ITEM 1. BUSINESS.
GENERAL
HEALTHSOUTH Corporation is the nation's largest provider of outpatient surgery, outpatient diagnostic and rehabilitative healthcare services. We provide these services through our national network of inpatient and outpatient healthcare facilities, including inpatient and outpatient rehabilitation facilities, outpatient surgery centers, diagnostic centers, occupational medicine centers, medical centers and other healthcare facilities. We believe that we provide patients, physicians and payors with high-quality healthcare services at significantly lower costs than traditional inpatient hospitals. Additionally, our national network, reputation for quality and focus on outcomes have enabled us to secure contracts with national and regional managed care payors. At December 31, 2000, HEALTHSOUTH operated over 2,000 locations in all 50 states, Puerto Rico, the United Kingdom, Canada and Australia.
Our 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 associated physician practices and other services) and outpatient healthcare facilities (including outpatient rehabilitation centers, outpatient surgery centers, outpatient diagnostic centers and occupational medicine centers). In our outpatient and inpatient rehabilitation facilities, we provide 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. Our 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 we provide can save money for payors and employers.
A patient referred to a HEALTHSOUTH rehabilitation facility 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. We have 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 our patients, regardless of the severity and complexity of their disabilities, can receive the level and intensity of services necessary to restore them to as productive, active and independent a lifestyle as possible.
In addition to our rehabilitation facilities, we operate the largest network of freestanding outpatient surgery centers in the United States. Our outpatient surgery centers provide the facilities and medical support staff necessary for physicians to perform non-emergency surgical procedures. Outpatient surgery is widely recognized as generally less expensive than surgery performed in a hospital, and we believe that outpatient surgery performed at a freestanding outpatient surgery center is generally less expensive than hospital-based outpatient surgery. Over 80% of our surgery center facilities are located in markets served by our rehabilitation facilities, enabling us to pursue opportunities for cross-referrals.
HEALTHSOUTH is also the largest operator of outpatient diagnostic centers in the United States. Most of our diagnostic centers operate in markets where we also provide rehabilitative healthcare and outpatient surgery services. We believe that our ability to offer a comprehensive range of healthcare services in a particular geographic market makes HEALTHSOUTH more attractive to both patients and payors in such market. We focus on marketing our services in an integrated system to patients and payors in such geographic markets. We are continually evaluating potential acquisitions that complement our existing operations, as well as divestitures of non-strategic assets and businesses.
HEALTHSOUTH was organized as a Delaware corporation in February 1984. Our principal executive offices are located at One HealthSouth Parkway, Birmingham, Alabama 35243, and our telephone number is (205) 967-7116.
COMPANY STRATEGY
Our objective is to continue to grow profitably and enhance our position as the preferred provider in our lines of business and geographic markets. In the 1994-1998 period, we pursued a strategy of rapid growth through acquisitions. During this period, we consummated a series of major acquisitions that strengthened our position in our primary lines of business. Today, we believe that we have a strong franchise in our core product lines that encompasses a geographic scope that is unlikely to be duplicated by competitors in the foreseeable future. Going forward, our business strategy will be focused on enhancing profit margins through operating efficiencies and organic growth, as well as selective acquisition and development activity. The following are key elements of our strategy:
o Leverage Our Existing National Network. As one of the largest providers of healthcare services in the United States, and as the largest provider in our primary lines of business, we believe we are well-positioned to leverage our existing network of facilities in order to realize economies of scale and compete successfully for national and regional contracts while retaining the flexibility to respond to particular needs of local markets. Our national network offers large national and regional employers and payors the convenience of dealing with a single provider, a well as offering us the ability 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. We believe that our operations management structure allows us to realize these benefits without sacrificing local market responsiveness. Our objective is to provide those outpatient and rehabilitative healthcare services needed within each local market by tailoring our services and facilities to that market's needs, thus bringing the benefits of nationally recognized expertise and quality into the local setting.
o Deliver Cost-Effective Services. We strive to provide high-quality healthcare services in cost-effective settings. To that end, we use standardized clinical protocols based on "best practices" techniques for the treatment of our patients. We use these standardized clinical protocols at all of our facilities, promoting the delivery of high-quality care in a highly efficient, consistent and cost-effective manner. We believe that our facilities are among the most cost-effective in the industry, making us an attractive healthcare provider for payors and self-insured employers. In addition, we believe that our low-cost profile favorably positions us to respond to reimbursement pricing pressure.
o Market to Managed Care Organizations and Other Payors. Since the late 1980s, we have 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. Our documented clinical outcomes and our daily experience with thousands of patients in delivering quality healthcare services at reasonable prices has enhanced our attractiveness to such entities and has given us a competitive advantage over smaller and regional competitors. These relationships have increased patient volume in our facilities and contributed to our same-store growth. These relationships also enable us to work with major payors to ensure competitive pricing and provide for more efficient billing, claims processing and payment procedures.
o Expand Our Integrated Service Model. Our Integrated Service Model ("ISM") strategy coordinates the delivery of our outpatient services in a given market through the integrated management and marketing of our outpatient operations. We plan to expand our ISM into the 300 largest markets in the United States. We believe our ISM strategy capitalizes on the complementary nature of our primary services. Almost all rehabilitation and surgery patients have diagnostic procedures, and many inpatient rehabilitation patients require some form of outpatient rehabilitation. Furthermore, a significant number of both inpatient and outpatient rehabilitation patients require surgery. Through the ISM, our healthcare services are delivered in a coordinated manner intended to enhance referrals across our business lines. The ISM also allows us to offer patients and payors attractive pricing on bundled services in a given market, as well as the convenience of dealing with a single source for patient care needs.
o Manage for Cash Flow. We have implemented disciplined financial policies that have resulted in strong cash flows as compared to other publicly traded healthcare companies. We intend to continue focusing on managing our business for cash flow and improving financial performance. We will also seek to leverage new technologies into tangible operating efficiencies, improved accounts receivable collection and cost-effective operations. In particular, we are aggressively working to reduce our accounts receivable days and enhance our operating margins by utilizing new electronic claims processing and payment technology, improving our charge capture systems and continuing our proactive efforts to work with payors to streamline payment processes and reduce reimbursement delays. We intend to use free cash flow to reduce outstanding debt and further strengthen our balance sheet.
o Implement Technology Initiatives. We intend to capitalize on our strong brand identity through strategic alliances and, where appropriate, equity participation with technology-oriented companies offering services that we believe will benefit us, both by creating greater efficiencies and cost savings for our operations and by expanding the range of services we offer and public awareness of our company. We believe that our network of over 2,000 facilities, our volume of daily interactions with patients across the country and our relationships with leading physicians and institutions offer these companies immediate operational scale and exposure of a type not available through other healthcare providers. We will seek to leverage those assets through business affiliations that we believe will both benefit our operations and increase stockholder value through strategic investment activities.
RISK FACTORS
Our business, operations and financial condition are subject to various 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 our company, our industry or our business, 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.
We Depend Upon Reimbursement by Third-Party Payors. Substantially all of our revenues are derived from private and governmental third-party payors. In 2000, approximately 29% of our revenues were derived from Medicare, approximately 3% from Medicaid and approximately 68% from commercial insurers, managed care plans, workers' compensation payors and other private pay revenue sources. There are increasing pressures from many payors 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 federal spending, there have been, and we expect that there will continue to be, a number of proposals to limit Medicare reimbursement for various services. We cannot now predict whether any of these pending proposals will be adopted or what effect the adoption of such proposals would have on HEALTHSOUTH.
Further, Medicare reimbursement for inpatient rehabilitation services is changing from a cost-based reimbursement system to a prospective payment system ("PPS"), with the phase-in of the PPS currently expected to begin sometime in 2001. While we believe we are well-positioned and well-prepared for the transition, we cannot be certain what effect the implementation of inpatient rehabilitation PPS will have on us. In addition, a delay in the implementation of inpatient rehabilitation PPS, lower than expected reimbursement rates or our failure to successfully execute our planned response to this change could have a material adverse effect on our financial condition or results of operations. See this Item, "Business -- Regulation".
