to minimize physical and cognitive
impairments, maximize functional ability and restore lost functional capacity.
The focus of rehabilitative healthcare is to ameliorate physical and cognitive
impairments resulting from illness or injury, and to restore or improve
functional ability so that individuals can return to work and lead independent
and fulfilling lives. Typically, rehabilitative healthcare services are provided
by a variety of healthcare professionals including physiatrists, rehabilitation
nurses, physical therapists, occupational therapists, speech- language
pathologists, respiratory therapists, recreation therapists, social workers,
psychologists, rehabilitation counselors and others. Over 80% of those receiving
rehabilitative healthcare services return to their homes, work, schools or
active retirement.
Demand for rehabilitative healthcare services continues to be driven by
advances in medical technologies, an aging population and the recognition on the
part of the payor community (insurers, self-insured companies, managed care
organizations and federal, state and local governments) that appropriately
administered rehabilitative services can improve quality of life as well as
lower overall healthcare costs. Studies conducted by insurance companies
demonstrate the ability of rehabilitation to significantly reduce the cost of
future care. Estimates of the savings range from $11 to $35 per dollar spent on
rehabilitation. Further, reimbursement changes have encouraged the rapid
discharge of patients from acute-care hospitals while they remain in need of
rehabilitative healthcare services.
The Company also believes that there is a growing trend toward the
provision of other healthcare services on an outpatient basis, fueled by
advances in technology, demands for cost-effective care and concerns for patient
comfort and convenience. An industry study indicates that there has been a 75%
increase in the number of treatments in all ambulatory settings from 1986 to
1996, with two-thirds of the total number of surgeries in the United States in
1996 being performed on an outpatient basis. The Company believes that these
trends will continue to foster demand for the delivery of healthcare services on
an outpatient basis.
3
PATIENT CARE SERVICES
The Company began its operations in 1984 with a focus on providing
comprehensive orthopaedic and musculoskeletal rehabilitation services on an
outpatient basis. Over the succeeding 14 years, the Company has consistently
sought and implemented opportunities to expand its services through acquisitions
and de novo development activities that complement its historic focus on
orthopaedic, sports medicine and occupational medicine services and that provide
independent platforms for growth. The Company's acquisitions and internal growth
have enabled it to become the largest provider of rehabilitative healthcare
services, both inpatient and outpatient, in the United States, as well as the
largest operator of freestanding outpatient surgery centers. In addition, the
Company has added diagnostic imaging services, occupational medicine services
and other outpatient services which provide natural enhancements to its
rehabilitative healthcare locations and facilitate the implementation of its
Integrated Service Model. The Company believes that these additional businesses
also provide opportunities for growth in other areas not directly related to the
rehabilitative business, and the Company intends to pursue further expansion in
those businesses.
Rehabilitative Services: General
When a patient is referred to one of the Company's rehabilitation
facilities, the patient undergoes an initial evaluation and assessment process
that results in the development of a rehabilitation care plan designed
specifically for that patient. Depending upon the patient's disability, this
evaluation process may involve the services of a single discipline, such as
physical therapy for a knee injury, or of multiple disciplines, as in the case
of a complicated stroke patient. HEALTHSOUTH has developed numerous
rehabilitation programs, which include stroke, head injury, spinal cord injury,
neuromuscular and work injury, that combine certain services to address the
needs of patients with similar disabilities. In this way, all of the facilities'
patients, regardless of the severity and complexity of their disabilities, can
receive the level and intensity of those services necessary for them to be
restored to as productive, active and independent a lifestyle as possible.
Outpatient Rehabilitation Services
The Company operates the largest group of affiliated proprietary outpatient
rehabilitation facilities in the United States. The Company's outpatient
rehabilitation centers offer a comprehensive range of rehabilitative healthcare
services, including physical therapy and occupational therapy, that are tailored
to the individual patient's needs, focusing predominantly on orthopaedic
injuries, sports injuries, work injuries, hand and upper extremity injuries,
back injuries, and various neurological/neuromuscular conditions. As of December
31, 1997, the Company provided outpatient rehabilitative healthcare services
through approximately 1,150 outpatient locations, including freestanding
outpatient centers and their satellites, outpatient satellites of inpatient
facilities and outpatient facilities managed under contract.
Continuing emphasis on containing increases in healthcare costs, as
evidenced by Medicare's prospective payment system, the growth in managed care
and the various alternative healthcare reform proposals, has resulted in earlier
discharge of patients from acute-care facilities. As a result, many hospital
patients do not receive the intensity of services that may be necessary for them
to achieve a full recovery from their diseases, disorders or traumatic
conditions. The Company's outpatient rehabilitation services play a significant
role in the continuum of care because they provide hospital-level services, in
terms of intensity, quality and frequency, in a more cost-efficient setting.
Patients treated at the Company's outpatient centers will undergo varying
courses of therapy depending upon their individual needs. Some patients may only
require a few hours of therapy per week for a few weeks, while others may spend
up to five hours per day in therapy for six months or more, depending on the
nature, severity and complexity of their injuries.
In general, the Company initially establishes an outpatient center in a
given market, either by acquiring an existing private therapy practice or
through de novo development, and institutes its clinical protocols and programs
in response to the community's general need for services. The Company will then
establish satellite clinics that are dependent upon the main facility for
management and adminis-
4
trative services. These satellite clinics generally provide a specific
evaluative or specialty service/program, such as hand therapy or foot and ankle
therapy, in response to specific market demands. The Company's outpatient
rehabilitation facilities range in size from 1,200 square feet for specialty
clinics to 20,000 square feet for large, full-service facilities. Currently, the
typical outpatient facility configuration ranges in size from 2,000 to 5,000
square feet and costs less than $500,000 to build out and equip.
Patient utilization of the Company's outpatient rehabilitation facilities
cannot be measured in the conventional manner applied to acute-care hospitals,
nursing homes and other healthcare providers which have a fixed number of
licensed beds and serve patients on a 24-hour basis. Utilization patterns in
outpatient rehabilitation facilities will be affected by the market to be
served, the types of injuries treated, the patient mix and the number of
available therapists, among other factors. Moreover, because of variations in
size, location, hours of operation, referring physician base and services
provided and other differences among each of the Company's outpatient
facilities, it is not possible to accurately assess patient utilization against
a norm.
Inpatient Services
INPATIENT REHABILITATION FACILITIES. At December 31, 1997, the Company
operated 132 inpatient rehabilitation facilities with 7,682 beds in the United
States, representing the largest group of affiliated proprietary inpatient
rehabilitation facilities in the nation, as well as a 71-bed rehabilitation
hospital in Australia. The Company's inpatient rehabilitation facilities provide
high-quality comprehensive services to patients who require intensive
institutional rehabilitation care.
Inpatient rehabilitation patients are typically those who are experiencing
significant physical disabilities due to various conditions, such as head
injury, spinal cord injury, stroke, certain orthopaedic problems and
neuromuscular disease. The Company's inpatient rehabilitation facilities provide
the medical, nursing, therapy and ancillary services required to comply with
local, state and federal regulations as well as accreditation standards of the
Joint Commission on Accreditation of Healthcare Organizations (the "JCAHO") and
the Commission on Accreditation of Rehabilitation Facilities ("CARF").
All of the Company's inpatient rehabilitation facilities utilize an
interdisciplinary team approach to the rehabilitation process and involve the
patient and family, as well as the payor, in the determination of the goals for
the patient. Internal case managers monitor each patient's progress and provide
documentation of patient status, achievement of goals, functional outcomes and
efficiency.
In certain markets the Company's rehabilitation hospitals may provide
outpatient rehabilitation services as a complement to their inpatient services.
Typically, this opportunity arises when patients complete their inpatient course
of treatment but remain in need of additional therapy that can be accomplished
on an outpatient basis. Depending upon the demand for outpatient services and
physical space constraints, the rehabilitation hospital may establish the
services either within its building or in a satellite location. In either case,
the clinical protocols and programs developed for use in the freestanding
outpatient centers will be utilized by these facilities.
A number of the Company's rehabilitation hospitals, including its
Nashville, Tennessee (Vanderbilt University), Memphis, Tennessee (Methodist
Hospitals), Dothan, Alabama (Southeast Alabama Medical Center), Charleston,
South Carolina (North Trident Regional Medical Center) and Columbia, Missouri
(University of Missouri) hospital facilities, have been developed in conjunction
with local tertiary-care facilities. This strategy of developing effective
referral and service networks prior to opening results in improved operating
efficiencies for the new facilities. The Company is utilizing this same concept
in the rehabilitation hospital under development with the University of Virginia
and has entered into or is pursuing similar affiliations with a number of its
existing rehabilitation hospitals.
MEDICAL CENTERS. At December 31, 1997, the Company operated four medical
centers with 800 licensed beds in four distinct markets. These facilities
provide general and specialty medical and surgical healthcare services,
emphasizing orthopaedics, sports medicine and rehabilitation.
The Company acquired its medical centers as outgrowths of its
rehabilitative healthcare services. Often, patients require medical and surgical
interventions prior to the initiation of their rehabilitative care. In each of
the markets in which the Company has acquired a medical center, the Company had
5
well-established relationships with the medical communities serving each
facility. In addition, each of the facilities enjoyed well-established
reputations in orthopaedics and/or sports medicine prior to their acquisition by
the Company. Following the acquisition of each of its medical centers, the
Company has provided the resources to improve upon the physical plant and expand
services through the introduction of new technology. The Company has also
developed additional relationships between these facilities and certain
university facilities, including the University of Miami, Auburn University and
the University of Alabama at Birmingham. Through these relationships, the influx
of celebrity athletes and personalities and the acquisition of new technology,
all of the Company's medical centers have improved their operating efficiencies
and enhanced census.
