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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998; OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______
Commission File Number 1-10315
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HEALTHSOUTH CORPORATION
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(Exact Name of Registrant as Specified in its Charter)
DELAWARE 63-0860407
- - - --------------------------------- ----------------------------------
(State or Other Jurisdiction (I.R.S. Employer Identification No.)
of Incorporation or Organization)
ONE HEALTHSOUTH PARKWAY
BIRMINGHAM, ALABAMA 35243
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(Address of Principal Executive (Zip Code)
Offices)
Registrant's Telephone Number, Including Area Code: (205) 967-7116
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Securities Registered Pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on which Registered
- - - --------------------------------- --------------------------------
COMMON STOCK, PAR VALUE NEW YORK STOCK EXCHANGE
$.01 PER SHARE
9.5% SENIOR SUBORDINATED NEW YORK STOCK EXCHANGE
NOTES DUE 2001
Securities Registered Pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the Registrant (1) has filed all Reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such Reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
|X|
State the aggregate market value of the voting stock held by
non-affiliates of the Registrant as of March 29, 1999:
Common Stock, par value $.01 per share -- $4,588,651,643
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of the latest practicable date.
Class Outstanding at March 25, 1999
- - - --------------------------- ------------------------------
COMMON STOCK, PAR VALUE
$.01 PER SHARE 415,214,088 SHARES
DOCUMENTS INCORPORATED BY REFERENCE
No documents are incorporated by reference into this Annual Report on Form 10-K.
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PART I
ITEM 1. BUSINESS.
GENERAL
HEALTHSOUTH Corporation ("HEALTHSOUTH" or the "Company") is the
nation's largest provider of outpatient surgery and rehabilitative healthcare
services. The Company provides these services through its national network of
inpatient and outpatient healthcare facilities, including inpatient and
outpatient rehabilitation facilities, outpatient surgery centers, diagnostic
centers, occupational health centers, medical centers and other healthcare
facilities. The Company believes that it provides patients, physicians and
payors with high-quality healthcare services at significantly lower costs than
traditional inpatient hospitals. Additionally, the Company's national network,
reputation for quality and focus on outcomes has enabled it to secure contracts
with national and regional managed care payors. At December 31, 1998, the
Company had nearly 1,900 locations in 50 states, the United Kingdom and
Australia, exclusive of locations being closed, consolidated or held for sale.
See Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations".
The Company's healthcare services are provided through inpatient
healthcare facilities and facilities providing other clinical services
(including inpatient rehabilitation facilities and specialty medical centers ,
as well as certain physician practices and other services) and outpatient
healthcare facilities (including outpatient rehabilitation centers, outpatient
surgery centers, outpatient diagnostic centers and occupational health centers).
In its outpatient and inpatient rehabilitation facilities, the Company provides
interdisciplinary programs for the rehabilitation of patients experiencing
disability due to a wide variety of physical conditions, such as stroke, head
injury, orthopaedic problems, neuromuscular disease and sports-related injuries.
The Company's rehabilitation services include physical therapy, sports medicine,
work hardening, neurorehabilitation, occupational therapy, respiratory therapy,
speech-language pathology and rehabilitation nursing. Independent studies have
shown that rehabilitation services like those provided by the Company can save
money for payors and employers.
A patient referred to one of the Company's rehabilitation facilities
undergoes an initial evaluation and assessment process that results in the
development of a rehabilitation care plan designed specifically for that
patient. Depending upon the patient's disability, this evaluation process may
involve the services of a single discipline, such as physical therapy for a knee
injury, or of multiple disciplines, as in the case of a complicated stroke
patient. HEALTHSOUTH has developed numerous rehabilitation programs, which
include stroke, head injury, spinal cord injury, neuromuscular and work injury,
that combine certain services to address the needs of patients with similar
disabilities. In this way, all of the facilities' patients, regardless of the
severity and complexity of their disabilities, can receive the level and
intensity of those services necessary to restore them to as productive, active
and independent a lifestyle as possible.
In addition to its rehabilitation facilities, the Company operates the
largest network of freestanding outpatient surgery centers in the United States.
The Company's outpatient surgery centers provide the facilities and medical
support staff necessary for physicians to perform non-emergency surgical
procedures. While outpatient surgery is widely recognized as generally less
expensive than surgery performed in a hospital, the Company believes that
outpatient surgery performed at a freestanding outpatient surgery center is
generally less expensive than hospital-based outpatient surgery. Over 80% of the
Company's surgery center facilities are located in markets served by its
rehabilitative service facilities, enabling the Company to pursue opportunities
for cross-referrals.
The Company is also among the largest operators of outpatient
diagnostic centers and occupational health centers in the United States. Most of
the Company's diagnostic centers and occupational health centers operate in
markets where the Company also provides rehabilitative healthcare and outpatient
surgery services. The Company believes that its ability to offer a comprehensive
range of healthcare services in a particular geographic market makes the Company
more attractive to both patients and payors in such market. The Company focuses
on marketing its services in an integrated system to patients and payors in such
geographic markets.
Over the last four years, the Company has completed several significant
acquisitions in both inpatient and outpatient rehabilitation services and has
expanded into the outpatient surgery center, diagnostic and occupational health
businesses. The Company believes that these acquisitions complement its
historical operations and enhance its market position. The Company further
believes that its expansion into the outpatient surgery,
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diagnostic and occupational health businesses provides it with platforms for
future growth. The Company is continually evaluating potential acquisitions that
complement its existing operations.
The Company was organized as a Delaware corporation in February 1984.
The Company's principal executive offices are located at One HealthSouth
Parkway, Birmingham, Alabama 35243, and its telephone number is (205) 967-7116.
COMPANY STRATEGY
The Company's principal objective is to be the provider of choice
throughout the United States for patients, physicians and payors alike for the
outpatient and inpatient and other clinical healthcare services that it
provides. The Company's growth strategy is based upon four primary elements: (i)
the implementation of the Company's integrated service model in appropriate
markets, (ii) successful marketing to managed care organizations and other
payors, (iii) the provision of high-quality, cost-effective healthcare services,
and (iv) the expansion of its national network.
o Integrated Service Model. The Company seeks, where appropriate, to
provide an integrated system of healthcare services, including
outpatient rehabilitation services, inpatient rehabilitation and other
clinical services, outpatient surgery services and outpatient
diagnostic services. The Company believes that its integrated system
offers payors the convenience of dealing with a single provider for
multiple services. Additionally, it believes that its facilities can
provide extensive cross-referral opportunities. For example, the
Company estimates that approximately one-third of its outpatient
rehabilitation patients have had outpatient surgery, virtually all
inpatient rehabilitation patients will require some form of outpatient
rehabilitation, and virtually all inpatient rehabilitation patients
have had some type of diagnostic procedure. The Company has implemented
its Integrated Service Model in certain of its markets, and intends as
its long-term goal to expand the model into the 300 leading markets in
the United States.
o Marketing to Managed Care Organizations and Other Payors. Since the
late 1980s, the Company has focused on the development of contractual
relationships with managed care organizations, major insurance
companies, large regional and national employer groups and provider
alliances and networks. The Company's documented outcomes and
experience with several hundred thousand patients in delivering quality
healthcare services at reasonable prices has enhanced its
attractiveness to such entities and has given the Company a competitive
advantage over smaller and regional competitors. These relationships
have increased patient flow to the Company's facilities and contributed
to the Company's same-store growth. These relationships also expose the
Company to pressure from payors to limit pricing for the Company's
services, and the Company endeavors to manage and monitor such
relationships in an effort to ensure both competitive pricing and
patient volumes for its facilities.
o Cost-Effective Services. The Company's goal is to provide high-quality
healthcare services in cost-effective settings. To that end, the
Company has developed standardized clinical protocols for the treatment
of its patients. This results in "best practices" techniques being
utilized at all of the Company's facilities, allowing the consistent
achievement of demonstrable, cost-effective clinical outcomes. The
Company's reputation for its clinical programs is enhanced through its
relationships with major universities throughout the nation, and its
support of clinical research in its facilities. Further, independent
studies estimate that, for every dollar spent on rehabilitation, $11 to
$35 is saved. Finally, surgical procedures typically are less expensive
in outpatient surgery centers than in hospital settings. The Company
believes that outpatient and rehabilitative healthcare services will
assume increasing importance in the healthcare environment as payors
continue to seek to reduce overall costs by shifting patients to more
cost-effective treatment settings.
o Expansion of National Network. As one of the largest providers of
healthcare services in the United States, the Company is able to
realize economies of scale and compete successfully for national
contracts with large payors and employers while retaining the
flexibility to respond to particular needs of local markets. The
national network affords the Company the opportunity to offer large
national and regional employers and payors the convenience of dealing
with a single provider, to utilize greater buying power through
centralized purchasing, to achieve more efficient costs of capital and
labor and to more effectively recruit and retain clinicians. These
national benefits are realized without sacrificing local market
responsiveness. The Company's objective is to provide those outpatient
and rehabilitative healthcare services needed within each local market
by tailoring its services and facilities to that market's needs, thus
bringing the benefits of nationally recognized expertise and quality
into the local setting.
3
RISK FACTORS
HEALTHSOUTH's business, operations and financial condition are subject
to certain risks. Some of these risks are described below, and readers of this
Annual Report on Form 10-K should take such risks into account in evaluating
HEALTHSOUTH or any investment decision involving HEALTHSOUTH. This section does
not describe all risks applicable to HEALTHSOUTH, and it is intended only as a
summary of certain material factors. More detailed information concerning the
factors described below is contained in other sections of this Annual Report on
Form 10-K.
HEALTHSOUTH Depends Upon Reimbursement by Third-Party Payors.
Substantially all of HEALTHSOUTH's revenues are derived from private and
governmental third-party payors (in 1998, approximately 35.9% from Medicare and
approximately 64.1% from commercial insurers, managed care plans, workers'
compensation payors and other private pay revenue sources). There are increasing
pressures from many payor sources to control healthcare costs and to reduce or
limit increases in reimbursement rates for medical services. There can be no
assurances that payments from government or private payors will remain at levels
comparable to present levels. In attempts to limit the federal budget deficit,
there have been, and HEALTHSOUTH expects that there will continue to be, a
number of proposals to limit Medicare reimbursement for certain services.
HEALTHSOUTH cannot now predict whether any of these pending proposals will be
adopted or what effect the adoption of such proposals would have on HEALTHSOUTH.
HEALTHSOUTH's Operations Are Subject to Extensive Regulation.
HEALTHSOUTH is subject to various other types of regulation by federal and state
governments, including licensure and certification laws, Certificate of Need
laws and laws relating to financial relationships among providers of healthcare
services, Medicare fraud and abuse and physician self-referral.