Our Operations Are Subject To Extensive Regulation. Our operations are 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 our 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 other government programs. Additionally, in many states, Certificates of Need or other similar approvals are required for expansion of our operations. We could be adversely affected if we cannot obtain such approvals, by changes in the standards applicable to approvals and by possible delays and expenses associated with obtaining approvals. Our failure to obtain, retain or renew any required regulatory approvals, licenses or certificates could prevent us from being reimbursed for our services or from offering some of our services, or could adversely affect our results of operations.
Our business 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 regulations include exclusion from participation in the Medicare and Medicaid programs, asset forfeiture, civil penalties and criminal penalties, any of which could have a material adverse effect on our business, results of operations or financial condition. 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. See this Item, "Business -- Regulation".
Healthcare Reform Legislation May Affect Our 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 patients. At the federal level, Congress has continued to propose or consider 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 expand 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 on HEALTHSOUTH. That impact may be material to our business, financial condition or results of operations.
We Face National, Regional and Local Competition. We operate in a highly competitive industry. Although we are the largest provider of our range of inpatient and outpatient healthcare services on a nationwide basis, in any particular market we 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 we may encounter in the future, will not adversely affect our results of operations. See this Item, "Business -- Competition".
We are Subject To Material Litigation. We are, and may in the future be, subject to litigation which, if determined adversely to us, could have a material adverse affect on our business, financial condition or results of operations. In addition, some of the companies and businesses we have acquired have been subject to such litigation. While we attempt to conduct our operations in such a way as to reduce the risk that adverse results in litigation could have a material adverse affect on us, 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".
Our 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 our results of operations and future prospects. In addition, these perceptions may be greatly affected not only by information we provide but also by opinions and reports created by investment analysts and other third parties which do not necessarily reflect information provided by us. Adverse movement in HEALTHSOUTH's stock price, particularly as a result of factors over which we have no control, may adversely affect our access to capital and the ability to consummate acquisitions using our stock.
RECENT DEVELOPMENTS
From time to time, we determine to divest assets or businesses that we have acquired which are no longer consistent with our current business strategy. In that connection, in the first quarter of 2001, we announced that we had entered into a letter of intent with HCA - The Hospital Company to sell our Richmond, Virginia facility and a related outpatient surgery center to an affiliate of HCA. In addition, we also announced that we had entered into a letter of intent to sell substantially all of our occupational medicine center operations to U.S. HealthWorks, Inc. In both cases, we determined that the facilities being divested were not consistent with our current strategy and that management resources devoted to those operations could be better utilized in connection with our strategic businesses.
Both divestiture transactions are subject to the completion of definitive documentation and the satisfaction of various conditions. We currently expect that both transactions will close at or shortly after the end of the first quarter of 2001. We expect to use the proceeds from the transactions to pay down existing indebtedness.
INDUSTRY OVERVIEW
The United States Health Care Financing Administration ("HCFA") estimates that national health expenditures were approximately $1.2 trillion in 1999 and are projected to total $2.2 trillion, or 16.2% of the Gross Domestic Product, by 2008. Within the United States, hospital and physician expenditures traditionally account of the majority of personal healthcare spending. Accelerating private spending growth rates in 1998 caused the share of health spending paid by the private sector to increase for the first time since 1988, rising from 53.8% in 1997 to 54.5% in 1998. At the same time, growth in public sector spending for 1998 increased by 4.1%.
HCFA projects that the combination of demographic forces associated with the aging of the baby-boomers and continued economic strength is expected to continue to generate industry growth. The private sector in particular is expected to continue to benefit from demographic trends, technology improvements, and the ongoing focus on cost containment.
Outpatient and Inpatient Rehabilitation Markets
According to available information, there are approximately 35,000 inpatient rehabilitation beds and 8,000 to 9,000 outpatient rehabilitation centers in the United States. The need for rehabilitation is expected to continue to grow over the next few years driven by the increased percentage of persons over 65 years of age within the general United States population, who generally have the highest rehabilitation needs.
Outpatient Surgery Market
Based on industry estimates, the freestanding outpatient surgery center market is approximately $6 billion in size. There was a 75% increase in the number of treatments in ambulatory settings (hospital outpatient, freestanding ambulatory surgery centers and physicians' offices) from 1986 to 1996, and it is estimated that approximately 80% of surgeries performed today can be done on an outpatient basis. Additionally, the number of outpatient surgery cases increased 196% from 1993 through 1999, from 2.9 million to 5.7 million cases, due mostly to continued medical advances, which facilitated a shift of many procedures to ambulatory settings. Growth in the market is expected to continue during the next decade, after seeing the number of outpatient surgery centers increase from 2,300 in 1996 to more than 2,700 centers in 1999.
Diagnostic Market
The diagnostic market is highly fragmented, with radiologists, hospitals and independent organizations offering diagnostic services. It is estimated that there are currently approximately 2,700 diagnostic centers within the United States, an increase from approximately 1,300 centers in 1988. We expect the diagnostics market to continue to grow over the next few years due to increased sub-specializations, expanding geographic reach and the non-invasive and cost-effective nature of diagnostics in general.
PATIENT CARE SERVICES
HEALTHSOUTH began its operations in 1984 with a focus on providing comprehensive orthopaedic and musculoskeletal rehabilitation services on an outpatient basis. Over the succeeding 16 years, we have consistently sought and implemented opportunities to expand our services through acquisitions and start-up development activities that complement our historic focus on orthopaedic, sports medicine and occupational health services and that provide independent platforms for growth. Our acquisitions and internal growth have enabled HEALTHSOUTH to become one of the largest providers of healthcare services in the United States. The following sections discuss the range of services we offer in our inpatient and other clinical services and outpatient services business segments. See Note 14 of "Notes to Consolidated Financial Statements" for financial information concerning these segments.
Outpatient Services Segments
Our outpatient services segments, comprising our Ambulatory Services-East and Ambulatory Services-West divisions, include our outpatient rehabilitation facilities and occupational medicine centers, our outpatient surgery centers and our outpatient diagnostic centers. We are the largest operator of outpatient rehabilitation facilities, outpatient surgery centers and outpatient diagnostic centers in the United States.
OUTPATIENT REHABILITATION SERVICES. As of December 31, 2000, we provided outpatient rehabilitative healthcare services through approximately 1,407 locations in all 50 states and the United Kingdom, including freestanding outpatient centers, outpatient satellites of inpatient facilities and outpatient facilities managed under contract. This constitutes the largest network of outpatient rehabilitation facilities in the United States. Our 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, sports-related, work-related, hand and spine injuries and various neurological/neuromuscular conditions. 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. Our 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-effective setting.
We believe that the key factors influencing the outpatient rehabilitation business include cost, quality of services and outcomes achieved, convenience for patients and referral sources, and relationships with payors and self-insured employers. We believe that we are well-positioned to compete on all of these factors. Our national network allows us to benefit from economies of scale and to introduce standardized clinical protocols for the treatment of our patients, resulting in "best practices" techniques being utilized at all of our facilities. This has allowed us to consistently achieve demonstrable, cost-effective clinical outcomes. In addition, we believe that our facilities offer an attractive environment for patients and are located in convenient proximity to referring physicians and to our target patient populations. We believe that our national scale and our reputation for high-quality, cost-effective services enables us to obtain national, regional and local contracts with payors and with self-insured employers.
We endeavor to locate our outpatient rehabilitation centers in specific areas where we believe there is a demand for our services. In general, we initially establish an outpatient center in a given market, either by acquiring an existing private therapy practice or through start-up development, and institute our clinical protocols and programs in response to the community's general need for services. We will then establish satellite clinics that are dependent upon the main facility for management and administrative services. These satellite clinics generally provide a specific evaluative or specialty service/program, such as hand therapy or foot and ankle therapy, in response to specific market demands. Our outpatient centers are staffed by physical therapists, occupational therapists and other clinicians and appropriate support personnel, depending on the services provided at a particular location, and are open at hours designed to accommodate the needs of the patient population being served and the local demand for services.