Each of the Company's medical center facilities is licensed as an
acute-care hospital, is accredited by the JCAHO and participates in the Medicare
prospective payment system. See this Item, "Business -- Regulation".
INPATIENT FACILITY UTILIZATION. In measuring patient utilization of the
Company's inpatient facilities, various factors must be considered. Due to
market demand, demographics, start-up status, renovation, patient mix and other
factors, the Company may not treat all licensed beds in a particular facility as
available beds, which sometimes results in a material variance between licensed
beds and beds actually available for utilization at any specific time. The
Company is in a position to increase the number of available beds at such
facilities as market conditions dictate. During the year ended December 31,
1997, the Company's inpatient facilities achieved an overall utilization, based
on patient days and available beds, of 74.66%.
Surgery Centers
The Company is currently the largest operator of outpatient surgery centers
in the United States. At December 31, 1997, it operated 172 freestanding surgery
centers, including five mobile lithotripsy units, in 35 states. Over 80% of
these facilities are located in markets served by the Company's outpatient and
rehabilitative service facilities, enabling the Company to pursue opportunities
for cross-referrals between surgery and rehabilitative facilities as well as to
centralize administrative functions. The Company's surgery centers provide the
facilities and medical support staff necessary for physicians to perform
non-emergency surgical procedures. Its typical surgery center is a freestanding
facility with three to six fully equipped operating and procedure rooms and
ancillary areas for reception, preparation, recovery and administration. Each of
the Company's surgery centers is available for use only by licensed physicians,
oral surgeons and podiatrists, and the centers do not perform surgery on an
emergency basis.
Outpatient surgery centers, unlike hospitals, have not historically
provided overnight accommodations, food services or other ancillary services.
Over the past several years, states have increasingly permitted the use of
extended-stay recovery facilities by outpatient surgery centers. As a result,
many outpatient surgery centers are adding extended recovery care capabilities
where permitted. Most of the Company's surgery centers currently provide for
extended recovery stays. The Company's ability to develop such recovery care
facilities is dependent upon state regulatory environments in the particular
states where its centers are located.
The Company's outpatient surgery centers implement quality control
procedures to evaluate the level of care provided the centers. Each center has a
medical advisory committee of three to ten physicians which reviews the
professional credentials of physicians applying for medical staff privileges at
the center.
Diagnostic Centers
At December 31, 1997, the Company operated 101 diagnostic centers in 21
states and the United Kingdom. These centers provide outpatient diagnostic
imaging services, including magnetic resonance imaging ("MRI"), computerized
tomography ("CT") services, X-ray services, ultrasound services, mammography
services, nuclear medicine services and fluoroscopy. Not all services are
provided at all sites; however, most of the Company's diagnostic centers are
multi-modality centers.
6
The Company's diagnostic centers provide outpatient diagnostic procedures
performed by experienced radiological technicians. After the diagnostic
procedure is completed, the images are reviewed by radiologists who have
contracted with the Company. Such radiologists prepare a report of the test and
their findings, which are then delivered to the referring physician. The
Company's diagnostic centers are open at such hours as are appropriate for the
local medical community.
Because many patients at the Company's rehabilitative healthcare and
outpatient surgery facilities require diagnostic procedures of the type
performed at the Company's diagnostic centers, the Company believes that its
diagnostic operations are a natural complement to its other services and enhance
its ability to market those services to patients and payors.
Occupational Medicine Services
At December 31, 1997, the Company operated 93 occupational medicine centers
in 22 states. These centers provide cost-effective, outpatient primary medical
care and rehabilitation services to individuals for the treatment of
work-related medical problems.
The Company's occupational medicine centers market their services to large
and small employers, workers' compensation and health insurers and managed care
organizations. The services provided at the Company's occupational medicine
centers include outpatient primary medical care for work-related injuries and
illnesses, work-related physical examinations, physical therapy services and
workers' compensation medical services, as well as other services primarily
aimed at work-related injuries or illnesses. Medical services at the centers are
provided by licensed physicians who are employed by or under contract with the
Company or affiliated medical practices. These centers also employ nurses,
therapists and other licensed professional staff as necessary for the services
provided. The Company believes that occupational medicine primary care services
are a strategic component of its business, and that the physicians in its
occupational medicine centers can, in many cases, serve as "gatekeepers"
providing access to the other services offered by the Company.
Other Patient Care Services
In certain of its markets, the Company provides other patient care
services, including home healthcare, physician services and contract management
of hospital-based rehabilitative healthcare services. The Company evaluates
market opportunities on a case-by-case basis in determining whether to provide
additional services of these types, which may be complementary to facility-based
services provided by the Company or stand-alone businesses.
MARKETING OF FACILITIES AND SERVICES
The Company markets its facilities, and their services and programs, on
local, regional and national levels. Local and regional marketing activities are
typically coordinated by facility-based marketing personnel, whereas large-scale
regional and national efforts are coordinated by corporate-based personnel.
In general, the Company develops a marketing plan for each facility based
on a variety of factors, including population characteristics, physician
characteristics and incidence of disability statistics, in order to identify
specific service opportunities. Facility-oriented marketing programs are focused
on increasing the volume of patient referrals to the specific facility and
involve the development of ongoing relationships with area schools, businesses
and industries as well as physicians, health maintenance organizations and
preferred provider organizations.
The Company's larger-scale marketing activities are focused more broadly on
efforts to generate patient referrals to multiple facilities and the creation of
new business opportunities. Such activities include the development and
maintenance of contractual relationships or national pricing agreements with
large third-party payors, such as CIGNA, United Healthcare or other national
insurance companies, with national HMO/PPO companies, such as
Healthcare-COMPARE/AFFORDABLE, Hospital Network of America and Multiplan, with
national case management companies, such as INTRACORP
7
and Crawford & Co., and with national employers, such as Wal-Mart,
Georgia-Pacific Corporation, Dillard Department Stores, Goodyear Tire & Rubber
and Winn-Dixie. In addition, since many of the facilities acquired by the
Company during the past three years had very limited contractual relationships
with payors, managed care providers, employers and others, the Company is
expanding its existing payor relationships to include these facilities.
The Company carries out broader programs designed to further enhance its
public image. Among these is the HEALTHSOUTH Sports Medicine Council, headed by
Bo Jackson and involving other well-known professional and amateur athletes and
sports medicine specialists, which is dedicated to developing educational
programs focused on athletics for use in high schools. The Company has ongoing
relationships with the Ladies Professional Golf Association, the Southeastern
Conference, the U.S. Decathlon Team, USA Hockey, USA Wrestling, USA Volleyball
and more than 125 universities and colleges and 1,000 high schools to provide
sports medicine coverage of events and rehabilitative healthcare services for
injured athletes. In addition, the Company has established relationships with or
provided treatment services for athletes from some 40-50 professional sports
teams, as well as providing sports medicine services for Olympic and amateur
athletes. In 1996, the Company and the United States Olympic Committee
established the Richard M. Scrushy/HEALTHSOUTH Sports Medicine and Sport Science
Center at the USOC's Colorado Springs campus.
The Company is a national sponsor of the United Cerebral Palsy Association
and the National Arthritis Foundation and supports many other charitable
organizations on national and local levels. Through these endeavors, the Company
provides its employees with opportunities to support their communities.
SOURCES OF REVENUES
Private pay revenue sources represent the majority of the Company's
revenues. The following table sets forth the percentages of the Company's
revenues from various sources for the periods indicated:
YEAR ENDED YEAR ENDED
SOURCE DECEMBER 31, 1996 DECEMBER 31, 1997
- - -------------------------------------- ------------------- ------------------
Medicare ...................... 37.8% 36.9%
Commercial (1) ................ 34.9 35.1
Workers' Compensation ......... 11.3 11.1
All Other Payors (2) .......... 16.0 16.9
----- -----
100.0% 100.0%
- - ----------
(1) Includes commercial insurance, HMOs, PPOs and other managed care plans.
(2) Medicaid is included in this category, but is insignificant in amount.
The above table does not reflect the SCA, Advantage Health, PSCM, ReadiCare
or Health Images facilities for periods or portions thereof prior to the
effective date of the acquisitions. Comparable information for those facilities
is not available.
See this Item "Business -- Regulation -- Medicare Participation and
Reimbursement" for a description of certain of the reimbursement regulations
applicable to the Company's facilities.
COMPETITION
The Company competes in the geographic markets in which its facilities are
located. In addition, the Company's rehabilitation facilities compete on a
regional and national basis with other providers of specialized services such as
sports medicine and work hardening, and specific concentrations such as head
injury rehabilitation and orthopaedic surgery. The competition faced in each of
these markets is similar, with variations arising from the number of healthcare
providers in the given metropolitan area. The primary competitive factors in the
rehabilitation services business are quality of services, projected patient
outcomes, charges for services, responsiveness to the needs of the patients,
community and
8
physicians, and ability to tailor programs and services to meet specific needs
of the patients. Competitors and potential competitors include hospitals,
private practice therapists, rehabilitation agencies and others. Some of these
competitors may have greater patient referral support and financial and
personnel resources in particular markets than the Company. Management believes
that the Company competes successfully within the marketplace based upon its
reputation for quality, competitive prices, positive rehabilitation outcomes,
innovative programs, clean and bright facilities and responsiveness to needs.