The operation of HEALTHSOUTH's facilities and the provision of
healthcare services are subject to federal, state and local licensure and
certification laws. These facilities and services are subject to periodic
inspection by governmental and other authorities to assure compliance with the
various standards established for continued licensure under state law,
certification under the Medicare and Medicaid programs and participation in the
Veteran's Administration program. Additionally, in many states, Certificates of
Need or other similar approvals are required for expansion of HEALTHSOUTH's
operations. HEALTHSOUTH could be adversely affected if it cannot obtain such
approvals, by changes in the standards applicable to approvals and by possible
delays and expenses associated with obtaining approvals. HEALTHSOUTH's failure
to obtain, retain or renew any required regulatory approvals, licenses or
certificates could prevent HEALTHSOUTH from being reimbursed for its services or
from offering some of its services, or could adversely affect its results of
operations.
A wide array of Medicare/Medicaid fraud and abuse provisions apply to
the operations of HEALTHSOUTH. HEALTHSOUTH is subject to extensive federal and
state regulation with respect to financial relationships among healthcare
providers, physician self-referral arrangements and other fraud and abuse
issues. Penalties for violation of federal and state laws and regulation include
exclusion from participation in the Medicare/Medicaid programs, asset
forfeiture, civil penalties and criminal penalties. The Office of Inspector
General of the Department of Health and Human Services, the Department of
Justice and other federal agencies interpret healthcare fraud and abuse
provisions liberally and enforce them aggressively.
Healthcare Reform Legislation May Affect HEALTHSOUTH's Business. In
recent years, many legislative proposals have been introduced or proposed in
Congress and in some state legislatures that would effect major changes in the
healthcare system, either nationally or at the state level. Among the proposals
which are currently being, or which recently have been, considered are cost
controls on hospitals, insurance market reforms to increase the availability of
group health insurance to small businesses, requirements that all businesses
offer health insurance coverage to their employees and the creation of a single
government health insurance plan that would cover all citizens. The costs of
certain proposals would be funded in significant part by reductions in payment
by governmental programs, including Medicare and Medicaid, to healthcare
providers. There continue to be federal and state proposals that would, and
actions that do, impose more limitations on government and private payments to
healthcare providers such as HEALTHSOUTH and proposals to increase copayments
and deductibles from programs and private patients. At the federal level, both
Congress and the current Administration have continued to propose healthcare
budgets that substantially reduce payments under the Medicare and Medicaid
programs. In addition, many states are considering the enactment of initiatives
designed to reduce their Medicaid expenditures, to provide universal coverage or
additional levels of care and/or to impose additional taxes on healthcare
providers to help finance or expend the states' Medicaid systems. There can be
no assurance as to the ultimate content, timing or effect of any healthcare
reform legislation, nor is it possible at this time to estimate the impact of
potential legislation, which may be material, on HEALTHSOUTH.
4
HEALTHSOUTH Must Successfully Meet Year 2000 Compliance Risks.
HEALTHSOUTH is aware of the issues associated with the programming code in
existing computer systems as the year 2000 approaches. Many existing computer
programs use only two digits to identify a year in the date field. The issue is
whether such code exists in HEALTHSOUTH's mission-critical applications and if
that code will produce accurate information to date-sensitive calculations after
the turn of the century. As described under Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations", HEALTHSOUTH has
undertaken assessment activities to attempt to determine its year 2000
compliance status.
In that connection, it should be noted that substantially all of
HEALTHSOUTH's revenues are derived from reimbursement by governmental and
private third-party payors, and that HEALTHSOUTH is dependent upon such payors'
evaluation of their year 2000 compliance status to assess such risks. If such
payors are incorrect in their evaluation of their own year 2000 compliance
status, this could result in delays or errors in reimbursement to HEALTHSOUTH,
the effects of which could be material to HEALTHSOUTH.
Based on the information currently available, HEALTHSOUTH believes that
its risk associated with problems arising from year 2000 issues is not
significant. However, because of the many uncertainties associated with year
2000 compliance issues, and because HEALTHSOUTH's assessment is necessarily
based on information from third-party vendors, payors and suppliers, there can
be no assurance that HEALTHSOUTH's assessment is correct. HEALTHSOUTH will
continue with the assessment process described elsewhere in this Annual Report
on Form 10-K and, to the extent that changes in such assessment require it, will
attempt to develop alternatives or modifications to its compliance plan. There
can, however, be no assurance that such compliance plan, as it may be changed,
augmented or modified from time to time, will be successful.
HEALTHSOUTH Faces National, Regional and Local Competition. HEALTHSOUTH
operates in a highly competitive industry. HEALTHSOUTH generally operates its
facilities in communities that also are served by similar facilities operated by
its competitors. Although HEALTHSOUTH is the largest provider of its range of
inpatient and outpatient healthcare services on a nationwide basis, in any
particular market it may encounter competition from local or national entities
with longer operating histories or other superior competitive advantages. There
can be no assurance that such competition, or other competition which
HEALTHSOUTH may encounter in the future, will not adversely affect HEALTHSOUTH's
results of operations.
HEALTHSOUTH Is Subject to Material Litigation. HEALTHSOUTH is, and may
in the future be, subject to litigation which, if determined adversely to
HEALTHSOUTH, could have a material adverse affect on HEALTHSOUTH. In addition,
some of the companies and businesses acquired by HEALTHSOUTH have been subject
to such litigation. While HEALTHSOUTH attempts to conduct its operations in such
a way as to reduce the risk that adverse results in litigation could have a
material adverse affect on HEALTHSOUTH, there can be no assurance that pending
or future litigation, whether or not described in this Annual Report on Form
10-K, will not have such a material adverse affect. See Item 3, "Legal
Proceedings".
HEALTHSOUTH's Stock Price May Be Volatile. Healthcare stocks in
general, including HEALTHSOUTH's common stock, are subject to frequent changes
in stock price and trading volume, some of which may be large. These changes may
be influenced by the market's perceptions of the healthcare sector in general,
of other companies believed to be similar to HEALTHSOUTH, or of HEALTHSOUTH's
results of operations and future prospects. In addition, these perceptions may
be greatly affected not only by information provided by HEALTHSOUTH but also by
opinions and reports created by investment analysts and other third parties
which do not necessarily reflect information provided by HEALTHSOUTH. Adverse
movement in the Company's stock price, particularly as a result of factors over
which it has no control, may adversely affect the Company's access to capital
and the ability to consummate acquisitions using its stock.
GROWTH THROUGH ACQUISITIONS AND RELATED DIVESTITURES
Beginning in 1994, the Company has consummated a series of significant
acquisitions. The following paragraphs describe certain of such acquisitions
consummated during the period covered by the consolidated financial statements
contained in this Annual Report on Form 10-K, as well as related divestitures
and facility closings and consolidations in connection with the Company's
strategic plan.
During 1996, the Company acquired Surgical Care Affiliates, Inc.
("SCA"; 67 outpatient surgery centers in 24 states), Advantage Health
Corporation ("Advantage Health"; approximately 136 inpatient and outpatient
rehabilitation facilities in 11 states), Professional Sports Care
5
Management, Inc. ("PSCM"; 36 outpatient rehabilitation facilities in New York,
New Jersey and Connecticut) and ReadiCare, Inc. ("ReadiCare"; 37 occupational
health centers in California and Washington) in pooling-of-interests
transactions. During 1997, the Company acquired Health Images, Inc. ("Health
Images"; 55 diagnostic imaging centers in 13 states and the United Kingdom), ASC
Network Corporation ("ASC"; 29 surgery centers in eight states), Horizon/CMS
Healthcare Corporation ("Horizon/CMS"; 30 inpatient rehabilitation facilities
and approximately 275 outpatient rehabilitation centers in 24 states) and
National Imaging Affiliates, Inc. ("NIA"; eight diagnostic imaging centers in
six states). On December 31, 1997, the Company sold the long-term care assets of
Horizon/CMS, consisting of 139 long-term care facilities, 12 specialty
hospitals, 35 institutional pharmacy locations and over 1,000 rehabilitation
therapy contracts with long-term care facilities, to Integrated Health Services,
Inc. ("IHS"). During 1998, the Company acquired National Surgery Centers, Inc.
("NSC"; 40 surgery centers in 14 states), as well as 34 surgery centers
(including centers under management arrangements) from Columbia/HCA Healthcare
Corporation ("Columbia/HCA"). These transactions, along with the Company's other
significant acquisitions since 1993, have further enhanced the Company's
position as the nation's largest provider of inpatient and outpatient
rehabilitative services and outpatient surgery services and its position as one
of the largest providers of occupational health and diagnostic imaging services.
The Company believes that the geographic dispersion of the nearly 1,900
locations now operated by the Company makes it more attractive to managed care
networks, major insurance companies, regional and national employers and
regional provider alliances and enhances the Company's ability to implement its
Integrated Service Model in additional markets.
In the course of its major acquisitions, the Company has from time to
time acquired ancillary businesses, such as healthcare staffing and home health
services, which are not part of the Company's strategic lines of business, and
has also acquired facilities which are duplicative of certain existing
facilities or which do not meet the Company's operating and performance
standards. Accordingly, the Company has from time to time determined to sell,
close or consolidate certain acquired facilities and businesses in order to
focus its resources on those facilities and businesses which are most consistent
with its strategic plan and core operations. The most significant divestiture by
the Company was its divestiture of the long-term care assets of Horizon/CMS to
IHS in 1997, described above. In addition, in the third quarter of 1998, the
Company adopted a plan to close substantially all of its home health operations,
which had been obtained as minor components of larger strategic acquisitions,
and in the fourth quarter of 1998 the Company adopted a plan to close,
consolidate or hold for sale certain other non-strategic businesses and
duplicative facilities, as well as facilities which the Company had determined
could not be brought up to the Company's operating and performance standards
without undue expenditure of resources. Unless the context otherwise indicates,
descriptions of the Company's patient care services locations in this Annual
Report on Form 10-K do not include those facilities which, as of December 31,
1998, had been or were being closed, consolidated or sold.
See Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" for additional information concerning the
Company's acquisitions, divestitures and plans with respect to facility closings
and consolidations.