Outpatient rehabilitation patients are referred to our outpatient centers by physicians. In our markets, we strive to develop and maintain relationships with orthopaedic surgeons, neurologists and neurosurgeons, physiatrists and other physicians who serve patients likely to need the rehabilitation services we provide and to keep those physicians informed with respect to the scope and quality of those services. In addition, we attempt to locate our outpatient rehabilitation facilities in proximity to those types of physicians, in order to provide for convenient access to them. We also market our services to managed care payors and case management companies, as well as to self-insured employers and professional and amateur athletic organizations which are likely to have a large number of work-related or sports-related orthopaedic injuries. We believe that we offer high-quality services in a cost-effective setting that is attractive to patients, physicians and payors. In addition, at December 31, 2000, we operated approximately 113 occupational medicine centers in 29 states, which provide cost-effective, outpatient primary medical care and related services for work-related injuries and illnesses, work- related physical examinations, physical therapy services and workers' compensation medical services. Our occupational medicine centers market their services to large and small employers, workers' compensation and health insurers and managed care organizations. As described above, in the first quarter of 2001 we entered into a letter of intent to sell substantially all of our occupational medicine center operations. See this Item, "Business - Recent Developments".
OUTPATIENT SURGERY SERVICES. As of December 31, 2000, we provided outpatient surgery services through 222 freestanding surgery centers in 40 states. This constitutes the largest network of outpatient surgery centers in the United States. Over 80% of our outpatient surgery centers are located in markets served by our rehabilitation facilities, enabling us to pursue opportunities for cross-referrals between surgery and rehabilitation facilities, as well as to centralize administrative functions.
We believe that the key factors influencing the outpatient surgery business are physician utilization, cost and quality of services and case mix. Physicians typically choose to perform outpatient surgical procedures in a freestanding outpatient surgery center rather than an acute-care hospital because of the convenience of the surgery center for themselves and for their patients, in terms of access, scheduling and operating room turnaround time. Like most other outpatient surgery centers, the majority of our centers are owned in partnership with surgeons and other physicians who perform procedures at the centers. It is critical to the success of an outpatient surgery center that its physician partners utilize the center for a significant portion of their procedures, and we believe that our surgery centers offer our physician partners convenient, modern and well-equipped settings for outpatient surgery. We also believe that our reputation in the field of orthopaedic healthcare and the physician relationships we have developed in that area enhance our ability to attract orthopaedic surgical procedures, which are reimbursed more favorably than some other types of outpatient surgery.
Our surgery centers provide the facilities and medical support staff necessary for physicians to perform non-emergency surgical procedures. Our typical surgery center is a freestanding facility with two to six fully equipped operating and procedure rooms and ancillary areas for reception, preparation, recovery and administration. Each of our 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 our surgery centers currently provide for extended recovery stays. Our ability to develop such recovery care facilities is dependent upon state regulatory environments in the particular states where our centers are located.
Our 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. In order to increase volumes and margins in our outpatient surgery centers, we focus on educating physicians as to the advantages in terms of convenience, technology, quality of care and cost-effectiveness that we believe our surgery centers provide and on syndicating our surgery centers to physicians who we believe will provide us with a high volume of cases and a favorable case mix in terms of reimbursement.
To that end, we are increasing our efforts to syndicate additional partnership interests in our surgery centers to appropriate physicians and to buy out physician partners who have retired, moved away from a center's service area or otherwise do not utilize the center as a significant extension of their practice. In addition, we believe that the geographic scope of our surgery centers and the cost-effective nature of services performed in a freestanding outpatient surgery center are attractive to payors, and we market our outpatient surgery centers to those payors.
DIAGNOSTIC SERVICES. We are the largest operator of outpatient diagnostic centers in the United States. At December 31, 2000, we operated 142 diagnostic centers in 31 states and the United Kingdom. Our diagnostic centers provide outpatient diagnostic imaging services, including MRI services, 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 our diagnostic centers are multi-modality centers offering multiple types of service.
We believe that the key factors influencing the diagnostic center business are quality of service, turnaround time, relationships with referring physicians and patient convenience. In our diagnostic centers, we attempt to obtain the services of the best available radiologists to provide high-quality interpretations and to provide modern, well-maintained equipment and well-trained technicians. We attempt to locate our diagnostic centers in areas which are convenient for physicians and patients and to focus on prompt performance of diagnostic procedures and turnaround of interpretation reports. In addition, we believe that the reputation and relationships we have established with physicians through our outpatient rehabilitation and outpatient surgery services help us market our diagnostic services to those physicians and others.
Our 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 us. Those radiologists prepare a report of the test and their findings, which are then delivered to the referring physician. Our diagnostic centers are open at hours designed to accommodate the needs of the patient population being served and the local demand for services.
Because many patients at our rehabilitative healthcare and outpatient surgery facilities require diagnostic procedures of the type performed at our diagnostic centers, we believe that our diagnostic operations are a natural complement to our other services and enhance our ability to market those services to patients and payors.
OUTPATIENT SERVICES MANAGEMENT. Our outpatient services are managed by local market managers, who are responsible for all outpatient services in particular local markets, and regional market leaders, who are responsible for overseeing the market managers in particular regions. The market leaders report to division presidents responsible for our Ambulatory Services--East and Ambulatory Services--West divisions. This management approach, introduced in September 1999, replaced an earlier system which had separate, corporate-office-based management teams for each line of business. The new structure puts significant authority for operations, development and managed care contracting decisions in the hands of experienced managers who are positioned to respond to particular local and regional demands, trends and opportunities, with a full range of centralized corporate support resources backing them up. We believe that this approach allows us to better leverage our comparative regional advantage in terms of market share, relationships with payors, physicians and referral sources, and local market knowledge and experience.
INTEGRATED SERVICE MODEL STRATEGY. Our ISM strategy is an integral part of our outpatient operations. In major markets, we seek to provide an integrated system of healthcare services, including, as appropriate, outpatient rehabilitation services, outpatient surgery services and outpatient diagnostic services, offering payors the convenience of dealing with a single provider for multiple services and enhancing cross-referral opportunities among our facilities. The ISM also includes inpatient rehabilitation services in appropriate markets. We have implemented our ISM in over 180 of our markets, and intend as our long-term goal to expand the model into the 300 largest markets in the United States.
Inpatient and Other Clinical Services Segment
Our inpatient and other clinical services segment includes the operations of our inpatient rehabilitation facilities and medical centers, as well as the operations of certain other clinical services which are managerially aligned with our inpatient services. During the year ended December 31, 2000, our inpatient rehabilitation facilities achieved an overall utilization, based on patient days and available beds, of 79.6%. In measuring patient utilization of our inpatient facilities, various factors must be considered. Due to market demand, demographics, start-up status, renovation, patient mix and other factors, we 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. We are generally in a position to increase the number of available beds at such facilities as market conditions dictate.
INPATIENT REHABILITATION FACILITIES. At December 31, 2000, we operated 120 inpatient rehabilitation facilities with 7,696 licensed beds in the continental 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 and a 17-bed rehabilitation facility in Puerto Rico. Our inpatient rehabilitation facilities provide high-quality comprehensive services to patients who require intensive institutional rehabilitation care.
We believe that the key factors influencing the inpatient rehabilitation services business are cost and quality of care, clinical outcomes, relationships with payors, case managers, discharge planners and referral sources, and reimbursement rates. We believe that our reputation for quality of care and cost-effectiveness positions us well with payors and others to compete for patients. In addition, we believe that the economies of scale that we enjoy and the standardized clinical protocols that we utilize enable us to operate our inpatient rehabilitation facilities in a cost-effective manner that we expect will benefit us when the current cost-based Medicare reimbursement system for inpatient rehabilitation services is replaced by the new PPS system, which is expected to phase in sometime in 2001. See this Item, "Business -- Regulation". Further, we believe that our strategy of joint venturing our rehabilitation hospitals with nearby tertiary-care hospitals, where appropriate opportunities exist, enables us to enhance our clinical and research activities, to obtain various support and ancillary services from the acute-care hospitals without duplication of resources, and to provide a more coordinated continuum of care for the constituencies served by those acute-care hospitals.
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. Our 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. All of our 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, our 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 our freestanding outpatient centers are utilized by these facilities.
A number of our 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. In addition to those facilities so developed by us, we have entered into or are pursuing similar affiliations with a number of our rehabilitation hospitals which were obtained through our major acquisitions.
Inpatient rehabilitation patients have typically been discharged from an acute-care setting. Accordingly, we focus on marketing our services to acute-care hospital discharge planners and to case managers utilized by payors and case management companies, who are typically influential in determining appropriate post-acute treatment settings for their patients. In addition, we market our services to physiatrists, neurologists, neurosurgeons, orthopaedic surgeons and other physicians involved in the care and referral of patients suited for inpatient rehabilitation.