The Company's surgery centers compete primarily with hospitals and other
operators of freestanding surgery centers in attracting physicians and patients,
and in developing new centers and in acquiring existing centers. The primary
competitive factors in the outpatient surgery business are convenience, cost,
quality of service, physician loyalty and reputation. Hospitals have many
competitive advantages in attracting physicians and patients, including
established standing in a community, historical physician loyalty and
convenience for physicians making rounds or performing inpatient surgery in the
hospital. However, the Company believes that its national market system and its
historical presence in certain of the markets where its surgery centers are
located will enhance the Company's ability to operate these facilities
successfully.
The Company's diagnostic centers compete with local hospitals, other
multi-center imaging companies, local independent diagnostic centers and imaging
centers owned by local physician groups. The Company believes that the principal
competitive factors in the diagnostic services are price, quality of service,
ability to establish and maintain relationships with managed care payors and
referring physicians, reputation of interpreting physicians, facility location
and convenience of scheduling. Management believes that the Company's diagnostic
facilities compete successfully within their respective markets, taking into
account these factors.
The Company's medical centers are located in four urban areas of the
country, all with well established healthcare services provided by a number of
proprietary, not-for-profit, and municipal hospital facilities. The Company's
facilities compete directly with these local hospitals as well as various
nationally recognized centers of excellence in orthopaedics, sports medicine and
other specialties. Because the Company's facilities enjoy a national and
international reputation for orthopaedic surgery and sports medicine, the
Company believes that its medical centers' level of service and continuum of
care enable them to compete successfully, both locally and nationally.
The Company potentially faces competition any time it initiates a
Certificate of Need ("CON") project or seeks to acquire an existing facility or
CON. See this Item, "Business -- Regulation". This competition may arise either
from competing companies, national or regional, or from local hospitals which
file competing applications or oppose the proposed CON project. The necessity
for these approvals serves as a barrier to entry and has the potential to limit
competition by creating a franchise to provide services to a given area. The
Company has generally been successful in obtaining CONs or similar approvals
when required, although there can be no assurance that it will achieve similar
success in the future.
REGULATION
The healthcare industry is subject to regulation by federal, state and
local governments. The various levels of regulatory activity affect the
Company's business activities by controlling its growth, requiring licensure or
certification of its facilities, regulating the use of its properties and
controlling the reimbursement to the Company for services provided.
Licensure, Certification and Certificate of Need Regulations
Capital expenditures for the construction of new facilities, the addition
of beds or the acquisition of existing facilities may be reviewable by state
regulators under a statutory scheme which is sometimes referred to as a CON
program. States with CON programs place limits on the construction and
acquisition of healthcare facilities and the expansion of existing facilities
and services. In such states, approvals are required for capital expenditures
exceeding certain amounts which involve inpatient rehabilitation facilities or
services. Outpatient rehabilitation facilities and services do not require such
approvals in a majority of states.
9
State CON statutes generally provide that, prior to the addition of new
beds, the construction of new facilities or the introduction of new services, a
state health planning designated agency (a "SHPDA") must determine that a need
exists for those beds, facilities or services. The CON process is intended to
promote comprehensive healthcare planning, assist in providing high quality
healthcare at the lowest possible cost and avoid unnecessary duplication by
ensuring that only those healthcare facilities that are needed will be built.
Typically, the provider of services submits an application to the
appropriate SHPDA with information concerning the area and population to be
served, the anticipated demand for the facility or service to be provided, the
amount of capital expenditure, the estimated annual operating costs, the
relationship of the proposed facility or service to the overall state health
plan and the cost per patient day for the type of care contemplated. Whether the
CON is granted is based upon a finding of need by the SHPDA in accordance with
criteria set forth in CON statutes and state and regional health facilities
plans. If the proposed facility or service is found to be necessary and the
applicant to be the appropriate provider, the SHPDA will issue a CON containing
a maximum amount of expenditure and a specific time period for the holder of the
CON to implement the approved project.
Licensure and certification are separate, but related, regulatory
activities. The former is usually a state or local requirement and the latter is
a federal requirement. In almost all instances, licensure and certification will
follow specific standards and requirements that are set forth in readily
available public documents. Compliance with the requirements is monitored by
annual on-site inspections by representatives of various government agencies.
All of the Company's inpatient rehabilitation facilities and medical centers and
substantially all of the Company's surgery centers are currently required to be
licensed, but only the outpatient rehabilitation facilities located in Alabama,
Arizona, Kentucky, Maryland, Massachusetts, New Hampshire, New Mexico and Rhode
Island currently must satisfy such a licensing requirement.
Medicare Participation and Reimbursement
In order to participate in the Medicare program and receive Medicare
reimbursement, each facility must comply with the applicable regulations of the
United States Department of Health and Human Services relating to, among other
things, the type of facility, its equipment, its personnel and its standards of
medical care, as well as compliance with all state and local laws and
regulations. All of the Company's inpatient facilities, except for the St. Louis
head injury center, participate in the Medicare program. Approximately 444 of
the Company's outpatient rehabilitation facilities currently participate in, or
are awaiting the assignment of a provider number to participate in, the Medicare
program. All of the Company's surgery centers and diagnostic centers are
certified (or awaiting certification) under the Medicare program. Its
Medicare-certified facilities, inpatient and outpatient, undergo annual on-site
Medicare certification surveys in order to maintain their certification status.
Failure to comply with the program's conditions of participation may result in
loss of program reimbursement or other governmental sanctions. All such
facilities have been deemed to be in satisfactory compliance on all applicable
surveys. The Company has developed its operational systems to assure compliance
with the various standards and requirements of the Medicare program and has
established ongoing quality assurance activities to monitor compliance. The
Company believes that all of such facilities currently meet all applicable
Medicare requirements.
As a result of the Social Security Act Amendments of 1983, Congress adopted
a prospective payment system ("PPS") to cover the routine and ancillary
operating costs of most Medicare inpatient hospital services. Under this system,
the Secretary of Health and Human Services has established fixed payment amounts
per discharge based on diagnosis-related groups ("DRGs"). With limited
exceptions, a hospital's payment for Medicare inpatients is limited to the DRG
rate, regardless of the number of services provided to the patient or the length
of the patient's hospital stay. Under PPS, a hospital may retain the difference,
if any, between its DRG rate and its operating costs incurred in furnishing
inpatient services, and is at risk for any operating costs that exceed its DRG
rate. The Company's medical center facilities are generally subject to PPS with
respect to Medicare inpatient services.
10
The PPS program has been beneficial for the rehabilitation segment of the
healthcare industry because of the economic pressure on acute-care hospitals to
discharge patients as soon as possible. The result has been increased demand for
rehabilitation services for those patients discharged early from acute-care
hospitals. Outpatient rehabilitation services and freestanding inpatient
rehabilitation facilities are currently exempt from PPS, and inpatient
rehabilitation units within acute-care hospitals are eligible to obtain an
exemption from PPS upon satisfaction of certain federal criteria.
Currently, 12 of the Company's outpatient centers are Medicare-certified
Comprehensive Outpatient Rehabilitation Facilities ("CORFs") and 432 are
Medicare-certified rehabilitation agencies. CORFs have been designated
cost-reimbursed Medicare providers since 1982. Under the regulations, CORFs are
reimbursed reasonable costs (subject to certain limits) for services provided to
Medicare beneficiaries. Outpatient rehabilitation facilities certified by
Medicare as rehabilitation agencies are reimbursed on the basis of the lower of
reasonable costs for services provided to Medicare beneficiaries or charges for
such services. Outpatient rehabilitation facilities which are physician-directed
clinics, as well as outpatient surgery centers, are reimbursed by Medicare on a
fee screen basis; that is, they receive a fixed fee, which is determined by the
geographical area in which the facility is located, for each procedure
performed. The Company's outpatient rehabilitation facilities submit monthly
bills to their fiscal intermediaries for services provided to Medicare
beneficiaries, and the Company files annual cost reports with the intermediaries
for each such facility. Adjustments are then made if costs have exceeded
payments from the fiscal intermediary or vice versa.
The Company's inpatient facilities (other than the medical center
facilities) either are not currently covered by PPS or are exempt from PPS, and
are also cost-reimbursed, receiving the lower of reasonable costs or charges.
Typically, the fiscal intermediary pays a set rate based on the prior year's
costs for each facility. As with outpatient facilities subject to cost-based
reimbursement, annual cost reports are filed with the Company's fiscal
intermediary and payment adjustments are made, if necessary.
As part of the Balanced Budget Act of 1997, Congress directed the United
States Department of Health and Human Services to develop regulations that would
subject inpatient rehabilitation hospital to a PPS. The prospective rates are to
be phased in beginning October 1, 2000, and are to be fully implemented on
October 1, 2002. The Act requires that the rates must equal 98% of the amount of
payments that would have been made if the PPS had not been adopted. In addition,
the Act requires the establishment of a PPS for hospital outpatient department
services, effective for services furnished beginning in 1999. Since the drafting
of the regulations covering these initiatives is in very early stages, the
Company cannot predict at this time the effect that any such changes may have on
its operations.
Over the past several years an increasing number of healthcare providers
have been accused of violating the federal False Claims Act. That Act prohibits
the knowing presentation of a false claim to the United States government.