INDUSTRY BACKGROUND
In 1996, there were an estimated 3,500,000 inpatient hospital
discharges in the United States involving impairments requiring rehabilitative
healthcare services. "Rehabilitative healthcare services" refers to the range of
skilled services provided to individuals in order to minimize physical and
cognitive impairments, maximize functional ability and restore lost functional
capacity. The focus of rehabilitative healthcare is to ameliorate physical and
cognitive impairments resulting from illness or injury, and to restore or
improve functional ability so that individuals can return to work and lead
independent and fulfilling lives. Typically, rehabilitative healthcare services
are provided by a variety of healthcare professionals including physiatrists,
rehabilitation nurses, physical therapists, occupational therapists,
speech-language pathologists, respiratory therapists, recreation therapists,
social workers, psychologists, rehabilitation counselors and others. Over 80% of
those receiving rehabilitative healthcare services return to their homes, work,
schools or active retirement.
Demand for rehabilitative healthcare services continues to be driven by
advances in medical technologies, an aging population and the recognition on the
part of the payor community (insurers, self-insured companies, managed care
organizations and federal, state and local governments) that appropriately
administered rehabilitative services can improve quality of life as well as
lower overall healthcare costs. Studies conducted by insurance companies
demonstrate the ability of rehabilitation to significantly reduce the cost of
future care. Estimates of the savings range from $11 to $35 per dollar spent on
rehabilitation. Further, reimbursement changes have encouraged the rapid
discharge of patients from acute-care hospitals while they remain in need of
rehabilitative healthcare services.
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The Company also believes that there is a growing trend toward the
provision of other healthcare services on an outpatient basis, fueled by
advances in technology, demands for cost-effective care and concerns for patient
comfort and convenience. An industry study indicates that there was a 75%
increase in the number of treatments in all ambulatory settings from 1986 to
1996, with over 70% of the total number of surgeries in the United States
currently being performed on an outpatient basis. The Company believes that
these trends will continue to foster demand for the delivery of healthcare
services on an outpatient basis.
PATIENT CARE SERVICES
The Company began its operations in 1984 with a focus on providing
comprehensive orthopaedic and musculoskeletal rehabilitation services on an
outpatient basis. Over the succeeding 14 years, the Company has consistently
sought and implemented opportunities to expand its services through acquisitions
and de novo development activities that complement its historic focus on
orthopaedic, sports medicine and occupational health services and that provide
independent platforms for growth. The Company's acquisitions and internal growth
have enabled it to become one of the largest providers of healthcare services in
the United States. The following sections discuss the range of services offered
by the Company in its inpatient and other clinical services and outpatient
services business segments.
Inpatient and Other Clinical Services
The Company's inpatient and other clinical services business segment
includes the operations of its inpatient rehabilitation facilities and medical
centers, as well as the operations of certain physician practices and other
clinical services which are managerially aligned with the Company's inpatient
services.
INPATIENT REHABILITATION FACILITIES. At December 31, 1998, the Company
operated 124 inpatient rehabilitation facilities with 7,690 beds in the United
States, representing the largest group of affiliated proprietary inpatient
rehabilitation facilities in the nation, as well as a 71-bed rehabilitation
hospital in Australia. The Company's inpatient rehabilitation facilities provide
high-quality comprehensive services to patients who require intensive
institutional rehabilitation care.
Inpatient rehabilitation patients are typically those who are
experiencing significant physical disabilities due to various conditions, such
as head injury, spinal cord injury, stroke, certain orthopaedic problems and
neuromuscular disease. The Company's inpatient rehabilitation facilities provide
the medical, nursing, therapy and ancillary services required to comply with
local, state and federal regulations as well as accreditation standards of the
Joint Commission on Accreditation of Healthcare Organizations (the "JCAHO") and
the Commission on Accreditation of Rehabilitation Facilities ("CARF").
All of the Company's inpatient rehabilitation facilities utilize an
interdisciplinary team approach to the rehabilitation process and involve the
patient and family, as well as the payor, in the determination of the goals for
the patient. Internal case managers monitor each patient's progress and provide
documentation of patient status, achievement of goals, functional outcomes and
efficiency.
In certain markets the Company's rehabilitation hospitals may provide
outpatient rehabilitation services as a complement to their inpatient services.
Typically, this opportunity arises when patients complete their inpatient course
of treatment but remain in need of additional therapy that can be accomplished
on an outpatient basis. Depending upon the demand for outpatient services and
physical space constraints, the rehabilitation hospital may establish the
services either within its building or in a satellite location. In either case,
the clinical protocols and programs developed for use in the freestanding
outpatient centers are utilized by these facilities.
A number of the Company's rehabilitation hospitals were developed in
conjunction with local tertiary-care facilities, including major teaching
hospitals such as those at Vanderbilt University, the University of Missouri and
the University of Virginia. This strategy of developing effective referral and
service networks prior to opening results in improved operating efficiencies for
the new facilities and provides a more coordinated continuum of care for the
constituencies served by the tertiary-care facilities. In addition to those
facilities so developed by the Company, the Company has entered into or is
pursuing similar affiliations with a number of its rehabilitation hospitals
which were obtained through the Company's major acquisitions.
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MEDICAL CENTERS. At December 31, 1998, the Company operated four
medical centers with 810 licensed beds in four distinct markets. These
facilities provide general and specialty medical and surgical healthcare
services, emphasizing orthopaedics, sports medicine and rehabilitation.
The Company acquired its medical centers as outgrowths of its
rehabilitative healthcare services. Often, patients require medical and surgical
interventions prior to the initiation of their rehabilitative care. In each of
the markets in which the Company has acquired a medical center, the Company had
well-established relationships with the medical communities serving each
facility. In addition, each of the facilities enjoyed well-established
reputations in orthopaedics and/or sports medicine prior to their acquisition by
the Company. Following the acquisition of each of its medical centers, the
Company has provided the resources to improve upon the physical plant and expand
services through the introduction of new technology. The Company has also
developed additional relationships between these facilities and certain
university facilities, including the University of Miami, Auburn University and
the University of Alabama at Birmingham. Through these relationships, the influx
of celebrity athletes and personalities and the acquisition of new technology,
all of the Company's medical centers have improved their operating efficiencies
and enhanced census.
Each of the Company's medical center facilities is licensed as an
acute-care hospital, is accredited by the JCAHO and participates in the Medicare
prospective payment system. See this Item, "Business -- Regulation".
In measuring patient utilization of the Company's inpatient facilities,
various factors must be considered. Due to market demand, demographics, start-up
status, renovation, patient mix and other factors, the Company may not treat all
licensed beds in a particular facility as available beds, which sometimes
results in a material variance between licensed beds and beds actually available
for utilization at any specific time. The Company is in a position to increase
the number of available beds at such facilities as market conditions dictate.
During the year ended December 31, 1998, the Company's inpatient facilities
achieved an overall utilization, based on patient days and available beds, of
76.25%.
Outpatient Services
The Company's outpatient services business segment includes the
Company's outpatient rehabilitation facilities, its outpatient surgery centers,
its outpatient diagnostic centers and its occupational health centers.
OUTPATIENT REHABILITATION SERVICES. The Company operates the largest
group of affiliated proprietary outpatient rehabilitation facilities in the
United States. The Company's outpatient rehabilitation centers offer a
comprehensive range of rehabilitative healthcare services, including physical
therapy and occupational therapy, that are tailored to the individual patient's
needs, focusing predominantly on orthopaedic injuries, sports injuries, work
injuries, hand and upper extremity injuries, back injuries, and various
neurological/neuromuscular conditions. As of December 31, 1998, the Company
provided outpatient rehabilitative healthcare services through approximately
1,187 outpatient locations, including freestanding outpatient centers and their
satellites, outpatient satellites of inpatient facilities and outpatient
facilities managed under contract.
Continuing emphasis on containing increases in healthcare costs, as
evidenced by Medicare's prospective payment system, the growth in managed care
and the various alternative healthcare reform proposals, has resulted in earlier
discharge of patients from acute-care facilities. As a result, many hospital
patients do not receive the intensity of services that may be necessary for them
to achieve a full recovery from their diseases, disorders or traumatic
conditions. The Company's outpatient rehabilitation services play a significant
role in the continuum of care because they provide hospital-level services, in
terms of intensity, quality and frequency, in a more cost-efficient setting.
Patients treated at the Company's outpatient centers will undergo
varying courses of therapy depending upon their individual needs. Some patients
may only require a few hours of therapy per week for a few weeks, while others
may spend up to five hours per day in therapy for six months or more, depending
on the nature, severity and complexity of their injuries.
In general, the Company initially establishes an outpatient center in a
given market, either by acquiring an existing private therapy practice or
through de novo development, and institutes its clinical protocols and programs
in response to the community's general need for services. The Company will then
establish satellite clinics that are dependent upon the main facility for
management and administrative services.
8
These satellite clinics generally provide a specific evaluative or specialty
service/program, such as hand therapy or foot and ankle therapy, in response to
specific market demands.
Patient utilization of the Company's outpatient rehabilitation
facilities cannot be measured in the conventional manner applied to acute- care
hospitals, nursing homes and other healthcare providers which have a fixed
number of licensed beds and serve patients on a 24-hour basis. Utilization
patterns in outpatient rehabilitation facilities will be affected by the market
to be served, the types of injuries treated, the patient mix and the number of
available therapists, among other factors. Moreover, because of variations in
size, location, hours of operation, referring physician base and services
provided and other differences among each of the Company's outpatient
facilities, it is not possible to accurately assess patient utilization against
a norm.
SURGERY CENTERS. The Company is currently the largest operator of
outpatient surgery centers in the United States. At December 31, 1998, it
operated 221 freestanding surgery centers, including eight mobile lithotripsy
units, in 41 states. Over 80% of these facilities are located in markets served
by the Company's rehabilitation facilities, enabling the Company to pursue
opportunities for cross-referrals between surgery and rehabilitation facilities
as well as to centralize administrative functions. The Company's surgery centers
provide the facilities and medical support staff necessary for physicians to
perform non-emergency surgical procedures. Its typical surgery center is a
freestanding facility with three to six fully equipped operating and procedure
rooms and ancillary areas for reception, preparation, recovery and
administration. Each of the Company's surgery centers is available for use only
by licensed physicians, oral surgeons and podiatrists, and the centers do not
perform surgery on an emergency basis.
Outpatient surgery centers, unlike hospitals, have not historically
provided overnight accommodations, food services or other ancillary services.
Over the past several years, states have increasingly permitted the use of
extended-stay recovery facilities by outpatient surgery centers. As a result,
many outpatient surgery centers are adding extended recovery care capabilities
where permitted. Most of the Company's surgery centers currently provide for
extended recovery stays. The Company's ability to develop such recovery care
facilities is dependent upon state regulatory environments in the particular
states where its centers are located.
The Company's outpatient surgery centers implement quality control
procedures to evaluate the level of care provided at the centers. Each center
has a medical advisory committee of three to ten physicians which reviews the
professional credentials of physicians applying for medical staff privileges at
the center.