MEDICAL CENTERS. At December 31, 2000, we operated five medical centers with 1,125 licensed beds in four geographic markets, including one facility managed under contract. These facilities provide general and specialty medical and surgical healthcare services, emphasizing orthopaedics, sports medicine and rehabilitation. We acquired our medical centers as outgrowths of our 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 we have acquired a medical center, we had well-established relationships with the medical communities serving each facility. Following the acquisition of each of our medical centers, we have provided the resources to improve upon the physical plant and expand services through the introduction of new technology. We have 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 our medical centers have improved their operating efficiencies and enhanced census.
Each of our medical center facilities is licensed as an acute-care hospital, is accredited by the JCAHO and participates in the Medicare acute-care prospective payment system. See this Item, "Business -- Regulation".
As described above, in the first quarter of 2001 we entered into a letter of intent to sell our Richmond, Virginia medical center and a related surgery center. See this Item, "Business - Recent Developments".
Other Patient Care Services
In some markets, we provide other patient care services, including physician services and contract management of hospital- based rehabilitative healthcare services. We evaluate 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 we provide or stand-alone businesses. These services are included within our business segment with which they are most closely aligned in the particular local market.
MARKETING
We market our services to patients, payors, physicians, case managers and other referral sources through a combination of national, regional and local strategies. We believe that these strategies have allowed us to develop a strong corporate brand identity, and have enabled us to focus our marketing efforts on particular demographic factors and competitive strengths in local and regional markets.
We develop a local 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.
Our larger-scale marketing activities are focused more broadly on efforts to generate patient referrals to multiple facilities and the creation of new business opportunities. These 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 and Multiplan, with national case management companies, such as INTRACORP and Crawford & Co., and with national employers, such as Delta Airlines, Georgia-Pacific Corporation, Federated Department Stores, Goodyear Tire & Rubber and Winn-Dixie.
We also carry out broader programs designed to further enhance our 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. We have ongoing relationships with the Professional Golfers Association, the Senior Professional Golfers Association, the Ladies Professional Golf Association, the Southwestern Athletic Conference, and other professional and amateur sports organizations, as well as numerous universities, colleges and high schools to provide sports medicine coverage of events and rehabilitative healthcare services for injured athletes. In addition, we have 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, HEALTHSOUTH 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.
We maintain a Web site at www.healthsouth.com, which provides information on the company, health information, targeted information and services for physicians and patients, links to our Securities and Exchange Commission filings and press releases, a facility locator and links to other relevant information, as well as other specialized Web sites. We believe that our Web sites enhance consumer and physician awareness of our services and locations and access to those services, as well as providing a valuable resource for health information related to the services that we provide.
We are a national sponsor of the United Cerebral Palsy Association and the National Arthritis Foundation and support many other charitable organizations on national and local levels. Through these endeavors, HEALTHSOUTH and its employees are able to support charitable organizations and activities within their communities.
SOURCES OF REVENUES
Most of our revenues come from non-governmental revenue sources. The following table sets forth the percentages of our revenues from various sources for the periods indicated:
- ------------------ (1) Includes commercial insurance, HMOs, PPOs and other managed care plans.
(2) Medicaid is included in this category, representing approximately 2% of 1999 revenues and 3% of 2000 revenues.
See this Item, "Business -- Regulation -- Medicare Participation and Reimbursement" for a description of certain of the reimbursement regulations applicable to our facilities.
COMPETITION
Our rehabilitation facilities compete on a local, 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 particular area. The primary competitive factors in the rehabilitation components of our 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 we do. We believe that we compete successfully within the marketplace based upon our reputation for quality, competitive prices, positive rehabilitation outcomes, innovative programs, clean and bright facilities and responsiveness to needs.
Our surgery centers compete primarily with hospitals and other operators of freestanding surgery centers in attracting physicians and patients and in developing new centers and 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, we believe that our national market system and our historical presence in many of the markets where our surgery centers are located enhance our ability to operate these facilities successfully.
Our diagnostic centers compete with local hospitals, other multi-center imaging companies, local independent diagnostic centers and imaging centers owned by local physician groups. We believe that the principal competitive factors in the diagnostic services business 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. We believe that our diagnostic facilities compete successfully within their respective markets, taking into account these factors.
Our 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. Our facilities compete directly with these local hospitals as well as various nationally recognized centers of excellence in orthopaedics, sports medicine and other specialties. Because our facilities enjoy a national and international reputation for orthopaedic surgery and sports medicine, we believe that our medical centers' level of service and continuum of care enable them to compete successfully, both locally and nationally.
We potentially face competition any time we initiate a Certificate of Need project or seek to acquire an existing facility or Certificate of Need. 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 Certificate of Need 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. We have generally been successful in obtaining Certificates of Need or similar approvals when required, although there can be no assurance that we 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 our business activities by controlling our growth, requiring licensure or certification of our facilities, regulating the use of our properties and controlling the reimbursement we receive 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 Certificate of Need program. States with Certificate of Need 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. Most states do not require such approvals for outpatient rehabilitation, occupational health and diagnostic facilities and services.
State Certificate of Need 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 must determine that a need exists for those beds, facilities or services. The Certificate of Need 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 agency 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 Certificate of Need is granted is based upon a finding of need by the agency in accordance with criteria set forth in Certificate of Need 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 agency will issue a Certificate of Need containing a maximum amount of expenditure and a specific time period for the holder of the Certificate of Need to implement the approved project.
Licensure and certification are separate, but related, regulatory activities. Licensure is usually a state or local requirement, and certification 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 our inpatient rehabilitation facilities and medical centers and substantially all of our 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. Most states do not require diagnostic and occupational medicine facilities to be licensed.
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 our inpatient facilities, except for our St. Louis head injury center, participate in the Medicare program. Approximately 1,178 of our outpatient rehabilitation facilities currently participate in, or are awaiting the assignment of a provider number to participate in, the Medicare program. All of our surgery centers are certified (or awaiting certification) under the Medicare program. Diagnostic and occupational health facilities are not certified by the Medicare program. Our 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. We have developed our operational systems to attempt to assure compliance with the various standards and requirements of the Medicare program and have established ongoing quality assurance activities to monitor compliance.
As a result of the Social Security Act Amendments of 1983, Congress adopted a PPS to cover the routine and ancillary operating costs of most Medicare inpatient acute-care 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, reimbursement received by an acute-care hospital 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 acute-care
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. Our medical center facilities are generally subject to acute-care PPS with respect to Medicare inpatient services.
The acute-care 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 have been exempt from PPS, and inpatient rehabilitation units within acute-care hospitals have been eligible to obtain an exemption from PPS upon satisfaction of certain federal criteria. As discussed below, freestanding inpatient rehabilitation facilities and hospital-based inpatient rehabilitation units are to be placed under a PPS currently expected to be phased in beginning later in 2001.
Currently, 17 of our outpatient centers are Medicare-certified Comprehensive Outpatient Rehabilitation Facilities ("CORFs") and 983 are Medicare-certified rehabilitation agencies or satellites. Additionally, we have certification applications pending for two 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. Our outpatient rehabilitation facilities submit monthly bills to their fiscal intermediaries for services provided to Medicare beneficiaries, and we file annual cost reports with the intermediaries for each such facility.
Our inpatient facilities (other than the medical center facilities) either are not currently covered by PPS or are currently exempt from PPS, and are currently 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. Annual cost reports are filed with our 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, which was expected to be phased in beginning April 2001, and to be fully implemented by April 2003. The Act required that the rates must equal 98% of the amount of payments that would have been if the PPS had not been adopted. More recently, the Medicare, Medicaid, and SCHIP Benefits Improvement and Protection Act of 2000 amended the requirements of the Balanced Budget Act to require that rates for federal fiscal year 2002 must equal 100% of the amount of payments that would have been made if the PPS had not been adopted and to allow inpatient rehabilitation facilities to elect to transition immediately to full PPS reimbursement in their first cost reporting year beginning after the effective date of PPS implementation, instead of having PPS phased in over three cost reporting years, as originally required. Final regulations implementing inpatient rehabilitation PPS have not yet been released, and the United States Department of Health and Human Services has announced that it intends to delay the scheduled April 1, 2001 implementation date to a later date that has not yet been determined. In addition, the Act requires the establishment of a PPS for hospital outpatient department services, effective for services furnished beginning in 1999. Regulations implementing that requirement became effective August 1, 2000. We do not expect those regulations to have a material effect on us.