Because the Company performs thousands of similar procedures a year for which it
is reimbursed by Medicare and there is a relatively long statute of limitations,
a billing error could result in significant civil penalties. The Company does
not believe that it is or has been in violation of the False Claims Act.
Relationships with Physicians and Other Providers
Various state and federal laws regulate relationships among providers of
healthcare services, including employment or service contracts and investment
relationships. These restrictions include a federal criminal law prohibiting (i)
the offer, payment, solicitation or receipt of remuneration by individuals or
entities, to induce referrals of patients for services reimbursed under the
Medicare or Medicaid programs or (ii) the leasing, purchasing, ordering,
arranging for or recommending the lease, purchase or order of any item, good,
facility or service covered by such programs (the "Fraud and Abuse Law"). In
addition to federal criminal sanctions, violators of the Fraud and Abuse Law may
be subject to significant civil sanctions, including fines and/or exclusion from
the Medicare and/or Medicaid programs.
In 1991, the Office of the Inspector General ("OIG") of the United States
Department of Health and Human Services promulgated regulations describing
compensation arrangements which are not viewed as illegal remuneration under
the Fraud and Abuse Law (the "Safe Harbor Rules"). The Safe
11
Harbor Rules create certain standards ("Safe Harbors") for identified types of
compensation arrangements which, if fully complied with, assure participants in
the particular arrangement that the OIG will not treat such participation as a
criminal offense under the Fraud and Abuse Law or as the basis for an exclusion
from the Medicare and Medicaid programs or an imposition of civil sanctions. The
OIG closely scrutinizes healthcare joint ventures involving physicians and other
referral sources. In 1989, the OIG published a Fraud Alert that outlined
questionable features of "suspect" joint ventures.
In 1992, regulations were published in the Federal Register implementing
the OIG sanction and civil money penalty provisions established in the Fraud and
Abuse Law. The regulations (the "Exclusion Regulations") provide that the OIG
may exclude a Medicare provider from participation in the Medicare Program for a
five-year period upon a finding that the Fraud and Abuse Law has been violated.
The regulations expressly incorporate a test adopted by three federal circuit
courts providing that if one purpose of remuneration that is offered, paid,
solicited or received is to induce referrals, then the statute is violated. The
regulations also provide that after the OIG establishes a factual basis for
excluding a provider from the program, the burden of proof shifts to the
provider to prove that the Fraud and Abuse Law has not been violated.
The Company currently operates 22 of its rehabilitation hospitals and many
of its outpatient rehabilitation facilities as limited partnerships or limited
liability companies (collectively, "partnerships") with third-party investors.
Seven of the rehabilitation hospital partnerships involve physician investors,
13 of the rehabilitation hospital partnerships involve other institutional
healthcare providers and two of the rehabilitation hospital partnerships involve
both institutional providers and other investors, some of whom are physicians.
Seven of the outpatient partnerships currently have a total of 20 physician
limited partners, some of whom refer patients to the partnerships. Those
partnerships which are providers of services under the Medicare program, and
their limited partners, are subject to the Fraud and Abuse Law. A number of the
relationships established by the Company with physicians and other healthcare
providers do not fit within any of the Safe Harbors. The Safe Harbor Rules do
not expand the scope of activities that the Fraud and Abuse Law prohibits, nor
do they provide that failure to fall within a Safe Harbor constitutes a
violation of the Fraud and Abuse Law; however, the OIG has informally indicated
that failure to fall within a Safe Harbor may subject an arrangement to
increased scrutiny.
Most of the Company's surgery centers are owned by partnerships, which
include as partners physicians who perform surgical procedures at such centers.
Subsequent to the promulgation of the Safe Harbor Rules in 1991, the Department
of Health and Human Services issued for public comment additional proposed Safe
Harbors, one of which specifically addresses surgeon ownership interests in
ambulatory surgery centers (the "Proposed ASC Safe Harbor"). As proposed, the
Proposed ASC Safe Harbor would protect payments to be made to surgeons as a
return on investment interest in a surgery center if, among other conditions,
all the investors are surgeons who are in a position to refer patients directly
to the center and perform surgery on such referred patients. Since a subsidiary
of the Company is an investor in each limited partnership which owns a surgery
center, the Company's arrangements with physician investors do not fit within
the Proposed ASC Safe Harbor as currently proposed. The Company is unable at
this time to predict whether the Proposed ASC Safe Harbor will become final, and
if so, whether the language and requirements will remain as currently proposed,
or whether changes will be made prior to becoming final. There can be no
assurance that the Company will ever meet the criteria under the Proposed ASC
Safe Harbor as proposed or as it may be adopted in final form. The Company
believes, however, that its arrangements with physicians with respect to its
surgery center facilities should not fall within the activities prohibited by
the Fraud and Abuse Law.
Certain of the Company's diagnostic centers are owned or operated by
partnerships which include radiologists as partners. While such ownership
interests are not directly covered by the Safe Harbor Rules, the Company does
not believe that such arrangements violate the Fraud and Abuse Law because
radiologists are typically not in a position to make or induce referrals to
diagnostic centers. In addition, the Company's mobile lithotripsy operations are
conducted by partnerships in which urologists are limited partners. Because such
urologists are in a position to, and do, perform lithotripsy procedures
utilizing the Company's lithotripsy equipment, the Company believes that the
same analysis underlying the Proposed ASC Safe Harbor should apply to ownership
interests in lithotripsy equipment held by
12
urologists. In addition, the Company believes that the nature of lithotripsy
services (i.e., lithotripsy is only prescribed and utilized when a condition for
which lithotripsy is the treatment of choice has been diagnosed) makes the risk
of overutilization unlikely. There can be no assurance, however, that the Fraud
and Abuse Law will not be interpreted in a manner contrary to the Company's
beliefs with respect to diagnostic and lithotripsy services.
While several federal court decisions have aggressively applied the
restrictions of the Fraud and Abuse Law, they provide little guidance as to the
application of the Fraud and Abuse Law to the Company's partnerships. The
Company believes that it is in compliance with the current requirements of
applicable federal and state law, but no assurances can be given that a federal
or state agency charged with enforcement of the Fraud and Abuse Law and similar
laws might not assert a contrary position or that new federal or state laws, or
new interpretations of existing laws, might not adversely affect relationships
established by the Company with physicians or other healthcare providers or
result in the imposition of penalties on the Company or certain of its
facilities. Even the assertion of a violation could have a material adverse
effect upon the Company.
The so-called "Stark II" provisions of the Omnibus Budget Reconciliation
Act of 1993 amend the federal Medicare statute to prohibit the making by a
physician of referrals for "designated health services" (including physical
therapy, occupational therapy, radiology services or radiation therapy) to an
entity in which the physician has an investment interest or other financial
relationship, subject to certain exceptions. Such prohibition took effect on
January 1, 1995 and applies to all of the Company's partnerships with physician
partners. On January 9, 1998, the Department of Health and Human Services
published proposed regulations (the "Proposed Stark Regulations") under the
Stark II statute and solicited comments thereon. In addition, a number of states
have passed or are considering statutes which prohibit or limit physician
referrals of patients to facilities in which they have an investment interest.
In response to these regulatory activities, the Company has restructured most of
its partnerships which involve physician investors to the extent required by
applicable law, in order to eliminate physician ownership interests not
permitted by applicable law. The Company intends to take such actions as may be
required to cause the remaining partnerships to be in compliance with applicable
laws and regulations, including, if necessary, the prohibition of physician
partners from referring patients. The Company believes that this restructuring
has not adversely affected and will not adversely affect the operations of its
facilities.
Ambulatory surgery is not identified as a "designated health service" under
Stark II, and the Company does not believe the statute is intended to cover
ambulatory surgery services. The Proposed Stark Regulations would expressly
clarify that the provision of designated health services in an ambulatory
surgery center would be excepted from the referral prohibition of Stark II if
payment for such designated health services is included in the ambulatory
surgery center payment rate.
Lithotripsy facilities operated by the Company frequently operate on
hospital campuses, and it is possible to conclude that such services are
"inpatient and outpatient hospital services" -- a category of designated health
services under Stark II. The legislative history of the Stark II statute
indicates that the statute was not intended to cover the provision of
lithotripsy services by physician-owned lithotripsy providers under contract
with a hospital. In the commentary to the Proposed Stark Regulations, the
Department of Health and Human Services specifically solicited comments as to
whether lithotripsy services should be excluded from the definition of
"inpatient and outpatient hospital services". In the event that lithotripsy
services are not so excluded, the Company believes that the operations of its
lithotripsy partnerships either comply with, or can be restructured to comply
with, certain other exceptions to the Stark II referral prohibitions, and the
Company intends to take such steps as may be required to cause those
partnerships to be in compliance with Stark II if the final regulations so
require. In addition, physicians frequently perform endoscopic procedures in the
procedure rooms of the Company's surgery centers, and it is possible to construe
such services to be "designated health services". While the Company does not
believe that Stark II was intended to apply to such services, if that were
determined to be the case, the Company intends to take steps necessary to cause
the operations of its facilities to comply with the law.