DIAGNOSTIC CENTERS. At December 31, 1998, the Company operated 118
diagnostic centers in 25 states and the United Kingdom. These centers provide
outpatient diagnostic imaging services, including magnetic resonance imaging
("MRI"), computerized tomography ("CT") services, X-ray services, ultrasound
services, mammography services, nuclear medicine services and fluoroscopy. Not
all services are provided at all sites; however, most of the Company's
diagnostic centers are multi-modality centers.
The Company's diagnostic centers provide outpatient diagnostic
procedures performed by experienced radiological technicians. After the
diagnostic procedure is completed, the images are reviewed by radiologists who
have contracted with the Company. Such radiologists prepare a report of the test
and their findings, which are then delivered to the referring physician. The
Company's diagnostic centers are open at such hours as are appropriate for the
local medical community.
Because many patients at the Company's rehabilitative healthcare and
outpatient surgery facilities require diagnostic procedures of the type
performed at the Company's diagnostic centers, the Company believes that its
diagnostic operations are a natural complement to its other services and enhance
its ability to market those services to patients and payors.
OCCUPATIONAL HEALTH SERVICES. At December 31, 1998, the Company
operated 119 occupational health centers in 28 states. These centers provide
cost-effective, outpatient primary medical care and rehabilitation services to
individuals for the treatment of work-related medical problems.
The Company's occupational health centers market their services to
large and small employers, workers' compensation and health insurers and managed
care organizations. The services provided at the Company's occupational health
centers include outpatient primary medical care for work-related injuries and
illnesses, work-related physical examinations, physical therapy services and
workers' compensation medical services, as well as other services primarily
aimed at work-related injuries or illnesses. Medical services at the centers are
provided by licensed
9
physicians who are employed by or under contract with the Company or affiliated
medical practices. These centers also employ nurses, therapists and other
licensed professional staff as necessary for the services provided. The Company
believes that occupational health primary care services are a strategic
component of its business, and that the physicians in its occupational health
centers can, in many cases, serve as "gatekeepers" providing access to the other
services offered by the Company.
Other Patient Care Services
In certain of its markets, the Company provides other patient care
services, including physician services and contract management of hospital-based
rehabilitative healthcare services. The Company evaluates market opportunities
on a case-by-case basis in determining whether to provide additional services of
these types, which may be complementary to facility-based services provided by
the Company or stand-alone businesses. These services are included within the
business segment of the Company with which they are most closely aligned in the
particular local market.
MARKETING OF FACILITIES AND SERVICES
The Company markets its facilities, and their services and programs, on
local, regional and national levels. Local and regional marketing activities are
typically coordinated by local or area-based marketing personnel, whereas
large-scale regional and national efforts are coordinated by corporate-based
personnel. In Integrated Service Model markets, area marketing activities are
coordinated by an ISM Advisory Committee reflecting the Company's range of
services in each market.
In general, the Company develops a marketing plan for each facility
based on a variety of factors, including population characteristics, physician
characteristics and incidence of disability statistics, in order to identify
specific service opportunities. Facility-oriented marketing programs are focused
on increasing the volume of patient referrals to the specific facility and
involve the development of ongoing relationships with area schools, businesses
and industries as well as physicians, health maintenance organizations and
preferred provider organizations.
The Company's larger-scale marketing activities are focused more
broadly on efforts to generate patient referrals to multiple facilities and the
creation of new business opportunities. Such activities include the development
and maintenance of contractual relationships or national pricing agreements with
large third-party payors, such as CIGNA, United Healthcare or other national
insurance companies, with national HMO/PPO companies, such as First Health,
Hospital Network of America and Multiplan, with national case management
companies, such as INTRACORP and Crawford & Co., and with national employers,
such as Wal-Mart, Georgia-Pacific Corporation, Federated Department Stores,
Goodyear Tire & Rubber and Winn-Dixie. In addition, since many of the facilities
acquired by the Company during the past four years had very limited contractual
relationships with payors, managed care providers, employers and others, the
Company is expanding its existing payor relationships to include these
facilities.
The Company carries out broader programs designed to further enhance
its name recognition and association with amateur and professional athletics.
Among these is the HEALTHSOUTH Sports Medicine Council, headed by Bo Jackson and
involving other well-known professional and amateur athletes and sports medicine
specialists, which is dedicated to developing educational programs focused on
athletics for use in high schools. The Company has ongoing relationships with
the Professional Golfers Association, the Senior Professional Golfers
Association, the Ladies Professional Golf Association, the Southeastern
Conference, the U.S. Decathlon Team, USA Hockey, USA Wrestling, USA Volleyball
and more than 125 universities and colleges and 2,000 high schools to provide
sports medicine coverage of events and rehabilitative healthcare services for
injured athletes. In addition, the Company has established relationships with or
provided treatment services for athletes from some 40-50 professional sports
teams, as well as providing sports medicine services for Olympic and amateur
athletes. In 1996, the Company and the United States Olympic Committee
established the Richard M. Scrushy/HEALTHSOUTH Sports Medicine and Sport Science
Center at the USOC's Colorado Springs campus.
The Company is a national sponsor of the United Cerebral Palsy
Association and the National Arthritis Foundation and supports many other
charitable organizations on national and local levels. Through these endeavors,
the Company and its employees are able to support charitable organizations and
activities within their communities.
10
SOURCES OF REVENUES
Private pay revenue sources represent the majority of the Company's
revenues. The following table sets forth the percentages of the Company's
revenues from various sources for the periods indicated:
YEAR ENDED YEAR ENDED
SOURCE DECEMBER 31, 1997 DECEMBER 31, 1998
- - - --------------------------- ----------------- -----------------
Medicare ....................................................36.9% 35.9%
Commercial (1)......................................................35.1 37.0
Workers' Compensation...............................................11.1 10.8
All Other Payors (2)................................................16.9 16.3
---- ----
100.0% 100.0%
===== =====
- - - -----------
(1) Includes commercial insurance, HMOs, PPOs and other managed care plans.
(2) Medicaid is included in this category, but is insignificant in amount.
The above table does not reflect the NSC facilities for periods or
portions thereof prior to the effective date of the NSC acquisition. Comparable
information for those facilities is not available.
See this Item "Business -- Regulation -- Medicare Participation and
Reimbursement" for a description of certain of the reimbursement regulations
applicable to the Company's facilities.
COMPETITION
The Company's rehabilitation facilities compete on a regional and
national basis with other providers of specialized services such as sports
medicine and work hardening, and specific concentrations such as head injury
rehabilitation and orthopaedic surgery. The competition faced in each of these
markets is similar, with variations arising from the number of healthcare
providers in the given metropolitan area. The primary competitive factors in the
Company's rehabilitation components of the Company's inpatient and outpatient
business segments are quality of services, projected patient outcomes, charges
for services, responsiveness to the needs of the patients, community and
physicians, and ability to tailor programs and services to meet specific needs
of the patients. Competitors and potential competitors include hospitals,
private practice therapists, rehabilitation agencies and others. Some of these
competitors may have greater patient referral support and financial and
personnel resources in particular markets than the Company. Management believes
that the Company competes successfully within the marketplace based upon its
reputation for quality, competitive prices, positive rehabilitation outcomes,
innovative programs, clean and bright facilities and responsiveness to needs.
The Company's surgery centers compete primarily with hospitals and
other operators of freestanding surgery centers in attracting physicians and
patients and in developing new centers and in acquiring existing centers. The
primary competitive factors in the outpatient surgery business are convenience,
cost, quality of service, physician loyalty and reputation. Hospitals have many
competitive advantages in attracting physicians and patients, including
established standing in a community, historical physician loyalty and
convenience for physicians making rounds or performing inpatient surgery in the
hospital. However, the Company believes that its national market system and its
historical presence in certain of the markets where its surgery centers are
located will enhance the Company's ability to operate these facilities
successfully.
The Company's diagnostic centers compete with local hospitals, other
multi-center imaging companies, local independent diagnostic centers and imaging
centers owned by local physician groups. The Company believes that the principal
competitive factors in the diagnostic services are price, quality of service,
ability to establish and maintain relationships with managed care payors and
referring physicians, reputation of interpreting physicians, facility location
and convenience of scheduling. Management believes that the Company's diagnostic
facilities compete successfully within their respective markets, taking into
account these factors.
11
The Company's medical centers are located in four urban areas of the
country, all with well established healthcare services provided by a number of
proprietary, not-for-profit, and municipal hospital facilities. The Company's
facilities compete directly with these local hospitals as well as various
nationally recognized centers of excellence in orthopaedics, sports medicine and
other specialties. Because the Company's facilities enjoy a national and
international reputation for orthopaedic surgery and sports medicine, the
Company believes that its medical centers' level of service and continuum of
care enable them to compete successfully, both locally and nationally.
The Company potentially faces competition any time it initiates a
Certificate of Need ("CON") project or seeks to acquire an existing facility or
CON. See this Item, "Business -- Regulation". This competition may arise either
from competing national or regional companies or from local hospitals or other
providers which file competing applications or oppose the proposed CON project.
The necessity for these approvals serves as a barrier to entry and has the
potential to limit competition by creating a franchise to provide services to a
given area. The Company has generally been successful in obtaining CONs or
similar approvals when required, although there can be no assurance that it will
achieve similar success in the future.
REGULATION
The healthcare industry is subject to regulation by federal, state and
local governments. The various levels of regulatory activity affect the
Company's business activities by controlling its growth, requiring licensure or
certification of its facilities, regulating the use of its properties and
controlling the reimbursement to the Company for services provided.
Licensure, Certification and Certificate of Need Regulations
Capital expenditures for the construction of new facilities, the
addition of beds or the acquisition of existing facilities may be reviewable by
state regulators under a statutory scheme which is sometimes referred to as a
CON program. States with CON programs place limits on the construction and
acquisition of healthcare facilities and the expansion of existing facilities
and services. In such states, approvals are required for capital expenditures
exceeding certain amounts which involve inpatient rehabilitation facilities or
services or outpatient surgery centers. Outpatient rehabilitation, occupational
health and diagnostic facilities and services do not require such approvals in a
majority of states.
State CON statutes generally provide that, prior to the addition of new
beds, the construction of new facilities or the introduction of new services, a
state health planning designated agency (a "SHPDA") must determine that a need
exists for those beds, facilities or services. The CON process is intended to
promote comprehensive healthcare planning, assist in providing high quality
healthcare at the lowest possible cost and avoid unnecessary duplication by
ensuring that only those healthcare facilities that are needed will be built.