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, these proposed rules have not been promulgated in final form, and we cannot currently predict when final rules, if any, will be adopted or the content or effect on our operations of those 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 HEALTHSOUTH 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 or cost reporting error could result in significant civil or criminal penalties.
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 (a) 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 (b) 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 issued regulations describing compensation arrangements which are not viewed as illegal remuneration under the Fraud and Abuse Law (the "1991 Safe Harbor Rules"). The 1991 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 that 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.
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 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 it has not violated the Fraud and Abuse Law.
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, and has continued to rely on such Fraud Alert in later pronouncements. We currently operate 23 of our rehabilitation hospitals and many of our outpatient rehabilitation facilities as limited partnerships or limited liability companies (collectively, "partnerships") with third-party investors. Six of the rehabilitation hospital partnerships involve physician investors and 17 of the rehabilitation hospital partnerships involve other institutional healthcare providers. Eight of the outpatient partnerships currently have a total of 21 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 we have established with physicians and other healthcare providers do not fit within any of the Safe Harbors. The 1991 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 indicated that failure to fall within a Safe Harbor may subject an arrangement to increased scrutiny.
Most of our surgery centers are owned by partnerships, which include as partners physicians who perform surgical or other procedures at such centers. On November 19, 1999, the Department of Health and Human Services promulgated rules setting forth additional Safe Harbors under the Fraud and Abuse Law (the "1999 Safe Harbors"). Included in the 1999 Safe Harbors is a Safe Harbor which would protect payments to investors in ambulatory surgery centers who are surgeons who refer patients directly to the center and perform surgery themselves on referred patients as an extension of their practices (the "ASC Safe Harbor"). Under the ASC Safe Harbor, ownership in a freestanding ambulatory surgery center will be protected if a number of conditions are satisfied. Included in those conditions is a requirement that each investor be either (a) a surgeon who derived at least one-third of his medical practice income for
the previous fiscal year or twelve-month period from performing procedures on the list of Medicare-covered procedures for ambulatory surgery centers or (b) not in a position to make or influence referrals to the center, nor provide items or services to the center, nor an employee of the center or of any investor. In addition, if all physician investors are not members of a single specialty, at least one-third of the Medicare-eligible ambulatory surgery procedures performed by each physician investor for the previous fiscal year or previous twelve-month period must be performed at the center in which the investment is made. Since a subsidiary of HEALTHSOUTH is an investor in each partnership which owns a surgery center and provides management and other services to the surgery center, our arrangements with physician investors do not fit within the specific terms of the ASC Safe Harbor. In addition, because we do not control the medical practices of our physician investors or control where they perform surgical procedures, it is possible that the quantitative tests described above will not be met, or that other conditions of the ASC Safe Harbor will not be met. Accordingly, while the ASC Safe Harbor is helpful in establishing the principle that a physician investor's interest in a surgery center partnership should be considered as an extension of the physician's practice and not as a prohibited financial relationship, there can be no assurance that such ownership interests will not be challenged under the Fraud and Abuse Law. We believe, however, that our arrangements with physicians with respect to surgery center facilities should not fall within the activities prohibited by the Fraud and Abuse Law.
Some of our 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, we do 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, our 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 our lithotripsy equipment, we believe that the same analysis underlying the ASC Safe Harbor should apply to ownership interests in lithotripsy equipment held by urologists. In addition, we believe 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 our 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 our partnerships. We believe that our operations are 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 we have established with physicians or other healthcare providers or result in the imposition of penalties on HEALTHSOUTH or particular HEALTHSOUTH facilities. Even the assertion of a violation could have a material adverse effect upon our business, results of operations or financial condition.
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 our 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. On January 4, 2001, the Department of Health and Human Services published final regulations relating to part of the Stark II statute (the "Phase I Final Stark Regulations") and announced its intention to publish a second, "Phase II" set of regulations covering the remainder of the statute and responding to comments received on the Phase I Final Stark Regulations at some unspecified future date. The Phase I Final Stark Regulations, which differ substantially in many respects from the Proposed Stark Regulations, have a specified effective date of January 4, 2002; however, recent actions by the new Administration have suspended the effective date of all regulations that had not yet gone into effect pending its review. We cannot currently predict whether this suspension will have the effect of delaying
the January 4, 2002 date. 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, we have restructured most of our partnerships which involve physician investors to the extent required by applicable law, in order to eliminate physician ownership interests not permitted by applicable law. We intend 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. We believe that this restructuring has not adversely affected and will not adversely affect the operations of our facilities.
Ambulatory surgery is not identified as a "designated health service" under Stark II, and we do not believe the statute is intended to cover ambulatory surgery services. The Phase I Final Stark Regulations expressly clarify that the provision of designated health services in an ambulatory surgery center is excepted from the referral prohibition of Stark II if payment for such designated health services is included in the ambulatory surgery center payment rate.
Our lithotripsy units 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. However, the Phase I Final Stark Regulations indicate that lithotripsy services provided at a hospital would constitute "inpatient and outpatient hospital services" and thus would be subject to Stark II. Based upon the Phase I Final Stark Regulations and the associated commentary by the Health Care Financing Administration, we believe that the operations of our lithotripsy partnerships, to the extent that they involve designated health services, either fall within exceptions contained in the Phase I Final Stark Regulations or, depending on the particular situation, might be restructured to comply with them before the effective date of the Phase I Final Stark Regulations. To the extent practicable, we intend to take such steps as may be required to cause such partnerships to be in compliance. If we are required to terminate any of these relationships, we believe such action will not adversely affect our operations. In addition, physicians frequently perform endoscopic procedures in the procedure rooms of our surgery centers, and it is possible to construe such services to be "designated health services". While we do not believe that Stark II was intended to apply to such services, if that were determined to be the case, we intend to take steps necessary to cause the operations of our facilities to comply with the law.
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 "health care 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.
In addition, HIPAA mandates, for all healthcare providers, standardization in the use, storage, and transfer of electronically transmitted healthcare data and also requires that healthcare providers, payors and clearinghouses adopt detailed new procedures for ensuring the privacy and security of individually identifiable health information. In August 2000, the Department of Health and Human Services published final regulations adopting standards for electronic transactions and for code sets to be used in those transactions. Those regulations have a specified effective date of October 16, 2002 for most providers, including us. In December 2000, the Department released final regulations establishing standards for the privacy of individually identifiable health information. The final privacy regulations, which differ substantially from previously proposed regulations, impose significant limitations on the use and disclosure of individually identifiable health information by providers, including us, as well as payors and clearinghouses. The final regulations are currently scheduled to take effect in April 2003. The final privacy regulations have been significantly criticized by many parts of the healthcare industry, and further changes in such regulations or delays in their implementation are possible.
Compliance with the HIPAA privacy and electronic standards regulations will require significant changes in current information and claims processing practices utilized by healthcare providers, including us. It is not possible at this time to estimate the cost of such compliance. However, we have taken steps intended to ensure that we will comply with the applicable regulations by their respective effective dates, and we believe that we will be able to do so without a material adverse effect on our business, financial condition or results of operations.
We cannot predict whether other regulatory or statutory provisions will be enacted by federal or state authorities which would prohibit or otherwise regulate relationships which we have 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. We believe, however, that we will be able to adjust our operations so as to be in compliance with any regulatory or statutory provision that may be applicable. See this Item, "Business -- Patient Care Services" and "Business -- Sources of Revenues".
INSURANCE
Beginning December 1, 1993, we became self-insured for professional liability and comprehensive general liability. We purchased coverage for all claims incurred prior to December 1, 1993. In addition, we 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, 2000, we had adequate reserves to cover losses on asserted and unasserted claims. In the fourth quarter of 2000, we formed an offshore captive insurance subsidiary to which we expect to transition the administration of our self-insurance programs.