13
The Health Insurance Portability and Accountability Act of 1996
In an effort to combat healthcare fraud, Congress included several
anti-fraud measures in the Health Insurance Portability and Accountability Act
of 1996 ("HIPAA"). HIPAA, among other things, amends existing crimes and
criminal penalties for Medicare fraud and enacts new federal healthcare fraud
crimes. HIPAA also expands the Fraud and Abuse Law to apply to all federal
healthcare programs, defined to include any plan or program that provides health
benefits through insurance that is funded by the federal government. Under
HIPAA, the Secretary of the Department of Health and Human Services (the
"Secretary") may exclude from the Medicare program any individual who has a
direct or indirect ownership or control interest in a healthcare entity that has
been convicted of a healthcare fraud crime or that has been excluded from the
Medicare conviction or exclusion of the entity. HIPAA directs the Secretary to
establish a program to collect information on healthcare fraud and abuse to
encourage individuals to report information concerning fraud and abuse against
the Medicare program and provides for payment of a portion of amounts collected
to such individuals. HIPAA mandates the establishment of a Fraud and Abuse
Program, among other programs, to control fraud and abuse with respect to health
plans and to conduct investigations, audits, evaluations, and inspections
relating to the delivery of and payment for healthcare in the United States.
HIPAA prohibits any person or entity from knowingly and willfully
committing a federal healthcare offense relating to a healthcare benefit
program. Under HIPAA, a "health care benefit program" broadly includes any
private plan or contract affecting interstate commerce under which any medical
benefit, item, or service is provided to any individual. Among the "federal
health care offenses" prohibited by HIPAA are healthcare fraud and making false
statements relative to healthcare matters. Any person or entity that knowingly
and willfully defrauds or attempts to defraud a healthcare benefit program or
obtains by means of false or fraudulent pretenses, representations or promises,
any of the money or property of any healthcare benefit program in connection
with the delivery of healthcare services is subject to a fine and/or
imprisonment. In addition, HIPAA provides that any person or entity that
knowingly and willfully falsifies or conceals or covers up a material fact or
makes any materially false or fraudulent statements in connection with the
delivery of or payment of healthcare services by a healthcare benefit plan is
subject to a fine and/or imprisonment.
HIPAA further expands the list of acts which are subject to civil monetary
penalties under federal law and increases the amount of civil penalties which
may be imposed. HIPAA provides for civil fines for individuals who retain an
ownership or control interest in a Medicare or Medicaid participating entity
after such individuals have been excluded from participating in the Medicare or
Medicaid program. HIPAA further provides for civil fines for individuals who
offer inducements to Medicare or Medicaid eligible patients if the individuals
know or should know that their offers will influence the patients to order or
receive items or services from a particular provider, practitioner or supplier.
The Company cannot predict whether other regulatory or statutory provisions
will be enacted by federal or state authorities which would prohibit or
otherwise regulate relationships which the Company has established or may
establish with other healthcare providers or the possibility of materially
adverse effects on its business or revenues arising from such future actions.
Management of the Company believes, however, that the Company will be able to
adjust its operations so as to be in compliance with any regulatory or statutory
provision as may be applicable. See this Item, "Business -- Patient Care
Services" and "Business -- Sources of Revenues".
INSURANCE
Beginning December 1, 1993, the Company became self-insured for
professional liability and comprehensive general liability. The Company
purchased coverage for all claims incurred prior to December 1, 1993. In
addition, the Company purchased underlying insurance which would cover all
claims once established limits have been exceeded. It is the opinion of
management that as of December 31, 1997, the Company had adequate reserves to
cover losses on asserted and unasserted claims.
In connection with the Horizon/CMS acquisition, the Company assumed
Horizon/CMS's open professional and general liability claims. The Company has
entered into an agreement with an insurance
14
carrier to assume responsibility for the majority of open claims. Under this
agreement, a "risk transfer" is being conducted which will convert Horizon/CMS's
self-insured claims to insured liabilities consistent with the terms of the
underlying insurance policy.
EMPLOYEES
As of December 31, 1997, the Company employed 56,281 persons, of whom
36,873 were full-time employees and 19,408 were part-time employees. Of the
above employees, 1,070 were employed at the Company's headquarters in
Birmingham, Alabama. Except for approximately 80 employees at one rehabilitation
hospital (about 18% of that facility's workforce), none of the Company's
employees are represented by a labor union. The Company is not aware of any
current activities to organize its employees at other facilities. Management of
the Company considers the relationship between the Company and its employees to
be good.
ITEM 2. PROPERTIES.
The Company's executive offices currently occupy approximately 200,000
square feet in a newly-constructed headquarters building in Birmingham, Alabama.
The headquarters building, which was occupied by the Company in February 1997,
was constructed on a 73-acre parcel of land owned by the Company pursuant to a
tax retention operating lease structured through NationsBanc Leasing
Corporation. Substantially all of the Company's outpatient rehabilitation and
occupational medicine operations are carried out in leased facilities. The
Company owns 37 of its inpatient rehabilitation facilities and leases or
operates under management contracts the remainder of its inpatient
rehabilitation facilities. The Company also owns 48 of its surgery centers and
45 of its diagnostic centers and leases the remainder. The Company constructed
its rehabilitation hospitals in Florence and Columbia, South Carolina, Kingsport
and Nashville, Tennessee, Concord, New Hampshire, Dothan, Alabama, and Columbia,
Missouri and is constructing its Charlottesville, Virginia rehabilitation
hospital, on property leased under long-term ground leases. The property on
which the Company's Memphis, Tennessee rehabilitation hospital is located is
owned in partnership by the Company and Methodist Hospitals of Memphis. The
Company owns its four medical center facilities. The Company currently owns, and
from time to time may acquire, certain other improved and unimproved real
properties in connection with its business. See Notes 5 and 7 of "Notes to
Consolidated Financial Statements" for information with respect to the
properties owned by the Company and certain indebtedness related thereto.
In management's opinion, the Company's physical properties are adequate for
the Company's needs for the foreseeable future, and are consistent with its
expansion plans described elsewhere in this Annual Report on Form 10-K.
15
The following table sets forth a listing of the Company's patient care
services locations at December 31, 1997:
OUTPATIENT INPATIENT
REHABILITATION REHABILITATION MEDICAL SURGERY DIAGNOSTIC OTHER
STATE FACILITIES FACILITIES(BEDS)(2) CENTERS(BEDS)(2) CENTERS CENTERS SERVICES
- - --------------------------- --------------------- --------------------- ------------------ --------- ------------ ---------
Alabama ................... 26 7 (336) 1 (219) 5 6 11
Alaska .................... 7 1 1 4
Arizona ................... 24 4 (243) 2 1 6
Arkansas .................. 8 5 (278) 2 5
California ................ 57 1 (60) 35 1 31
Colorado .................. 45 1 (64) 5 7 1
Connecticut ............... 34 1 (30) 5 3
Delaware .................. 5 1
District of Columbia ...... 1 1
Florida ................... 80 12 (735) 1 (285) 18 7 27
Georgia ................... 30 1 (50) 3 10 4
Hawaii .................... 13 1
Idaho ..................... 5 1
Illinois .................. 49 5 3 1
Indiana ................... 18 4 (260) 5 3
Iowa ...................... 3 1
Kansas .................... 6 4 (231) 1
Kentucky .................. 5 2 (80) 3
Louisiana ................. 4 6 (367) 1 2 2
Maine ..................... 7 4 (155) 4
Maryland .................. 27 2 (66) 7 8 1
Massachusetts ............. 27 14 (806) 1 2 12
Michigan .................. 23 1 (30) 1 1
Minnesota ................. 14
Mississippi ............... 7
Missouri .................. 48 2 (86) 10 9
Montana ................... 3
Nebraska .................. 2
Nevada .................... 21 2 (126) 1 2
New Hampshire ............. 10 3 (99)
New Jersey ................ 71 1 (155) 1 2 1
New Mexico ................ 6 1 (61) 1 1
New York .................. 47 1 (27) 1 1
North Carolina ............ 17 3 1
North Dakota .............. 2
Ohio ...................... 38 1 (30) 7 4
Oklahoma .................. 17 3 (183) 1 1
Oregon .................... 29 1
Pennsylvania .............. 52 14 (1,085) 8 6 4
Rhode Island .............. 3
South Carolina ............ 9 4 (235) 2 6 2
South Dakota .............. 2
Tennessee ................. 34 6 (362) 6 5
Texas ..................... 103 19 (1,116) 1 (96) 21 20 41
Utah ...................... 1 1 (86) 1 1
Vermont ................... 1
Virginia .................. 21 1 (40) 1 (200) 3 9
Washington ................ 85 2 1 17
West Virginia ............. 2 4 (200) 1
Wisconsin ................. 3 4
Wyoming ................... 2
- - ----------
(1) Includes freestanding outpatient centers and their satellites, outpatient
satellites of inpatient rehabilitation facilities and outpatient facilities
managed under contract.
(2) "Beds" refers to the number of beds for which a license or certificate of
need has been granted, which may vary materially from beds available for
use.
16
In addition, at December 31, 1997, the Company operated six diagnostic
centers in the United Kingdom and one rehabilitation hospital in Australia.
ITEM 3. LEGAL PROCEEDINGS.
In the ordinary course of its business, the Company may be subject, from
time to time, to claims and legal actions by patients and others. The Company
does not believe that any such pending actions, if adversely decided, would have
a material adverse effect on its financial condition. See Item 1, "Business --
Insurance" and Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" for a description of the Company's
insurance coverage arrangements.
From time to time, the Company appeals decisions of various rate-making
authorities with respect to Medicare rates established for the Company's
facilities. These appeals are initiated in the ordinary course of business.
Management believes that adequate reserves have been established for possible
adverse decisions on any pending appeals and that the outcomes of currently
pending appeals, either individually or in the aggregate, will have no material
adverse effect on the Company's operations.