Typically, the provider of services submits an application to the
appropriate SHPDA with information concerning the area and population to be
served, the anticipated demand for the facility or service to be provided, the
amount of capital expenditure, the estimated annual operating costs, the
relationship of the proposed facility or service to the overall state health
plan and the cost per patient day for the type of care contemplated. Whether the
CON is granted is based upon a finding of need by the SHPDA in accordance with
criteria set forth in CON statutes and state and regional health facilities
plans. If the proposed facility or service is found to be necessary and the
applicant to be the appropriate provider, the SHPDA will issue a CON containing
a maximum amount of expenditure and a specific time period for the holder of the
CON to implement the approved project.
Licensure and certification are separate, but related, regulatory
activities. The former is usually a state or local requirement and the latter is
a federal requirement. In almost all instances, licensure and certification will
follow specific standards and requirements that are set forth in readily
available public documents. Compliance with the requirements is monitored by
annual on-site inspections by representatives of various government agencies.
All of the Company's inpatient rehabilitation facilities and medical centers and
substantially all of the Company's surgery centers are currently required to be
licensed, but only the outpatient rehabilitation facilities located in Alabama,
Arizona, Kentucky, Maryland, Massachusetts, New Hampshire, New Mexico and Rhode
Island currently must satisfy such a licensing requirement. Diagnostic and
occupational health facilities are not required to be licensed in a majority of
states.
12
Medicare Participation and Reimbursement
In order to participate in the Medicare program and receive Medicare
reimbursement, each facility must comply with the applicable regulations of the
United States Department of Health and Human Services relating to, among other
things, the type of facility, its equipment, its personnel and its standards of
medical care, as well as compliance with all state and local laws and
regulations. All of the Company's inpatient facilities, except for the St. Louis
head injury center, participate in the Medicare program. Approximately 1,065 of
the Company's outpatient rehabilitation facilities currently participate in, or
are awaiting the assignment of a provider number to participate in, the Medicare
program. All of the Company's surgery centers are certified (or awaiting
certification) under the Medicare program. Diagnostic and occupational health
facilities are not certified by the Medicare program. Its Medicare-certified
facilities, inpatient and outpatient, undergo annual on-site Medicare
certification surveys in order to maintain their certification status. Failure
to comply with the program's conditions of participation may result in loss of
program reimbursement or other governmental sanctions. All such facilities have
been deemed to be in satisfactory compliance on all applicable surveys. The
Company has developed its operational systems to assure compliance with the
various standards and requirements of the Medicare program and has established
ongoing quality assurance activities to monitor compliance. The Company believes
that all of such facilities currently meet all applicable Medicare requirements.
As a result of the Social Security Act Amendments of 1983, Congress
adopted a prospective payment system ("PPS") to cover the routine and ancillary
operating costs of most Medicare inpatient hospital services. Under this system,
the Secretary of Health and Human Services has established fixed payment amounts
per discharge based on diagnosis-related groups ("DRGs"). With limited
exceptions, a hospital's payment for Medicare inpatients is limited to the DRG
rate, regardless of the number of services provided to the patient or the length
of the patient's hospital stay. Under PPS, a hospital may retain the difference,
if any, between its DRG rate and its operating costs incurred in furnishing
inpatient services, and is at risk for any operating costs that exceed its DRG
rate. The Company's medical center facilities are generally subject to PPS with
respect to Medicare inpatient services.
The PPS program has been beneficial for the rehabilitation segment of
the healthcare industry because of the economic pressure on acute-care hospitals
to discharge patients as soon as possible. The result has been increased demand
for rehabilitation services for those patients discharged early from acute-care
hospitals. Freestanding inpatient rehabilitation facilities are currently exempt
from PPS, and inpatient rehabilitation units within acute- care hospitals are
eligible to obtain an exemption from PPS upon satisfaction of certain federal
criteria.
Currently, 12 of the Company's outpatient centers are
Medicare-certified Comprehensive Outpatient Rehabilitation Facilities ("CORFs")
and 873 are Medicare-certified rehabilitation agencies or satellites thereof.
Additionally, the Company has certification applications pending for four CORF
sites and 176 rehabilitation agency sites (including satellites.) Through
December 31, 1998, CORFs were reimbursed reasonable costs (subject to certain
limits) for services provided to Medicare beneficiaries, and outpatient
rehabilitation facilities certified by Medicare as rehabilitation agencies were
reimbursed on the basis of the lower of reasonable costs for services provided
to Medicare beneficiaries or charges for such services. Outpatient
rehabilitation facilities which are physician-directed clinics, as well as
outpatient surgery centers, are reimbursed by Medicare on a fee screen basis;
that is, they receive a fixed fee, which is determined by the geographical area
in which the facility is located, for each procedure performed. From January 1,
1999, CORFs and rehabilitation agencies are reimbursed on a fee screen basis as
well. The Company's outpatient rehabilitation facilities submit monthly bills to
their fiscal intermediaries for services provided to Medicare beneficiaries, and
the Company files annual cost reports with the intermediaries for each such
facility.
The Company's inpatient facilities (other than the medical center
facilities) either are not currently covered by PPS or are exempt from PPS, and
are also cost-reimbursed, receiving the lower of reasonable costs or charges.
Typically, the fiscal intermediary pays a set rate based on the prior year's
costs for each facility. As with outpatient facilities subject to cost-based
reimbursement, annual cost reports are filed with the Company's fiscal
intermediary and payment adjustments are made, if necessary.
As part of the Balanced Budget Act of 1997, Congress directed the
United States Department of Health and Human Services to develop regulations
that would subject inpatient rehabilitation hospitals to a PPS. The prospective
rates are to be phased in beginning October 1, 2000, and are to be fully
implemented on October 1, 2002. The Act requires that the rates must equal 98%
of the amount of payments that would have been made if the PPS had not been
adopted. In addition, the Act requires the establishment of a PPS for hospital
outpatient department services, effective for services furnished beginning in
1999. Since the drafting of the regulations covering these initiatives is in
very early stages, the Company cannot predict at this time the effect that any
such changes may have on its continuing operations. See Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations" for a
discussion of the impact of the Balanced Budget Act on certain businesses
discontinued by the Company in 1998.
13
In June 1998, the Health Care Financing Administration issued proposed
rules setting forth new payment classifications which would significantly change
Medicare reimbursement for outpatient surgery centers. However, the comment
period for such proposed rules has now been extended for the third time, until
June 30, 1999, and the Company cannot currently predict when final rules, if
any, will be adopted or the content or effect on the Company's operations of
such rules.
Over the past several years an increasing number of healthcare
providers have been accused of violating the federal False Claims Act. That Act
prohibits the knowing presentation of a false claim to the United States
government. Because the Company performs thousands of similar procedures a year
for which it is reimbursed by Medicare and there is a relatively long statute of
limitations, a billing error could result in significant civil penalties. The
Company does not believe that it is or has been in violation of the False Claims
Act.
Relationships with Physicians and Other Providers
Various state and federal laws regulate relationships among providers
of healthcare services, including employment or service contracts and investment
relationships. These restrictions include a federal criminal law prohibiting (i)
the offer, payment, solicitation or receipt of remuneration by individuals or
entities, to induce referrals of patients for services reimbursed under the
Medicare or Medicaid programs or (ii) the leasing, purchasing, ordering,
arranging for or recommending the lease, purchase or order of any item, good,
facility or service covered by such programs (the "Fraud and Abuse Law"). In
addition to federal criminal sanctions, violators of the Fraud and Abuse Law may
be subject to significant civil sanctions, including fines and/or exclusion from
the Medicare and/or Medicaid programs.
In 1991, the Office of the Inspector General ("OIG") of the United
States Department of Health and Human Services promulgated regulations
describing compensation arrangements which are not viewed as illegal
remuneration under the Fraud and Abuse Law (the "Safe Harbor Rules"). The Safe
Harbor Rules create certain standards ("Safe Harbors") for identified types of
compensation arrangements which, if fully complied with, assure participants in
the particular arrangement that the OIG will not treat such participation as a
criminal offense under the Fraud and Abuse Law or as the basis for an exclusion
from the Medicare and Medicaid programs or an imposition of civil sanctions. The
OIG closely scrutinizes healthcare joint ventures involving physicians and other
referral sources. In 1989, the OIG published a Fraud Alert that outlined
questionable features of "suspect" joint ventures.
In 1992, regulations were published in the Federal Register
implementing the OIG sanction and civil money penalty provisions established in
the Fraud and Abuse Law. The regulations (the "Exclusion Regulations") provide
that the OIG may exclude a Medicare provider from participation in the Medicare
Program for a five-year period upon a finding that the Fraud and Abuse Law has
been violated. The regulations expressly incorporate a test adopted by three
federal circuit courts providing that if one purpose of remuneration that is
offered, paid, solicited or received is to induce referrals, then the statute is
violated. The regulations also provide that after the OIG establishes a factual
basis for excluding a provider from the program, the burden of proof shifts to
the provider to prove that the Fraud and Abuse Law has not been violated.
The Company currently operates 22 of its rehabilitation hospitals and
many of its outpatient rehabilitation facilities as limited partnerships or
limited liability companies (collectively, "partnerships") with third-party
investors. Seven of the rehabilitation hospital partnerships involve physician
investors, 13 of the rehabilitation hospital partnerships involve other
institutional healthcare providers and two of the rehabilitation hospital
partnerships involve both institutional providers and other investors, some of
whom are physicians. Seven of the outpatient partnerships currently have a total
of 20 physician limited partners, some of whom refer patients to the
partnerships. Those partnerships which are providers of services under the
Medicare program, and their limited partners, are subject to the Fraud and Abuse
Law. A number of the relationships established by the Company with physicians
and other healthcare providers do not fit within any of the Safe Harbors. The
Safe Harbor Rules do not expand the scope of activities that the Fraud and Abuse
Law prohibits, nor do they provide that failure to fall within a Safe Harbor
constitutes a violation of the Fraud and Abuse Law; however, the OIG has
informally indicated that failure to fall within a Safe Harbor may subject an
arrangement to increased scrutiny.
Most of the Company's surgery centers are owned by partnerships, which
include as partners physicians who perform surgical procedures at such centers.