In connection with our October 1997 acquisition of Horizon/CMS Healthcare Corporation, HEALTHSOUTH assumed responsibility for handling Horizon/CMS's open professional and general liability claims. We have entered into an agreement with an insurance carrier to assume responsibility for the majority of open claims. Under this agreement, a "risk transfer" converted Horizon/CMS's self-insured claims to insured liabilities consistent with the terms of the underlying insurance policy.
EMPLOYEES
As of December 31, 2000, we employed approximately 53,216 persons, of whom 34,427 were full-time employees and 18,789 were part-time or per diem employees. Of the above employees, 863 (including 39 part-time or per diem employees) were employed at our headquarters in Birmingham, Alabama. Except for approximately 93 employees at one rehabilitation hospital (about 16% of that facility's workforce), none of our employees are represented by a labor union. We are not aware of any current activities to organize our employees at other facilities. Management considers the relationship between HEALTHSOUTH and its employees to be good.
ITEM 2.
ITEM 2. PROPERTIES.
HEALTHSOUTH's executive offices occupy a headquarters building of approximately 200,000 square feet in Birmingham, Alabama. The headquarters building was constructed on a 73-acre parcel of land owned by HEALTHSOUTH pursuant to a tax retention operating lease structured through NationsBanc Leasing Corporation. Substantially all of our outpatient rehabilitation and occupational medicine operations are carried out in leased facilities. We own 45 of our inpatient rehabilitation facilities and lease or operate under management contracts the remainder of our inpatient rehabilitation facilities. We also own 80 of our surgery centers and 41 of our diagnostic centers and lease or operate under management arrangements the remainder. We constructed our 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 our Memphis, Tennessee rehabilitation hospital is located is owned in partnership by HEALTHSOUTH and Methodist Healthcare-Memphis Hospitals. We own four of our medical center facilities and manage one under contract. We currently own, and from time to time may acquire, certain other improved and unimproved real properties in connection with our business. See Notes 5 and 7 of "Notes to Consolidated Financial Statements" for information with respect to the properties we own and certain related indebtedness.
In management's opinion, our physical properties are adequate for our needs for the foreseeable future, and are consistent with our expansion plans described elsewhere in this Annual Report on Form 10-K.
The following table sets forth a listing of our primary domestic patient care services locations (including both facilities owned or leased by HEALTHSOUTH and facilities under management agreements or similar arrangements) at December 31, 2000:
- ------------------ (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.
(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, 2000, we operated six diagnostic centers and one outpatient rehabilitation center in the United Kingdom, one 71-bed rehabilitation hospital in Australia and one 17-bed inpatient rehabilitation facility in Puerto Rico, as well as numerous locations in various states providing other services. We also provided occupational medicine services at four industrial plants in Canada. See this Item, "Business -- Recent Developments", for a description of pending divestiture transactions.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
In the ordinary course of its business, HEALTHSOUTH may be subject, from time to time, to claims and legal actions by patients and others. We do not believe that any such pending actions, if adversely decided, would have a material adverse effect on our financial condition. See Item 1, "Business -- Insurance" for a description of our insurance coverage arrangements.
From time to time, we appeal decisions of various rate-making authorities with respect to Medicare rates established for HEALTHSOUTH 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 HEALTHSOUTH's operations.
SECURITIES LITIGATION
HEALTHSOUTH was served with various lawsuits filed beginning September 30, 1998 purporting to be class actions under the federal and Alabama securities laws. Such lawsuits were filed following a decline in our stock price at the end of the third quarter of 1998. Seven such suits were filed in the United States District Court for the Northern District of Alabama. In January 1999, those suits were ordered to be consolidated under the case style In re HEALTHSOUTH Corporation Securities Litigation, Master File No. CV98-O-2634-S. On April 12, 1999, the plaintiffs filed a consolidated amended complaint against HEALTHSOUTH and certain of our current and former officers and directors alleging that, during the period April 24, 1997 through September 30, 1998, the defendants misrepresented or failed to disclose certain material facts concerning our business and financial condition and the impact of the Balanced Budget Act of 1997 on our operations in order to artificially inflate the price of our 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 the consolidated amended complaint also claim to represent separate subclasses consisting of former stockholders of Horizon/CMS Healthcare Corporation and National Surgery Centers, Inc. ("NSC") who received shares of HEALTHSOUTH common stock in connection with our 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.
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 our business and financial condition, allegedly in violation of Sections 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 HEALTHSOUTH. That suit largely replicates the allegations originally set forth in the individual complaints filed in the federal actions described in the preceding paragraph and alleges that the current directors of HEALTHSOUTH, certain former directors and certain officers of HEALTHSOUTH breached their fiduciary duties to HEALTHSOUTH and engaged in other allegedly tortious conduct. The plaintiff in that case has forborne pursuing its claim thus far pending further developments in the federal action, and the defendants have not yet been required to file a responsive pleading in the case.
We filed a motion to dismiss the consolidated amended complaint in the federal action in late June 1999. On September 13, 2000, the magistrate judge issued his report and recommendation, recommending that the court dismiss the amended complaint in its entirety, with leave to amend. The plaintiffs objected
to that report, and we responded to that objection. On December 20, 2000, without oral argument, the court issued an order rejecting the magistrate judge's report and recommendation and denying our motion to dismiss. We believed that the December 20, 2000 order failed to follow the standards required under the Private Securities Litigation Reform Act of 1995 and Rule 9(b) of the Federal Rules of Civil Procedure, and we filed a motion asking the court to reconsider that order or to certify it for an interlocutory appeal to the United States Eleventh Circuit Court of Appeals. Oral argument on that motion was held on March 2, 2001, and the court denied that motion on March 12, 2001. Accordingly, we filed our answer to the consolidated amended complaint on March 26, 2001. We believe that all claims asserted in the above suits are without merit, and expect to vigorously defend against such claims. Because such suits remain at an early stage, we cannot currently predict the outcome of any such suits or the magnitude of any potential loss if our defense is unsuccessful.
CERTAIN HORIZON/CMS LITIGATION
On October 29, 1997, we acquired Horizon/CMS through the merger of a wholly owned subsidiary of HEALTHSOUTH 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.
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. 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 Integrated Health Services, Inc. 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 continued at the pretrial hearing phase for over a year, including numerous adjournments, and Horizon/CMS is still awaiting a decision by the court as to 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, Continental Medical Systems, Inc. ("CMS"), a Horizon/CMS subsidiary acquired in 1995, 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. Some of the plaintiffs' claims were dismissed by order of the court in September 1999. 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' remaining claims and, as a result, intends to vigorously contest such claims. Horizon/CMS has also filed various counterclaims against the plaintiffs. Because this litigation remains at a procedurally early stage, HEALTHSOUTH 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 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 asserted that Horizon/CMS's alleged refusal to provide pregnant employees with light-duty assignments to accommodate their temporary disabilities caused by pregnancy violated Sections 701(k) and 703(a) of Title VII, 42 U.S.C. (section)(section) 2000e-(k) and 2000e-2(a). In this lawsuit, the EEOC sought, among other things, to permanently enjoin Horizon/CMS's employment practices in this regard. The trial court granted summary judgment in favor of Horizon/CMS on one count and dismissed the other count after a jury trial. The EEOC appealed the summary judgment ruling to the United States Court of Appeals for the Tenth Circuit, but did not appeal the dismissal of the other count. On July 31, 2000, a three-judge panel of the Court of Appeals reversed the summary judgment and remanded the case for trial on the sole remaining count. The matter has not yet gone to trial.
Texas Nursing Facility Litigation
In July 1996, Horizon/CMS was sued 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. On February 20, 1998, the court reduced the jury's verdict and entered a judgment in the amount of approximately $11,237,000. On August 24, 2000, the Texas Supreme Court upheld the trial court's damage award, as reduced, and remanded the case for a final recalculation of interest. All damages in this case less Horizon/CMS's self-insured retention of $250,000 were covered by insurance.