CERTAIN HORIZON/CMS LITIGATION
On October 29, 1997, HEALTHSOUTH acquired Horizon/CMS through the merger of
a wholly owned subsidiary of HEALTHSOUTH with and into Horizon/CMS. Horizon/CMS
is currently a party, or is subject, to certain material litigation matters and
disputes, which are described below, as well as various other litigation matters
and disputes arising in the ordinary course of its business. The Company is not
itself a party to the litigation described below.
SEC and NYSE Investigations
The Division of Enforcement of the SEC is conducting a private
investigation with respect to trading in the securities of Horizon/CMS and
Continental Medical Systems, Inc. ("CMS"), which was acquired by Horizon/CMS in
June 1995. In connection with that investigation, Horizon/CMS produced certain
documents, and Neal M. Elliott, then Chairman of the Board, President and Chief
Executive Officer of Horizon/CMS, and certain other former officers of
Horizon/CMS have given testimony to the SEC. Horizon/CMS has also been informed
that certain of its division office employees and an individual, affiliates of
whom had limited business relationships with Horizon/CMS, have responded to
subpoenas from the SEC. Mr. Elliott also produced certain documents in response
to a subpoena from the SEC. In addition, Horizon/CMS and Mr. Elliott have
responded to separate subpoenas from the SEC pertaining to trading in
Horizon/CMS's common stock and various material press releases issued in 1996 by
Horizon/CMS; Horizon/CMS's February 18, 1997 announcement that the Company would
acquire Horizon/CMS; and any discussions of proposed business combinations
between Horizon/CMS and Medical Innovations and Horizon/CMS and certain other
companies. The investigation is, to the knowledge of the Company and
Horizon/CMS, ongoing, and neither Horizon/CMS nor the Company possesses all the
facts with respect to the matters under investigation. Although neither
Horizon/CMS nor the Company has been advised by the SEC that the SEC has
concluded that any of Horizon/CMS, Mr. Elliott or any other current or former
officer of director of Horizon/CMS has been involved in any violation of the
federal securities laws, there can be no assurance as to the outcome of the
investigation or the time of its conclusion. Both Horizon/CMS and the Company
have, to the extent requested to date, cooperated fully with the SEC in
connection with the investigation.
In March 1995, the New York Stock Exchange informed Horizon/CMS that it had
initiated a review of trading in Hillhaven Corporation common stock prior to the
announcement of Horizon/CMS's proposed acquisition of Hillhaven. In April 1995,
the NYSE extended the review of trading to include all dealings with CMS. On
April 3, 1996, the NYSE notified Horizon/CMS that it had initiated a review of
trading in its common stock preceding Horizon/CMS's March 1, 1996 press release
announcing a revision in Horizon/CMS's third quarter earnings estimate. On
February 20, 1997, the NYSE notified Horizon/CMS that it was reviewing trading
in Horizon/CMS's securities prior to the February 18, 1997 announcement that the
Company would acquire Horizon/CMS. Horizon/CMS has cooperated with the NYSE in
its reviews and, to Horizon/CMS's knowledge, the reviews are ongoing.
17
In February 1997, the Company received a subpoena from the SEC with respect
to its investigation concerning trading in Horizon/CMS common stock prior to the
February 18, 1997 announcement that the Company would acquire Horizon/CMS and a
request for information from the NYSE in connection with its review of such
trading. The Company responded to such subpoena and request for information and
advised both the SEC and the NYSE that it intended to cooperate fully in any
investigations or reviews relating to such trading. The Company provided certain
additional information to the SEC in April 1997. Since that time, the Company
has had no further inquiries from either the SEC or the NYSE with respect to
such matters, and is unaware of the current status of such investigations or
reviews.
Michigan Attorney General Investigation Into Long-Term Care Facility In
Michigan
Horizon/CMS learned in September 1996 that the Attorney General of the
State of Michigan was investigating one of its skilled nursing facilities. The
facility, in Howell, Michigan, was owned and operated by Horizon/CMS from
February 1994 until December 31, 1997. As widely reported in the press, the
Attorney General seized a number of patient, financial and accounting records
that were located at this facility. By order of a circuit judge in the county in
which the facility is located, the Attorney General was ordered to return
patient records to the facility for copying. Horizon/CMS advised the Michigan
Attorney General that it was willing to cooperate fully in the investigation.
The facility in question was sold by Horizon/CMS to IHS on December 31, 1997.
On February 19, 1998, the State of Michigan filed a criminal complaint
against Horizon/CMS, four former employees of the facility and one former
Horizon/CMS regional manager, alleging various violations in 1995 and 1996 of
certain statutes relating to patient care, patient medical records and the
making of false statements with respect to the condition or operations of the
facility (State of Michigan v. Horizon/CMS Healthcare Corp., et al., Case No.
98-630-FY, State of Michigan District Court 54B). The maximum fines chargeable
against Horizon/CMS under the counts alleged in the complaint (exclusive of
charges against the individual defendants, some of which charges may result in
indemnification obligations for Horizon/CMS) aggregate $69,000. Horizon/CMS
denies the allegations made in the complaint and expects to vigorously defend
against the charges. Because such charges have just been filed, it is not
possible to predict at this time the outcome or effect of this litigation or the
length of time it will take to resolve this litigation.
Stockholder Derivative Actions
Commencing in April and continuing into May 1996, Horizon/CMS was served
with nine complaints alleging a class action derivative action brought by
stockholders of Horizon/CMS for and on behalf of Horizon/CMS in the Court of
Chancery of New Castle County, Delaware, against certain then-current and former
directors of Horizon/CMS. The nine lawsuits have been consolidated into one
action styled In re Horizon/CMS Healthcare Corporation Shareholders Litigation.
The plaintiffs alleged, among other things, that Horizon/CMS's then-current and
former directors breached their fiduciary duties to Horizon/CMS and the
stockholders as a result of (i) the purported failure to supervise adequately
and the purported knowing mismanagement of the operations of Horizon/CMS, and
(ii) the purported misuse of inside information in connection with the sale of
Horizon/CMS's Common Stock by certain of the current and former directors in
January and February 1996. To that end, the plaintiffs sought an accounting from
the directors for profits to themselves and damages suffered by Horizon/CMS as a
result of the transaction complained of in the complaint and attorneys' fees and
costs. On June 21, 1996, the individual defendants filed a motion with the
Chancery Court seeking to dismiss this matter because, among other things, the
plaintiffs failed to make a demand on the board of directors prior to commencing
this litigation.
In April 1996, Horizon/CMS was served with complaint in a stockholder's
derivative lawsuit styled Lind v. Rocco A. Ortenzio, Neal M. Elliott, Klemett L.
Belt, Jr., Robert A. Ortenzio, Russell L. Carson, Bryan C. Cressey, Charles H.
Gonzales, Michael A. Jeffries, Gerard M. Martin, Frank M. McCord, Raymond N.
Noveck, Barry M. Portnoy, LeRoy S. Zimmerman and Horizon/CMS Healthcare
Corporation, No. CIV 96-0538-BB, pending in the United States District Court for
the District of New Mexico.
18
The claims alleged by the plaintiff, and the relief sought, were substantially
identical to those in the Delaware litigation. Horizon/CMS filed a motion
seeking a stay of this case pending the outcome of the motion to dismiss in the
Delaware derivative lawsuits or, in the alternative, to dismiss this case for
those same reasons.
On February 24, 1998, the plaintiffs in the consolidated Delaware case
voluntarily dismissed their action without prejudice. Horizon/CMS expects that
the plaintiff in the New Mexico case will likewise dismiss his action. If that
does not occur, Horizon/CMS will renew and vigorously prosecute its motion to
dismiss the New Mexico action. If such dismissal does not occur, the Company
cannot currently predict the outcome or the effect of the New Mexico litigation
or the length of time it will take to resolve such litigation.
Lawsuit by Former Shareholders of Communi-Care, Inc. and Pro Rehab, Inc.
On May 28, 1997, CMS was served with a lawsuit styled Kenneth Hubbard and
Lynn Hubbard v. Rocco Ortenzio, Robert A. Ortenzio and Continental Medical
Systems, Inc., No. 3:97 CV294MCK, filed in the United States District Court for
the Western District of North Carolina, Charlotte Division, by the former
shareholders of Communi-Care, Inc. and Pro Rehab, Inc. seeking damages arising
out of certain "earnout" provisions of the definitive purchase agreements under
which CMS purchased the outstanding stock of Communi-Care, Inc. and Pro Rehab,
Inc. from such shareholders. The plaintiffs allege that the manner in which CMS
and the other defendants operated the companies after their acquisition breached
its fiduciary duties to the plaintiffs, constituted fraud, gross negligence and
bad faith and a breach of their employment agreements with the companies. As a
result of such alleged conduct, the plaintiffs assert that they are entitled to
damages in an amount in excess of $27,000,000 from CMS and the other defendants.
Horizon/CMS believes, based upon its evaluation of the legal and factual matters
relating to the plaintiffs' assertions, that it has valid defenses to the
plaintiffs' claims and, as a result, intends to vigorously contest such claims.
Because this litigation remains at an early stage, the Company cannot now
predict the outcome or effect of such litigation or the length of time it will
take to resolve such litigation.
RehabOne Litigation
In March 1997, Horizon/CMS was served with a lawsuit filed in the United
States District Court for the Middle District of Pennsylvania, styled RehabOne,
Inc. v. Horizon/CMS Healthcare Corporation, Continental Medical Systems, Inc.