Subsequent to the promulgation of the Safe Harbor Rules in 1991, the Department
of Health and Human Services issued for public comment additional proposed Safe
Harbors, one of which specifically addresses surgeon ownership interests in
ambulatory surgery centers (the "Proposed ASC Safe Harbor"). As proposed, the
Proposed ASC Safe Harbor would protect payments to be made to surgeons as a
return on investment interest in a surgery center if, among other conditions,
all the investors are surgeons who are in a position to refer patients directly
to the center and perform surgery on such referred patients. Since a subsidiary
14
of the Company is an investor in each limited partnership which owns a surgery
center, the Company's arrangements with physician investors do not fit within
the Proposed ASC Safe Harbor as currently proposed. The Company is unable at
this time to predict whether the Proposed ASC Safe Harbor will become final, and
if so, whether the language and requirements will remain as currently proposed,
or whether changes will be made prior to becoming final. There can be no
assurance that the Company will ever meet the criteria under the Proposed ASC
Safe Harbor as proposed or as it may be adopted in final form. The Company
believes, however, that its arrangements with physicians with respect to its
surgery center facilities should not fall within the activities prohibited by
the Fraud and Abuse Law.
Certain of the Company's diagnostic centers are owned or operated by
partnerships which include radiologists as partners. While such ownership
interests are not directly covered by the Safe Harbor Rules, the Company does
not believe that such arrangements violate the Fraud and Abuse Law because
radiologists are typically not in a position to make or induce referrals to
diagnostic centers. In addition, the Company's mobile lithotripsy operations are
conducted by partnerships in which urologists are limited partners. Because such
urologists are in a position to, and do, perform lithotripsy procedures
utilizing the Company's lithotripsy equipment, the Company believes that the
same analysis underlying the Proposed ASC Safe Harbor should apply to ownership
interests in lithotripsy equipment held by urologists. In addition, the Company
believes that the nature of lithotripsy services (i.e., lithotripsy is only
prescribed and utilized when a condition for which lithotripsy is the treatment
of choice has been diagnosed) makes the risk of overutilization unlikely. There
can be no assurance, however, that the Fraud and Abuse Law will not be
interpreted in a manner contrary to the Company's beliefs with respect to
diagnostic and lithotripsy services.
While several federal court decisions have aggressively applied the
restrictions of the Fraud and Abuse Law, they provide little guidance as to the
application of the Fraud and Abuse Law to the Company's partnerships. The
Company believes that it is in compliance with the current requirements of
applicable federal and state law, but no assurances can be given that a federal
or state agency charged with enforcement of the Fraud and Abuse Law and similar
laws might not assert a contrary position or that new federal or state laws, or
new interpretations of existing laws, might not adversely affect relationships
established by the Company with physicians or other healthcare providers or
result in the imposition of penalties on the Company or certain of its
facilities. Even the assertion of a violation could have a material adverse
effect upon the Company.
The so-called "Stark II" provisions of the Omnibus Budget
Reconciliation Act of 1993 amend the federal Medicare statute to prohibit the
making by a physician of referrals for "designated health services" (including
physical therapy, occupational therapy, radiology services or radiation therapy)
to an entity in which the physician has an investment interest or other
financial relationship, subject to certain exceptions. Such prohibition took
effect on January 1, 1995 and applies to all of the Company's partnerships with
physician partners. On January 9, 1998, the Department of Health and Human
Services published proposed regulations (the "Proposed Stark Regulations") under
the Stark II statute and solicited comments thereon. The Proposed Stark
Regulations would implement, amplify and clarify the Stark II statute. Final
regulations are not expected to be promulgated until after 1999. In addition, a
number of states have passed or are considering statutes which prohibit or limit
physician referrals of patients to facilities in which they have an investment
interest. In response to these regulatory activities, the Company has
restructured most of its partnerships which involve physician investors to the
extent required by applicable law, in order to eliminate physician ownership
interests not permitted by applicable law. The Company intends to take such
actions as may be required to cause the remaining partnerships to be in
compliance with applicable laws and regulations, including, if necessary, the
prohibition of physician partners from referring patients. The Company believes
that this restructuring has not adversely affected and will not adversely affect
the operations of its facilities.
Ambulatory surgery is not identified as a "designated health service"
under Stark II, and the Company does not believe the statute is intended to
cover ambulatory surgery services. The Proposed Stark Regulations would
expressly clarify that the provision of designated health services in an
ambulatory surgery center would be excepted from the referral prohibition of
Stark II if payment for such designated health services is included in the
ambulatory surgery center payment rate.
Lithotripsy facilities operated by the Company frequently operate on
hospital campuses, and it is possible to conclude that such services are
"inpatient and outpatient hospital services" -- a category of designated health
services under Stark II. The legislative history of the Stark II statute
indicates that the statute was not intended to cover the provision of
lithotripsy services by physician-owned lithotripsy providers under contract
with a hospital. In the commentary to the Proposed Stark Regulations, the
Department of Health and Human Services specifically solicited comments as to
whether lithotripsy services should be excluded from the definition of
"inpatient and outpatient hospital services". In the event that lithotripsy
services are not so excluded, the Company believes that the operations of its
lithotripsy partnerships either comply with, or can be restructured to comply
with, certain other exceptions to the Stark II referral prohibitions, and the
Company intends to take such steps as may be required to cause those
partnerships to be in compliance with Stark II if the final regulations so
require. In addition, physicians frequently perform endoscopic procedures in the
procedure rooms of the Company's surgery centers, and it is possible to construe
such services to be "designated health services". While the Company does not
believe that Stark II was intended to apply to such services, if that were
determined to be the case, the Company intends to take steps necessary to cause
the operations of its facilities to comply with the law.
15
The Health Insurance Portability and Accountability Act of 1996
In an effort to combat healthcare fraud, Congress included several
anti-fraud measures in the Health Insurance Portability and Accountability Act
of 1996 ("HIPAA"). HIPAA, among other things, amends existing crimes and
criminal penalties for Medicare fraud and enacts new federal healthcare fraud
crimes. HIPAA also expands the Fraud and Abuse Law to apply to all federal
healthcare programs, defined to include any plan or program that provides health
benefits through insurance that is funded by the federal government. Under
HIPAA, the Secretary of the Department of Health and Human Services (the
"Secretary") may exclude from the Medicare program any individual who has a
direct or indirect ownership or control interest in a healthcare entity that has
been convicted of a healthcare fraud crime or that has been excluded from the
Medicare program. HIPAA directs the Secretary to establish a program to collect
information on healthcare fraud and abuse to encourage individuals to report
information concerning fraud and abuse against the Medicare program and provides
for payment of a portion of amounts collected to such individuals. HIPAA
mandates the establishment of a Fraud and Abuse Program, among other programs,
to control fraud and abuse with respect to health plans and to conduct
investigations, audits, evaluations, and inspections relating to the delivery of
and payment for healthcare in the United States.
HIPAA prohibits any person or entity from knowingly and willfully
committing a federal healthcare offense relating to a healthcare benefit
program. Under HIPAA, a "health care benefit program" broadly includes any
private plan or contract affecting interstate commerce under which any medical
benefit, item, or service is provided to any individual. Among the "federal
health care offenses" prohibited by HIPAA are healthcare fraud and making false
statements relative to healthcare matters. Any person or entity that knowingly
and willfully defrauds or attempts to defraud a healthcare benefit program or
obtains by means of false or fraudulent pretenses, representations or promises,
any of the money or property of any healthcare benefit program in connection
with the delivery of healthcare services is subject to a fine and/or
imprisonment. In addition, HIPAA provides that any person or entity that
knowingly and willfully falsifies, conceals or covers up a material fact or
makes any materially false or fraudulent statements in connection with the
delivery of or payment of healthcare services by a healthcare benefit plan is
subject to a fine and/or imprisonment.
HIPAA further expands the list of acts which are subject to civil
monetary penalties under federal law and increases the amount of civil penalties
which may be imposed. HIPAA provides for civil fines for individuals who retain
an ownership or control interest in a Medicare or Medicaid participating entity
after such individuals have been excluded from participating in the Medicare or
Medicaid program. HIPAA further provides for civil fines for individuals who
offer inducements to Medicare or Medicaid eligible patients if the individuals
know or should know that their offers will influence the patients to order or
receive items or services from a particular provider, practitioner or supplier.
The Company cannot predict whether other regulatory or statutory
provisions will be enacted by federal or state authorities which would prohibit
or otherwise regulate relationships which the Company has established or may
establish with other healthcare providers or the possibility of materially
adverse effects on its business or revenues arising from such future actions.
Management of the Company believes, however, that the Company will be able to
adjust its operations so as to be in compliance with any regulatory or statutory
provision as may be applicable. See this Item, "Business -- Patient Care
Services" and "Business -- Sources of Revenues".
INSURANCE
Beginning December 1, 1993, the Company became self-insured for
professional liability and comprehensive general liability. The Company
purchased coverage for all claims incurred prior to December 1, 1993. In
addition, the Company purchased underlying insurance which would cover all
claims once established limits have been exceeded. It is the opinion of
management that as of December 31, 1998, the Company had adequate reserves to
cover losses on asserted and unasserted claims.
In connection with the Horizon/CMS acquisition, the Company assumed
Horizon/CMS's open professional and general liability claims. The Company has
entered into an agreement with an insurance carrier to assume responsibility for
the majority of open claims. Under this agreement, a "risk transfer" is being
conducted which will convert Horizon/CMS's self-insured claims to insured
liabilities consistent with the terms of the underlying insurance policy.
In connection with the risk transfer, the carrier has questioned the
availability of coverage for punitive damages. The Company and Horizon/CMS have
filed a declaratory judgment action in the United States District Court for the
District of New Mexico seeking a declaration that such damages are required to
be covered (HEALTHSOUTH Corporation, et al. v. St. Paul Fire and Marine
Insurance Company, et al., Civ. No. 98-800 BB/DIS-ACE). Thereafter, the carrier
filed an action seeking a contrary declaration in the United States District
Court for the
16
Northern District of Texas (St. Paul Fire and Marine Insurance Company, et al.
v. Horizon/CMS Healthcare Corporation, et al., Civil Action No. 4-98CV-575-Y).
The parties have filed preliminary motions in both actions, and the Company
cannot now predict the outcome or effect of these actions or the length of time
it will take to resolve them.
EMPLOYEES
As of December 31, 1998, the Company employed approximately 51,901
persons, of whom 32,558 were full-time employees and 19,343 were part-time
employees. Of the above employees, 821 were employed at the Company's
headquarters in Birmingham, Alabama. Except for approximately 77 employees at
one rehabilitation hospital (about 14.6% of that facility's workforce), none of
the Company's employees are represented by a labor union. The Company is not
aware of any current activities to organize its employees at other facilities.
Management of the Company considers the relationship between the Company and its
employees to be good.
ITEM 2. PROPERTIES.