In addition, Horizon/CMS is the defendant in a case styled Cecil Fuqua, as Executor of the Estate of Wyvonne Fuqua, Deceased, v. Horizon/CMS Healthcare Corporation, Civil Action No. 4-98-CV- 1087-Y, United States District Court for the Northern District of Texas, Fort Worth Division. This case likewise involved injuries allegedly suffered by a resident at the Heritage Western Hills nursing facility. Horizon/CMS tendered the claim to its insurance carrier, which accepted coverage and provided a defense through the carrier's selected counsel. In October 2000, the court issued a sanctions order effectively preventing Horizon/CMS from raising any defense as to liability in the matter, and in February 2001, the jury returned a verdict against Horizon/CMS for actual damages totaling approximately $2,765,000 (plus 10% per annum prejudgment interest) and $310,000,000 in punitive damages. Horizon/CMS has filed various post-judgment motions for a new trial and for a reduction in the amount of the judgment, and has also filed a notice of its intent to appeal the judgment and various orders and rulings leading to the judgment once the court has ruled on the post-judgment motions. Horizon/CMS believes that it has strong arguments in support of its post-judgment motions and strong arguments to be made on appeal, if necessary. Horizon/CMS currently believes that the amount of the judgment will be reduced and the amount of any ultimate judgment or settlement will be covered by insurance. However, there can be no assurance that Horizon/CMS will be successful in having the judgment reduced or reversed, and Horizon/CMS and HEALTHSOUTH would potentially be liable for any portion of the judgment not covered by insurance.
Horizon/CMS was also a defendant in a case styled Lillian Ernst as Independent Executrix of the Estate of Robert Ernst, Deceased, v. Horizon/CMS Healthcare Corporation, et al., No. 99-CI-08116, 285th Judicial District Court, Bexar County, Texas. This case involved injuries allegedly suffered by a resident at the Blanco Vista nursing and rehabilitation facility in San Antonio, Texas. Horizon/CMS tendered the claim to its insurance carrier, which accepted coverage and provided a defense through the carrier's selected counsel. In February 2001, the jury returned a verdict against Horizon/CMS for actual damages of $7,000,000 and punitive damages of $75,000,000. The plaintiff and the insurance carrier agreed during trial that Horizon/CMS's liability would be capped at $20,000,000 and the carrier settled the claim for that amount after trial. The entire liability was paid by the insurance carrier, with no contribution from Horizon/CMS.
See Item 1, "Business -- Insurance".
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
HEALTHSOUTH common stock is listed for trading on the New York Stock Exchange under the symbol "HRC". The following table sets forth for the fiscal periods indicated the high and low reported sale prices for HEALTHSOUTH common stock as reported on the NYSE Composite Transactions Tape.
The closing price per share for HEALTHSOUTH common stock on the New York Stock Exchange on March 26, 2001 was $13.70.
There were approximately 6,884 holders of record of HEALTHSOUTH common stock as of March 26, 2001.
We have never paid cash dividends on our common stock (although certain of the companies we have acquired in pooling-of-interests transactions had paid dividends prior to such acquisitions), and we do not anticipate paying cash dividends in the foreseeable future. We currently anticipate that any future earnings will be retained to finance our operations.
RECENT SALES OF UNREGISTERED SECURITIES
There were no unregistered sales of equity securities by HEALTHSOUTH in 2000.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
Set forth below is a summary of selected consolidated financial data for HEALTHSOUTH for the years indicated. All amounts have been restated to reflect the effects of the 1996 acquisitions of Surgical Care Affiliates, Inc. ("SCA") and Advantage Health Corporation, the 1997 acquisition of Health Images, Inc. and the 1998 acquisition of NSC, each of which was accounted for as a pooling of interests.
- ---------- (1) Expenses related to the SCA, Advantage Health, Professional Sports Care Management, Inc. and ReadiCare, Inc. acquisitions in 1996, the Health Images acquisition in 1997 and the NSC acquisition in 1998.
(2) See "Notes to Consolidated Financial Statements".
(3) Adjusted to reflect a two-for-one stock split effected in the form of a 100% stock dividend paid on March 17, 1997.
(4) Diluted earnings per share in 1996 and 1997 reflect shares reserved for issuance upon conversion of HEALTHSOUTH's 5% Convertible Subordinated Debentures due 2001. Substantially all of those Debentures were converted into shares of HEALTHSOUTH common stock in 1997.
(5) Includes current portion of long-term debt.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
GENERAL
The following discussion is intended to facilitate the understanding and assessment of significant changes and trends related to the consolidated results of operations and financial condition of HEALTHSOUTH, including various factors related to acquisitions we have made during the periods indicated, the timing and nature of which have significantly affected our consolidated results of operations. This discussion and analysis should be read in conjunction with our consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K.
We completed the following major acquisitions over the last three years:
o On July 1, 1998, we acquired Columbia/HCA Healthcare Corporation's interest in (or entered into interim management arrangements with respect to) 34 outpatient surgery centers located in 13 states (the "Columbia/HCA Acquisition"). The cash purchase price was approximately $550,402,000.
o On July 22, 1998, we acquired National Surgery Centers, Inc. (the "NSC Acquisition"). A total of 20,426,261 shares of HEALTHSOUTH common stock were issued in connection with the transaction, representing a value of approximately $574,489,000. At that time, NSC operated 40 outpatient surgery centers in 14 states.
o On June 29, 1999, we acquired from Mariner Post-Acute Network, Inc. ("Mariner") substantially all of the assets of Mariner's American Rehability Services division (the "Rehability Acquisition"), which operated approximately 160 outpatient rehabilitation centers in 18 states. The net cash purchase price was approximately $54,521,000.
Each of the Columbia/HCA Acquisition and the Rehability Acquisition was accounted for under the purchase method of accounting and, accordingly, the acquired operations are included in our consolidated financial statements from their respective dates of acquisition. The NSC Acquisition was accounted for as a pooling of interests and, with the exception of data set forth relating to revenues derived from Medicare and Medicaid, all amounts shown in the following discussion have been restated to reflect such acquisitions. NSC did not separately track such revenues (see Note 2 of "Notes to Consolidated Financial Statements" for further discussion).
We determine the amortization period of the cost in excess of net asset value of purchased facilities based on an evaluation of the facts and circumstances of each individual purchase transaction. The evaluation includes an analysis of historic and projected financial performance, an evaluation of the estimated useful life of the buildings and fixed assets acquired, the indefinite useful life of certificates of need and licenses acquired, the competition within local markets, lease terms where applicable, and the legal terms of partnerships where applicable. We utilize independent appraisers and rely on our own management expertise in evaluating each of the factors noted above. With respect to the carrying value of the excess of cost over net asset value of individual purchased facilities and other intangible assets, we determine on a quarterly basis whether an impairment event has occurred by considering factors such as the market value of the asset, a significant adverse change in legal factors or in the business climate, adverse action by regulators, a history of operating losses or cash flow losses, or a projection of continuing losses associated with an operating entity. The carrying value of excess cost over net asset value of purchased facilities and other intangible assets will be evaluated if the facts and circumstances suggest that it has been impaired. If this evaluation indicates that the value of the asset will not be recoverable, as determined based on the undiscounted cash flows of the entity acquired over the remaining amortization period, our carrying value of the asset will be reduced by the estimated shortfall of cash flows to the estimated fair market value.
Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about Segments of an Enterprise and Related Information" requires an enterprise to report operating segments based upon the way its operations are managed. This approach defines operating segments along the lines used by
management to assess performance and make operating and resource allocation decisions. Based on our management and reporting structure, segment information has been presented for inpatient and other clinical services, outpatient services -- East and outpatient services -- West.
The inpatient and other clinical services segment primarily includes the operations of our inpatient rehabilitation facilities and medical centers, as well as the operations of certain physician practices and other clinical services which are managerially aligned with our inpatient services. The outpatient services segments primarily include the operations of our outpatient rehabilitation facilities, outpatient surgery centers and outpatient diagnostic centers and follow the geographic management reporting structure we use for our outpatient services operations.
See Note 14 of "Notes to Consolidated Financial Statements" for financial data for each of our operating segments.
Our revenues include net patient service revenues and other operating revenues. Net patient service revenues are reported at estimated net realizable amounts from patients, insurance companies, third-party payors (primarily Medicare and Medicaid) and others for services rendered. Revenues from third-party payors also include estimated retroactive adjustments under reimbursement agreements which are subject to final review and settlement by appropriate authorities. We determine allowances for doubtful accounts based on the specific agings and payor classifications at each facility, and contractual adjustments based on historical experience and the terms of payor contracts. Net accounts receivable include only those amounts we estimate to be collectible.