David Nation and Robert Ortenzio, No. CV-97-0292. In this lawsuit the plaintiff
alleges violations of federal and state securities laws, fraud and negligent
misrepresentation by Horizon/CMS and certain former officers of CMS in
connection with the issuance of a warrant to purchase 500,000 shares of
Horizon/CMS Common Stock (the "Warrant"). The Warrant was issued to the
plaintiff in connection with the settlement of certain prior litigation between
the plaintiff and CMS. The plaintiff's complaint does not state the amount of
damages sought. Horizon/CMS disputes the factual and legal assertions of the
plaintiff in this litigation and intends to vigorously contest the plaintiff's
claims. Because this litigation is at an early stage, the Company cannot predict
the length of time it will take to resolve the litigation or the outcome or
effect of the litigation.
EEOC Litigation
In March 1997, the Equal Employment Opportunity Commission (the "EEOC")
filed a complaint against Horizon/CMS alleging that Horizon/CMS had engaged in
unlawful employment practices in respect of Horizon/CMS's employment policies
related to pregnancies. Specifically, the EEOC asserts that Horizon/CMS's
alleged refusal to provide pregnant employees with light-duty assignments to
accommodate their temporary disabilities caused by pregnancy violates Sections
701(k) and 703(a) of Title VII, 42 U.S.C. (section)(section) 2000e-(k) and
2000e-2(a). In this lawsuit, the EEOC seeks, among other things, to permanently
enjoin Horizon/CMS's employment practices in this regard. Horizon/CMS disputes
the factual and legal assertions of the EEOC in this litigation and intends to
vigorously contest the EEOC's claims. Because this litigation has just
commenced, the Company cannot predict the length of time it will take to resolve
the litigation or the outcome of the litigation.
19
North Louisiana Rehabilitation Hospital Medicare Billing Investigation
In August 1996, the United States Attorney for the Western District of
Louisiana, without actually initiating litigation, apprised Horizon/CMS of
alleged civil liability under the federal False Claims Act for what the
government believes were false or fraudulent Medicare and other federal program
claims submitted by Horizon/CMS's North Louisiana Rehabilitation Hospital
("NLRH") during the period from 1989 through 1992, including certain claims
submitted by a physician who was a member of the medical staff and under
contract to NLRH during the period. Specifically, the government alleges that
NLRH facilitated the submission of false claims under Part B of the Medicare
program by the physician and that NLRH itself submitted false claims under Part
A of the Medicare program for services that were not medically necessary. In
August 1996, the U.S. Attorney identified allegedly improper Part A and Part B
billings, together with penalty provisions under the False Claims Act, ranging
in the aggregate from approximately $1,700,000 to $2,200,000. The government
does not dispute that the Medicare Part A services were rendered, but only
whether they were medically necessary. Horizon/CMS has vigorously contested the
allegation that any cases of disputed medical necessity in this matter
constitute false or fraudulent claims under the civil False Claims Act.
Moreover, Horizon/CMS denies that NLRH facilitated the submission of false
claims under Medicare Part B.
In late April 1997, Horizon/CMS received administrative subpoenas relating
to the matter and has since then produced extensive materials with respect
thereto. Without conceding liability for either the Medicare Part A or Part B
claims, in May 1997, Horizon commenced preliminary settlement discussions with
the government. In preparation for settlement meetings held in late June and
mid-July 1997, Horizon/CMS and the government developed and then refined their
respective analyses of any losses the government may have incurred in this
regard. Following the July 1997 meetings, the government proposed to Horizon/CMS
that the matter be settled by Horizon/CMS's paying the government $4,900,000
with respect to alleged Medicare Part A overpayments and that Horizon/CMS and
certain individual physicians pay the government $820,000 with respect to
Medicare Part B claims for physician services. In late July, Horizon/CMS
responded by offering to settle the matter for $3,700,000 for alleged Medicare
Part A overpayments and $445,000 for alleged Medicare Part B claims for which
Horizon/CMS potentially could bear any responsibility. The government recently
advised Horizon/CMS that it has accepted the latter's settlement offer in this
regard, and the parties are currently in the process of negotiating and
implementing definitive settlement documentation.
Heritage Western Hills Litigation
Since July 1996, Horizon/CMS has been a defendant in a lawsuit styled Lexa
A. Auld, Administratrix of Martha Hary, Deceased v. Horizon/CMS Healthcare
Corporation and Charles T. Maxvill, D.O., No. 48-165121, 48th Judicial District
Court, Tarrant County, Texas. The case involved injuries allegedly suffered by a
resident of the Heritage Western Hills nursing facility in Fort Worth, Texas.
Horizon/CMS tendered the claim to its insurance carrier, which accepted coverage
with a reservation of rights and provided a defense through the carrier's
selected counsel in Dallas, Texas. The case went to trial on October 29, 1997,
and on November 7, 1997, the jury rendered a verdict in favor of the plaintiff
in the amount of $2,370,000 in compensatory damages and $90,000,000 in punitive
damages. Counsel has advised Horizon/CMS that, under applicable Texas law, the
punitive damages award is, at worst, limited to four times the amount of the
compensatory damages (the "Punitive Damages Cap"), and thus that the maximum
amount of an enforceable judgment in favor of the plaintiff is approximately
$12,000,000. Counsel has also advised Horizon/CMS that there are, potentially,
other and further caps on both the amount of compensatory damages available to
the plaintiff and the amount of punitive damages. Horizon/CMS filed the required
motions with the court to impose the Punitive Damages Cap. On February 20, 1998,
the court reduced the jury's verdict and entered a judgment in the amount of
approximately $11,237,000. Horizon/CMS also vigorously disputes the efficacy of
the jury's verdict and has appealed the judgment.
Horizon/CMS's insurance carrier continues to defend the matter subject to a
reservation of rights. Horizon/CMS based upon an evaluation by its then-current
internal counsel, after reviewing the findings contained in the jury verdict,
the insurance policy at issue and the carrier's handling of the case, believes
20
that the entirety of any judgment ultimately entered is covered by and payable
from such insurance policy, less Horizon/CMS's self-insured retention of
$250,000. On November 19, 1997, the insurance carrier sent Horizon/CMS a letter
indicating its belief that certain policy exclusions might apply and requesting
additional information which might affect its coverage determination.
Horizon/CMS has retained separate counsel to analyze the coverage issues and
advise Horizon/CMS on its position, and Horizon/CMS expects to continue to
negotiate any coverage issues with its carrier. Settlement negotiations by
Horizon/CMS's insurance carrier, in conjunction with the Company's retained
counsel, continue with the plaintiff. It is not possible at this time to predict
the outcome of any post-trial motions or appeals, the resolution of any coverage
issues, the outcome of any settlement negotiations or the ultimate amount of any
liability which will be borne by Horizon/CMS.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
21
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock is listed for trading on the New York Stock
Exchange (Symbol: HRC). The following table sets forth for the fiscal periods
indicated the high and low reported sale prices for the Company's Common Stock
as reported on the NYSE Composite Transactions Tape. All prices shown have been
adjusted for a two-for-one stock split effected in the form of a 100% stock
dividend paid on March 17, 1997.
REPORTED
SALE PRICE
-------------------------
HIGH LOW
----------- -----------
1996
First Quarter .......... $ 19.07 $ 13.50
Second Quarter ......... 19.32 16.16
Third Quarter .......... 19.32 14.25
Fourth Quarter ......... 19.88 17.57
1997
First Quarter .......... $ 22.38 $ 17.94
Second Quarter ......... 27.12 17.75
Third Quarter .......... 28.94 23.12
Fourth Quarter ......... 28.31 22.00
- - ----------
The closing price for the Common Stock on the New York Stock Exchange on March
27, 1998, was $27.875.
There were approximately 5,977 holders of record of the Common Stock as of
March 13, 1998, excluding those shares held by depository companies for certain
beneficial owners.
The Company has never paid cash dividends on its Common Stock (although
certain of the companies acquired by the Company in poolings-of-interests
transactions had paid dividends prior to such acquisitions) and does not
anticipate the payment of cash dividends in the foreseeable future. The Company
currently anticipates that any future earnings will be retained to finance the
Company's operations.
RECENT SALES OF UNREGISTERED SECURITIES
On October 23, 1997, the Company issued an aggregate of 984,189 shares of
its Common Stock in connection with its acquisition of National Imaging
Affiliates, Inc. ("NIA"). The shares were issued to 100 persons and entities who
were, immediately prior to such acquisition, stockholders of NIA and were issued
pursuant to the exemptions provided in Section 4(2) of the Securities Act of
1933, as amended, and Rule 506 of Regulation D promulgated thereunder. The
Company believes that such exemptions are available because (a) the transaction
did not involve a public offering, (b) no more than 35 of the former NIA
stockholders were not "accredited investors", as such term is defined in
Regulation D, and (c) the Company otherwise complied with the requirements of
Rule 506. All such shares were registered for resale pursuant to a Registration
Statement on Form S-3 declared effective by the SEC on December 5, 1997.
22
ITEM 6. SELECTED FINANCIAL DATA.
Set forth below is a summary of selected consolidated financial data for
the Company for the years indicated. All amounts have been restated to reflect
the effects of the 1994 acquisition of ReLife, Inc. ("ReLife"), the 1995 SHC and
SSCI acquisitions, the 1996 SCA and Advantage Health acquisitions, and the 1997
Health Images acquisition, each of which was accounted for as a pooling of
interests.