The Company's executive offices currently occupy a headquarters
building of approximately 200,000 square feet in Birmingham, Alabama. The
headquarters building, which was occupied by the Company in February 1997, was
constructed on a 73-acre parcel of land owned by the Company pursuant to a tax
retention operating lease structured through NationsBanc Leasing Corporation.
Substantially all of the Company's outpatient rehabilitation and occupational
health operations are carried out in leased facilities. The Company owns 29 of
its inpatient rehabilitation facilities and leases or operates under management
contracts the remainder of its inpatient rehabilitation facilities. The Company
also owns 62 of its surgery centers and 35 of its diagnostic centers and leases
or operates under management arrangements the remainder. The Company constructed
its rehabilitation hospitals in Florence and Columbia, South Carolina, Kingsport
and Nashville, Tennessee, Concord, New Hampshire, Dothan, Alabama, Columbia,
Missouri, and Charlottesville, Virginia on property leased under long-term
ground leases. The property on which the Company's Memphis, Tennessee
rehabilitation hospital is located is owned in partnership by the Company and
Methodist Hospitals of Memphis. The Company owns its four medical center
facilities. The Company currently owns, and from time to time may acquire,
certain other improved and unimproved real properties in connection with its
business. See Notes 5 and 7 of "Notes to Consolidated Financial Statements" for
information with respect to the properties owned by the Company and certain
indebtedness related thereto.
In management's opinion, the Company's physical properties are adequate
for the Company's needs for the foreseeable future, and are consistent with its
expansion plans described elsewhere in this Annual Report on Form 10-K.
17
The following table sets forth a listing of the Company's primary domestic
patient care services locations (including both facilities owned or leased by
the Company and facilities under management agreements or similar arrangements)
at December 31, 1998, exclusive of those facilities to be closed, consolidated
or sold pursuant to plans adopted in 1998:
INPATIENT OCCUPATIONAL OUTPATIENT
REHABILITATION MEDICAL HEALTH REHABILITATION SURGERY DIAGNOSTIC
STATE FACILITIES (BEDS)(1) CENTERS (BEDS)(1) CENTERS CENTERS(2) CENTERS CENTERS
- - - ----- -------------------- ----------------- ------- ---------- ------- -------
Alabama 8 (404) 1 (219) 32 7 4
Alaska 4 7 1 1
Arizona 4 (243) 8 27 2 1
Arkansas 6 (309) 5 25 2
California 1 (60) 27 51 50 3
Colorado 1 (64) 1 35 5 5
Connecticut 1 (26) 2 18 6
Delaware 6 1
District of Columbia 1 1
Florida 9 (631) 1 (285) 6 83 18 8
Georgia 1 (50) 4 29 4 11
Hawaii 10 1
Idaho 4 1
Illinois 1 55 7 10
Indiana 3 (200) 2 14 5 1
Iowa 1 3 2
Kansas 4 (224) 11
Kentucky 2 (80) 2 4 6
Louisiana 5 (287) 3 5 2 3
Maine 2 (125) 11
Maryland 1 (44) 28 9 6
Massachusetts 11 (921) 1 52 1 2
Michigan 1 (30) 3 12
Minnesota 15 2
Mississippi 8 3
Missouri 2 (160) 1 55 8 1
Montana 4 1
Nebraska 1 5
Nevada 2 (130) 22 3
New Hampshire 3 (98) 9
New Jersey 1 (155) 1 66 3 3
New Mexico 1 (61) 1 6 1 1
New York 1 (27) 47 1 3
North Carolina 22 10 1
North Dakota 4
Ohio 1 (30) 3 36 7
Oklahoma 3 (155) 1 18 5 1
Oregon 31 1
Pennsylvania 14 (1,049) 3 57 6 8
Rhode Island 2 2
South Carolina 3 (216) 8 2 5
South Dakota 4 1
Tennessee 7 (407) 25 5 4
Texas 19 (1,114) 1 (106) 10 108 18 22
Utah 1 (86) 2 10 2
Vermont 1 2
Virginia 2 (90) 1 (200) 4 25 1 6
Washington 17 72 5 1
West Virginia 4 (214) 3 1
Wisconsin 1 4
Wyoming 2
-----------------------
(1) "Beds" refers to the number of beds for which a license or
certificate of need has been granted, which may vary materially
from beds available for use.
18
(2) Includes freestanding outpatient centers and their satellites,
outpatient satellites of inpatient rehabilitation facilities and
outpatient facilities managed under contract.
In addition, at December 31, 1998, the Company operated six diagnostic
centers in the United Kingdom and one rehabilitation hospital in Australia, as
well as numerous locations in various states providing other services.
ITEM 3. LEGAL PROCEEDINGS.
In the ordinary course of its business, the Company may be subject,
from time to time, to claims and legal actions by patients and others. The
Company does not believe that any such pending actions, if adversely decided,
would have a material adverse effect on its financial condition. See Item 1,
"Business -- Insurance" and Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations" for a description of the
Company's insurance coverage arrangements.
From time to time, the Company appeals decisions of various rate-making
authorities with respect to Medicare rates established for the Company's
facilities. These appeals are initiated in the ordinary course of business.
Management believes that adequate reserves have been established for possible
adverse decisions on any pending appeals and that the outcomes of currently
pending appeals, either individually or in the aggregate, will have no material
adverse effect on the Company's operations.
SECURITIES LITIGATION
The Company has been served with certain lawsuits filed beginning
September 30, 1998 which purport to be class actions under the federal and
Alabama securities laws. Such lawsuits were filed following a decline in the
Company's stock price at the end of the third quarter of 1998. Seven such suits
have been filed in the United States District Court for the Northern District of
Alabama: Robert M. Gordon, et al. v. HEALTHSOUTH Corporation, et al., Civil
Action No. 98-J-2634-S, Twin Plus LLC, et al. v. HEALTHSOUTH Corporation, et
al., Civil Action No. 98-PWG-2695-S, Irene Rigas, et al. v. HEALTHSOUTH
Corporation, et al., Civil Action No. 98-RRA-2777-S, Harry Schipper v.
HEALTHSOUTH Corporation, et al., Civil Action No. 98-N-2779-S, Ryan McCormick v.
HEALTHSOUTH Corporation, et al., Civil Action No. 98-RRA-2831-S, United Food &
Commercial Workers Union Local 100-A Pension Fund v. HEALTHSOUTH Corporation, et
al., Civil Action No. 98-BU-2869-S, and Vinod Parikh v. HEALTHSOUTH Corporation,
et al., Civil Action No. 98-BU-2869-S. These are substantially identical
complaints filed against the Company and certain of its officers and Directors
alleging that, during the period August 12, 1997 through September 30, 1998, the
defendants misrepresented or failed to disclose certain material facts
concerning the Company's business and financial condition in order to
artificially inflate the price of the Company's Common Stock and issued or sold
shares of such stock during the purported class period, all allegedly in
violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5
thereunder. Certain of the named plaintiffs in some of the complaints also
purport to represent separate subclasses consisting of former stockholders of
Horizon/CMS Healthcare Corporation and National Surgery Centers, Inc. who
received shares of the Company's Common Stock in connection with the Company's
acquisition of those entities and assert additional claims under Section 11 of
the Securities Act of 1933 with respect to the registration of securities issued
in those acquisitions. In January 1999, these complaints were ordered to be
consolidated, with a consolidated amended complaint due to be filed on April 5,
1999 (after a one-month extension requested by the plaintiffs' counsel). Another
suit, Peter J. Petrunya v. HEALTHSOUTH Corporation, et al., Civil Action No.
98-05931, was filed in the Circuit Court for Jefferson County, Alabama, alleging
that during the period July 16, 1996 through September 30, 1998 the defendants
misrepresented or failed to disclose certain material facts concerning the
Company's business and financial condition, allegedly in violation of Section
8-6-17 and 8-6-19 of the Alabama Securities Act. The Petrunya complaint was
voluntarily dismissed by the plaintiff without prejudice in January 1999.
Additionally, a suit styled Dennis Family Trust v. Richard M. Scrushy, et
al., Civil Action No. 98-06592, has been filed in the Circuit Court for
Jefferson County, Alabama, purportedly as a derivative action on behalf of the
Company. That suit largely replicates the allegations of the federal actions
described in the preceding paragraph and alleges that the current Directors of
the Company, certain former Directors and certain officers of the Company
breached their fiduciary duties to the Company and engaged in other allegedly
tortious conduct. The plaintiff in that case has forborne pursuing its claim
thus far pending further progress in the federal actions, and the Company has
not yet been required to file a responsive pleading in the case.
The Company believes that all claims asserted in the above suits are
without merit, and expects to vigorously defend against such claims. Because
such suits have only recently been filed, the Company cannot predict the outcome
of any such suits or the magnitude of any potential loss if the Company's
defense is unsuccessful.
19
CERTAIN HORIZON/CMS LITIGATION
On October 29, 1997, HEALTHSOUTH acquired Horizon/CMS through the merger
of a wholly owned subsidiary of HEALTHSOUTH with and into Horizon/CMS.
Horizon/CMS is currently a party, or is subject, to certain material litigation
matters and disputes, which are described below, as well as various other
litigation matters and disputes arising in the ordinary course of its business.
The Company is not itself a party to the litigation described below.
SEC and NYSE Investigations
The Division of Enforcement of the SEC has for some time been
conducting a private investigation with respect to trading in the securities of
Horizon/CMS and Continental Medical Systems, Inc. ("CMS"), which was acquired by
Horizon/CMS in June 1995. In connection with that investigation, Horizon/CMS
produced certain documents, and Neal M. Elliott, then Chairman of the Board,
President and Chief Executive Officer of Horizon/CMS, and certain other former
officers of Horizon/CMS have given testimony to the SEC. Horizon/CMS has also
been informed that certain of its division office employees and an individual,
affiliates of whom had limited business relationships with Horizon/CMS, have
responded to subpoenas from the SEC. Mr. Elliott also produced certain documents
in response to a subpoena from the SEC. In addition, Horizon/CMS and Mr. Elliott
have responded to separate subpoenas from the SEC pertaining to trading in
Horizon/CMS's common stock and various material press releases issued in 1996 by
Horizon/CMS; Horizon/CMS's February 18, 1997 announcement that the Company would
acquire Horizon/CMS; and any discussions of proposed business combinations
between Horizon/CMS and Medical Innovations and Horizon/CMS and certain other
companies. The Company and Horizon/CMS have no knowledge of the current status
of the investigation, and neither Horizon/CMS nor the Company possesses all the
facts with respect to the matters under investigation. Although neither
Horizon/CMS nor the Company has been advised by the SEC that the SEC has
concluded that any of Horizon/CMS, Mr. Elliott or any other current or former
officer or director of Horizon/CMS has been involved in any violation of the
federal securities laws, there can be no assurance as to the outcome of the
investigation or the time of its conclusion. Both Horizon/CMS and the Company
have, to the extent requested to date, cooperated fully with the SEC in
connection with the investigation.
In March 1995, the New York Stock Exchange informed Horizon/CMS that it
had initiated a review of trading in Hillhaven Corporation common stock prior to
the announcement of Horizon/CMS's proposed acquisition of Hillhaven. In April
1995, the NYSE extended the review of trading to include all dealings with CMS.
On April 3, 1996, the NYSE notified Horizon/CMS that it had initiated a review
of trading in its common stock preceding Horizon/CMS's March 1, 1996 press
release announcing a revision in Horizon/CMS's third quarter earnings estimate.
On February 20, 1997, the NYSE notified Horizon/CMS that it was reviewing
trading in Horizon/CMS's securities prior to the February 18, 1997 announcement
that the Company would acquire Horizon/CMS. Horizon/CMS has cooperated with the
NYSE in its reviews and has no knowledge of the current status of such reviews.
In February 1997, the Company received a subpoena from the SEC with
respect to its investigation concerning trading in Horizon/CMS common stock
prior to the February 18, 1997 announcement that the Company would acquire
Horizon/CMS and a request for information from the NYSE in connection with its
review of such trading. The Company responded to such subpoena and request for
information and advised both the SEC and the NYSE that it intended to cooperate
fully in any investigations or reviews relating to such trading. The Company
provided certain additional information to the SEC in April 1997.
Neither the Company nor Horizon/CMS has received any further inquiries
from the SEC or the NYSE with respect to the matters described above since
mid-1997, and the Company is unaware of the current status of such
investigations or reviews. The Company does not intend to describe these matters
in future reports unless it becomes aware of new developments with respect to
them.
Michigan Attorney General Litigation Regarding Long-Term Care Facility In
Michigan
Horizon/CMS learned in September 1996 that the Attorney General of the
State of Michigan was investigating one of its skilled nursing facilities. The
facility, in Howell, Michigan, was owned and operated by Horizon/CMS from
February 1994 until December 31, 1997. As widely reported in the press, the
Attorney General seized a number of patient, financial and accounting records
that were located at this facility. By order of a circuit judge in the county in
which the facility is located, the Attorney General was ordered to return
patient records to the facility for copying.
20
Horizon/CMS advised the Michigan Attorney General that it was willing to
cooperate fully in the investigation. The facility in question was sold by
Horizon/CMS to IHS on December 31, 1997.
On February 19, 1998, the State of Michigan filed a criminal complaint
against Horizon/CMS, four former employees of the facility and one former
Horizon/CMS regional manager, alleging various violations in 1995 and 1996 of
certain statutes relating to patient care, patient medical records and the
making of false statements with respect to the condition or operations of the
facility (State of Michigan v. Horizon/CMS Healthcare Corp., et al., Case No.
98-630-FY, State of Michigan District Court 54B). The maximum fines chargeable
against Horizon/CMS under the counts alleged in the complaint (exclusive of
charges against the individual defendants, some of which charges may result in
indemnification obligations for Horizon/CMS) aggregate $69,000. Horizon/CMS
denies the allegations made in the complaint and expects to vigorously defend
against the charges. The litigation has continued at the pretrial hearing phase
for several months, including numerous adjournments, and such pretrial hearing
phase is not expected to conclude until April 1999, after which time the court
will determine which, if any, charges may be brought to trial. Because of the
preliminary status of this litigation, it is not possible to predict at this
time the outcome or effect of this litigation or the length of time it will take
to resolve this litigation.
Lawsuit by Former Shareholders of Communi-Care, Inc. and Pro Rehab, Inc.
On May 28, 1997, CMS was served with a lawsuit styled Kenneth Hubbard
and Lynn Hubbard v. Rocco Ortenzio, Robert A. Ortenzio and Continental Medical
Systems, Inc., No. 3:97 CV294MCK, filed in the United States District Court for
the Western District of North Carolina, Charlotte Division, by the former
shareholders of Communi-Care, Inc. and Pro Rehab, Inc. seeking damages arising
out of certain "earnout" provisions of the definitive purchase agreements under
which CMS purchased the outstanding stock of Communi-Care, Inc. and Pro Rehab,
Inc. from such shareholders. The plaintiffs allege that the manner in which CMS
and the other defendants operated the companies after their acquisition breached
its fiduciary duties to the plaintiffs, constituted fraud, gross negligence and
bad faith and a breach of their employment agreements with the companies. As a
result of such alleged conduct, the plaintiffs assert that they are entitled to
damages in an amount in excess of $27,000,000 from CMS and the other defendants.
Horizon/CMS believes, based upon its evaluation of the legal and factual matters
relating to the plaintiffs' assertions, that it has valid defenses to the
plaintiffs' claims and, as a result, intends to vigorously contest such claims.
Because this litigation remains at a procedurally early stage, the Company
cannot now predict the outcome or effect of such litigation or the length of
time it will take to resolve such litigation.
EEOC Litigation
In March 1997, the Equal Employment Opportunity Commission (the "EEOC")
filed a complaint against Horizon/CMS alleging that Horizon/CMS had engaged in
unlawful employment practices in respect of Horizon/CMS's employment policies
related to pregnancies. Specifically, the EEOC asserts that Horizon/CMS's
alleged refusal to provide pregnant employees with light-duty assignments to
accommodate their temporary disabilities caused by pregnancy violates Sections
701(k) and 703(a) of Title VII, 42 U.S.C. ss.ss. 2000e-(k) and 2000e-2(a). In
this lawsuit, the EEOC seeks, among other things, to permanently enjoin
Horizon/CMS's employment practices in this regard. Horizon/CMS disputes the
factual and legal assertions of the EEOC in this litigation and intends to
vigorously contest the EEOC's claims. Because this litigation remains at a
procedurally early stage, the Company cannot predict the length of time it will
take to resolve the litigation or the outcome of the litigation.
Heritage Western Hills Litigation
Since July 1996, Horizon/CMS has been a defendant in a lawsuit styled
Lexa A. Auld, Administratrix of Martha Hary, Deceased v. Horizon/CMS Healthcare
Corporation and Charles T. Maxvill, D.O., No. 48-165121, 48th Judicial District
Court, Tarrant County, Texas. The case involved injuries allegedly suffered by a
resident of the Heritage Western Hills nursing facility in Fort Worth, Texas.
Horizon/CMS tendered the claim to its insurance carrier, which accepted coverage
with a reservation of rights and provided a defense through the carrier's
selected counsel in Dallas, Texas. The case went to trial on October 29, 1997,
and on November 7, 1997, the jury rendered a verdict in favor of the plaintiff
in the amount of $2,370,000 in compensatory damages and $90,000,000 in punitive
damages. Counsel has advised Horizon/CMS that, under applicable Texas law, the
punitive damages award is, at worst, limited to four times the amount of the
compensatory damages (the "Punitive Damages Cap"), and thus that the maximum
amount of an enforceable judgment in favor of the plaintiff is approximately
$12,000,000. Counsel has also advised Horizon/CMS that there are, potentially,
other and further caps on both the amount of compensatory damages available to
the plaintiff and the amount of punitive damages. Horizon/CMS filed the required
motions with the court to impose the Punitive Damages Cap. On February 20, 1998,
the court reduced the jury's verdict and entered a judgment in the amount of
approximately $11,237,000. Horizon/CMS also vigorously disputes the
21
efficacy of the jury's verdict and has appealed the judgment. The judgment was
left unchanged by the intermediate appellate court and is now being appealed to
the Texas Supreme Court.
Horizon/CMS's insurance carrier continues to defend the matter subject
to a reservation of rights. Horizon/CMS, based upon an evaluation by its
then-current internal counsel, after reviewing the findings contained in the
jury verdict, the insurance policy at issue and the carrier's handling of the
case, believes that the entirety of any judgment ultimately entered is covered
by and payable from such insurance policy, less Horizon/CMS's self-insured
retention of $250,000. On November 19, 1997, the insurance carrier sent
Horizon/CMS a letter indicating its belief that certain policy exclusions might
apply and requesting additional information which might affect its coverage
determination. Horizon/CMS has retained separate counsel to analyze the coverage
issues and advise Horizon/CMS on its position, and Horizon/CMS expects to
continue to negotiate any coverage issues with its carrier. Settlement
negotiations by Horizon/CMS's insurance carrier, in conjunction with the
Company's retained counsel, continue with the plaintiff. It is not possible at
this time to predict the outcome of any appeals, the resolution of any coverage
issues, the outcome of any settlement negotiations or the ultimate amount of any
liability which will be borne by Horizon/CMS. See Item 1, "Business --
Insurance".
HEALTH IMAGES/FONAR LITIGATION
On February 2, 1998, Fonar Corporation ("Fonar") filed an action
against HEALTHSOUTH in the United States District Court for the Eastern District
of New York styled Fonar Corporation v. HEALTHSOUTH, Inc., Civil Action No.
98-CV-679 (LDW)(ARL). In the complaint, Fonar alleges that HEALTHSOUTH infringed
United States Patent Number 4,871,966 (the "'966 patent") which pertains to the
operation of the Multi-Angle Oblique ("MAO") feature in MRI machines. The MAO
feature enables the MRI machine to scan multiple differing angles in a single
MAO scan. Fonar seeks damages in an unspecified amount, along with enhanced
damages for alleged willful infringement. Fonar's allegations of infringement
and willful infringement are based largely on the actions of Health Images prior
to its acquisition by HEALTHSOUTH in March 3, 1997. Health Images, and
subsequently HEALTHSOUTH, are alleged to have infringed the '966 patent through
the manufacture and use of MRI equipment that contains the MAO feature.
HEALTHSOUTH has answered Fonar's complaint denying the allegations of
infringement, and filed a third-party complaint against Picker International,
Inc., which seeks indemnity for those machines purchased by Health Images and
HEALTHSOUTH from Picker alleged to infringe the '966 patent. At this time, since
discovery has not yet commenced, HEALTHSOUTH cannot predict the outcome or
effect of this litigation or the length of time it will take to resolve this
litigation. The court has set the matter for a final pretrial conference on
September 15, 2000.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
22
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's common stock is listed for trading on the New York Stock
Exchange (Symbol: HRC). The following table sets forth for the fiscal periods
indicated the high and low reported sale prices for the Company's common stock
as reported on the NYSE Composite Transactions Tape. All prices shown have been
adjusted for a two-for-one stock split effected in the form of a 100% stock
dividend paid on March 17, 1997.