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------
1993 1994 1995 1996 1997
------------- ------------- ------------- ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
INCOME STATEMENT DATA:
Revenues ......................................... $1,055,295 $1,726,321 $2,118,681 $2,568,155 $3,017,269
Operating unit expenses .......................... 715,189 1,207,707 1,441,059 1,667,248 1,888,435
Corporate general and administrative expenses..... 43,378 67,798 65,424 79,354 82,757
Provision for doubtful accounts .................. 22,677 35,740 42,305 58,637 71,468
Depreciation and amortization .................... 75,425 126,148 160,901 207,132 250,010
Merger and acquisition related expenses (1) ...... 333 6,520 19,553 41,515 15,875
Loss on impairment of assets (2) ................. -- 10,500 53,549 37,390 --
Loss on abandonment of computer project .......... -- 4,500 -- -- --
Loss on disposal of surgery centers .............. -- 13,197 -- -- --
NME Selected Hospitals Acquisition
related expense .................................. 49,742 -- -- -- --
Interest expense ................................. 25,884 74,895 105,517 98,751 111,504
Interest income .................................. (6,179) (6,658) (8,009) (6,034) (4,414)
Gain on sale of partnership interest ............. (1,400) -- -- -- --
Gain on sale of MCA Stock ........................ -- (7,727) -- -- --
---------- ---------- ---------- ---------- ----------
925,049 1,532,620 1,880,299 2,183,993 2,415,635
---------- ---------- ---------- ---------- ----------
Income from continuing operations before
income taxes, minority interests and
extraordinary item .............................. 130,246 193,701 238,382 384,162 601,634
Provision for income taxes ....................... 40,450 68,560 86,161 143,929 206,153
---------- ---------- ---------- ---------- ----------
89,796 125,141 152,221 240,233 395,481
Minority interests ............................... 29,549 31,665 43,753 50,369 64,873
---------- ---------- ---------- ---------- ----------
Income from continuing operations before
extraordinary item .............................. 60,247 93,476 108,468 189,864 330,608
Income from discontinued operations .............. 3,986 (6,528) (1,162) -- --
Extraordinary item (2) ........................... -- -- (9,056) -- --
---------- ---------- ---------- ---------- ----------
Net income ...................................... $ 64,233 $ 86,948 $ 98,250 $ 189,864 $ 330,608
========== ========== ========== ========== ==========
Weighted average common shares outstanding
(3)(6) .......................................... 265,502 273,480 289,594 321,367 346,872
========== ========== ========== ========== ==========
Net income per common share: (3)(6)
Continuing operations ........................... $ 0.23 $ 0.34 $ 0.37 $ 0.59 $ 0.95
Discontinued operations ......................... 0.01 (0.02) 0.00 -- --
Extraordinary item .............................. -- -- (0.03) -- --
---------- ---------- ---------- ---------- ----------
$ 0.24 $ 0.32 $ 0.34 $ 0.59 $ 0.95
========== ========== ========== ========== ==========
Weighted average common share outstanding --
assuming dilution(3)(4)(6) ..................... 275,366 300,758 320,018 349,033 365,546
========== ========== ========== ========== ==========
Net income per common share -- assuming
dilution: (3)(4)(6)
Continuing operations ........................... $ 0.22 $ 0.32 $ 0.35 $ 0.55 $ 0.91
Discontinued operations ......................... 0.01 (0.02) 0.00 -- --
Extraordinary item .............................. -- -- (0.03) -- --
---------- ---------- ---------- ---------- ----------
$ 0.23 $ 0.30 $ 0.32 $ 0.55 $ 0.91
========== ========== ========== ========== ==========
23
DECEMBER 31,
-------------------------------------------------------------------------
1993 1994 1995 1996 1997
------------- ------------ ------------ ------------ ------------
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash and marketable securities ......... $ 153,011 $ 134,040 $ 159,793 $ 153,831 $ 152,399
Working capital ........................ 300,876 308,770 406,601 564,529 566,751
Total assets ........................... 2,000,566 2,355,920 3,107,808 3,529,706 5,401,053
Long-term debt (5) ..................... 1,028,610 1,164,135 1,453,018 1,560,143 1,601,824
Stockholders' equity ................... 727,737 837,160 1,269,686 1,569,101 3,157,428
- - ----------
(1) Expenses related to SHC's Ballas Merger in 1993, the ReLife and Heritage
Acquisitions in 1994, the SHC, SSCI and NovaCare Rehabilitation Hospitals
Acquisitions in 1995, the SCA, Advantage Health, PSCM and ReadiCare
Acquisitions in 1996, and the Health Images Acquisition in 1997.
(2) See "Notes to Consolidated Financial Statements".
(3) Adjusted to reflect a two-for-one stock split effected in the form of a 100%
stock dividend paid on April 17, 1995 and a two-for-one stock split effected
in the form of a 100% stock dividend paid on March 17, 1997.
(4) Diluted earnings per share in 1994, 1995, 1996 and 1997 reflect shares
reserved for issuance upon conversion of the Company's 5% Convertible
Subordinated Debentures due 2001. Substantially all of such Debentures were
converted into shares of the Company's Common Stock in 1997.
(5) Includes current portion of long-term debt.
(6) Earnings per share amounts prior to 1997 have been restated as required to
comply with Statement of Financial Accounting Standards No. 128, "Earnings
Per Share". For further discussion, see Note 1 of "Notes to Consolidated
Financial Statements".
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
GENERAL
The following discussion is intended to facilitate the understanding and
assessment of significant changes and trends related to the consolidated results
of operations and financial condition of the Company, including certain factors
related to recent acquisitions by the Company, the timing and nature of which
have significantly affected the Company's consolidated results of operations.
This discussion and analysis should be read in conjunction with the Company's
consolidated financial statements and notes thereto included elsewhere in this
Annual Report on Form 10-K.
The Company completed the following major acquisitions over the last three
years (common share amounts have been adjusted to reflect stock splits effected
in the form of 100% stock dividends paid on April 17, 1995 and March 17, 1997):
o On April 1, 1995, the Company purchased the operations of the
rehabilitation hospital division of NovaCare, Inc. (the "NovaCare
Rehabilitation Hospitals Acquisition"). The purchase price was
approximately $235,000,000. The NovaCare Rehabilitation Hospitals consisted
of 11 rehabilitation hospitals in seven states, 12 other facilities and two
Certificates of Need.
o On June 13, 1995, the Company acquired Surgical Health Corporation (the
"SHC Acquisition"). A total of 17,062,960 shares of the Company's Common
Stock were issued in the transaction, representing a value of $155,000,000
at the time of the acquisition. The Company also purchased SHC's
$75,000,000 aggregate principal amount of 11.5% Senior Subordinated Notes
due 2004 for an aggregate consideration of approximately $86,000,000. At
that time, SHC operated a network of 36 free-standing surgery centers in 11
states, and five mobile lithotripsy units.
o On October 26, 1995, the Company acquired Sutter Surgery Centers, Inc. (the
"SSCI Acquisition"). A total of 3,552,002 shares of the Company's Common
Stock were issued in the transaction, representing a value of $44,444,000
at the time of the acquisition. At that time, SSCI operated a network of 12
freestanding surgery centers in three states.
24
o On December 1, 1995, the Company acquired Caremark Orthopedic Services Inc.
(the "Caremark Acquisition"). The purchase price was approximately
$127,500,000. At that time, Caremark owned and operated approximately 120
outpatient rehabilitation centers in 13 states.
o On January 17, 1996, the Company acquired Surgical Care Affiliates, Inc.
(the "SCA Acquisition"). A total of 91,856,678 shares of the Company's
Common Stock were issued in the transaction, representing a value of
approximately $1,400,000,000 at the time of the acquisition. At that time,
SCA operated a network of 67 freestanding surgery centers in 24 states.
o On March 14, 1996, the Company acquired Advantage Health Corporation (the
"Advantage Health Acquisition"). A total of 18,203,978 shares of the
Company's Common Stock were issued in the transaction, representing a value
of approximately $315,000,000 at the time of the acquisition. At that time,
Advantage Health operated a network of 136 sites of service, including four
freestanding rehabilitation hospitals, one freestanding multi-use hospital,
one nursing home, 68 outpatient rehabilitation facilities, 14 inpatient
managed rehabilitation units, 24 rehabilitation services management
contracts and six managed subacute rehabilitation units, primarily located
in the northern United States.
o On August 20, 1996, the Company acquired Professional Sports Care
Management, Inc. (the "PSCM Acquisition"). A total of 3,622,888 shares of
the Company's Common Stock were issued in the transaction, representing a
value of approximately $59,000,000 at the time of the acquisition. At that
time, PSCM operated a network of 36 outpatient rehabilitation centers in
three states.
o On December 2, 1996, the Company acquired ReadiCare, Inc. (the "ReadiCare
Acquisition"). A total of 4,007,954 shares of the Company's Common Stock
were issued in the transaction, representing a value of approximately
$76,000,000 at the time of the acquisition. At that time, ReadiCare
operated a network of 37 occupational medicine and rehabilitation centers
in two states.
o On March 3, 1997, the Company acquired Health Images, Inc. ("Health
Images"). A total of 10,343,470 shares of the Company's Common Stock were
issued in the transaction, representing a value of approximately
$208,162,000 at the time of the acquisition. At that time, Health Images
operated 49 freestanding diagnostic centers in 13 states and six in the
United Kingdom.