Substantially all of our revenues are derived from private and governmental third-party payors. Our reimbursement from governmental third-party payors is based upon cost reports and other reimbursement mechanisms which require the application and interpretation of complex regulations and policies, and such reimbursement is subject to various levels of review and adjustment by fiscal intermediaries and others, which may affect the final determination of reimbursement. In addition, there are increasing pressures from many payor sources to control healthcare costs and to reduce or limit increases in reimbursement rates for medical services. There can be no assurance that payments under governmental and third-party payor programs will remain at levels comparable to present levels. In addition, there have been, and we expect that there will continue to be, a number of proposals to limit Medicare reimbursement for certain services. We cannot now predict whether any of these proposals will be adopted or, if adopted and implemented, what effect such proposals would have on us. Changes in reimbursement policies or rates by private or governmental payors could have an adverse effect on our future results of operations.
In many cases, we operate more than one site within a market. In such markets, there is customarily an outpatient center or inpatient facility with associated satellite outpatient locations. For purposes of the following discussion and analysis, same store operations are measured on locations within markets in which similar operations existed at the end of the period and include the operations of additional locations opened within the same market. New store operations are measured on locations within new markets. We may, from time to time, close or consolidate similar locations in multi-site markets to obtain efficiencies and respond to changes in demand.
RESULTS OF OPERATIONS
Twelve-Month Periods Ended December 31, 1998 and 1999
Our operations generated revenues of $4,072,107,000 in 1999, an increase of $66,033,000, or 1.6%, as compared to 1998 revenues. Same store revenues for the twelve months ended December 31, 1999 were $4,023,696,000, an increase of $97,792,000, or 2.4%, as compared to the same period in 1998, excluding discontinued home health operations. New store revenues for 1999 were $48,411,000. The increase in revenues is primarily attributable to the addition of new operations and increases in patient volume. Revenues generated from patients under the Medicare and Medicaid programs respectively accounted for 33.0% and 2.2% of total revenues for 1999, compared to 35.9% and 2.7% of total revenues for 1998. Revenues from any other single third-party payor were not significant in relation to our total revenues.
During 1999, same store inpatient days, outpatient visits, surgical cases and diagnostic cases increased 6.9%, 10.1%, 13.0% and 10.8%, respectively. Revenue per inpatient day, outpatient visit, surgical case and diagnostic case for same store operations decreased by (7.0)%, (1.3)%, (5.1)% and (7.2)%, respectively.
Operating expenses (expenses excluding corporate general and administrative expenses, provision for doubtful accounts, depreciation and amortization and interest expense) were $2,688,849,000, or 66.0% of revenues, for 1999, compared to 62.2% of revenues for 1998. Included in operating expenses for the year ended December 31, 1999, is a non-recurring expense item of approximately $40,183,000 which related primarily to our plan to write off obsolete equipment. During the fourth quarter of 1999, we reviewed equipment that had originally been acquired through various company mergers and acquisitions. During the acquisitions it was our intention to either continue using the equipment or transfer it to other locations where it could be utilized. During the fourth quarter of 1999, an obsolescence charge was taken based on our determination that certain equipment was obsolete due to changes in available technologies. Excluding the non-recurring expense, operating expenses were $2,648,666,000, or 65.0% of revenues, for the year ended December 31, 1999. The increase in operating expenses as a percentage of revenues is primarily attributable to the decline in same store revenues per inpatient day, outpatient visit, surgical case and diagnostic case. Same store operating expenses for 1999, excluding the non-recurring expense item noted above, were $2,614,953,000, or 65.0% of related revenues. New store operating expenses were $33,713,000, or 69.6% of related revenues. Corporate general and administrative expenses increased from $112,800,000 in 1998 to $149,285,000 in 1999. Included in corporate general and administrative expenses for the year ended December 31, 1999, is a non-recurring expense item of approximately $29,798,000. This expense item included write-offs of investments and notes of $14,603,000, expenses related to year 2000 remediation of $13,429,000 and expenses related to the proposed spin-off of our inpatient operations of $1,766,000. As part of our evaluation of the proposed spin-off in 1999, we determined that certain notes and investments totaling $14,603,000 should be written off. The year 2000 remediation expenditures were incurred during 1999 while testing for year 2000 compliance. Excluding the non-recurring expense, as a percentage of revenues, corporate general and administrative expenses increased from 2.8% in 1998 to 2.9% in 1999. Total operating expenses were $2,838,134,000, or 69.7% of revenues, for 1999, compared to $2,604,714,000, or 65.0% of revenues, for 1998. The provision for doubtful accounts was $342,708,000, or 8.4% of revenues, for 1999, compared to $112,202,000, or 2.8% of revenues, for 1998. Included in the provision for doubtful accounts is $117,752,000 in expense recognized in the third quarter of 1999 and $139,835,000 in expense recognized in the fourth quarter of 1999. The third quarter provision includes the charge-off of accounts receivable of facilities included in the impairment and restructuring charges recognized in 1998. These accounts receivable were determined to be uncollectible by local and regional operations management personnel who assumed collection responsibilities in the third quarter of 1999 in connection with the restructuring of our outpatient regional business offices, which had previously been responsible for collection activities. The fourth quarter charge reflected management's decision to adopt a more conservative approach in estimating the allowance for doubtful accounts. The revision in estimating the allowance for doubtful accounts was due to management's assessment of the healthcare payor environment. This approach focused more heavily upon the specific agings and payor classifications at each facility, as opposed to determining an estimate based primarily on historical write-off rates. Due to a deterioration of the payor environment, our days sales outstanding at the end of the second quarter of 1999 had grown to 94.5 days. Our subsequent reviews uncovered tremendous volumes of denied or pended claims. Further commitment to collecting these older receivables would have diluted our effectiveness in collecting current, ongoing accounts.
Depreciation and amortization expense was $374,248,000 for 1999, compared to $344,591,000 for 1998. The increase resulted from our investment in additional assets. Interest expense increased to $176,652,000 in 1999, compared to $148,163,000 for 1998, primarily because of the increased amount outstanding under our credit facilities (see "Liquidity and Capital Resources"). For 1999, interest income was $10,587,000, compared to $11,286,000 for 1998.
During the fourth quarter of 1999, we completed our budgets for the 2000 fiscal year. The existence of locations budgeting operating losses before interest, taxes, depreciation and amortization initiated our
need for a detail oriented impairment review. During the fourth quarter of 1999, we recorded a non-recurring expense item of $121,037,000 related to the impairment of long-term assets. The charge was based on a facility-by-facility review of each facility's financial performance which determined if there were trends that would indicate that the facility's ability to recover its investment in long-lived assets had been impaired. The evaluation indicated that the value of the asset would not be recoverable, as determined based on the undiscounted cash flows of the entity over the remaining amortization period, and the impairment loss was calculated based on the excess of the carrying amount of the asset over the asset's fair value. For further discussion, see Note 13 of "Notes to Consolidated Financial Statements".
Total unusual and non-recurring charges and expenses included in the results of operations for the year ended December 31, 1999 were approximately $448,605,000.
Income before minority interests and income taxes for 1999 was $229,915,000, compared to $267,373,000 for 1998. Minority interests reduced income before income taxes by $86,469,000 in 1999, compared to $77,468,000 for 1998. The provision for income taxes for 1999 was $66,929,000, compared to $143,347,000 for 1998. Excluding the tax effects of the impairment and restructuring charges in both periods and the merger costs and the loss on sale of assets in 1998, the effective tax rate for 1999 was 39.5%, compared to 39.0% for 1998 (see Note 10 of "Notes to Consolidated Financial Statements" for further discussion). Net income for 1999 was $76,517,000.
Twelve-Month Periods Ended December 31, 1999 and 2000
Our operations generated revenues of $4,195,115,000 in 2000, an increase of $123,008,000, or 3.0%, as compared to 1999 revenues. Same store revenues for the twelve months ended December 31, 2000 were $4,121,055,000, an increase of $48,948,000, or 1.2%, as compared to the same period in 1999. New store revenues for 2000 were $74,060,000. The increase in revenues is primarily attributable to increases in patient volume. Revenues generated from patients under the Medicare and Medicaid programs respectively accounted for 29.0% and 2.6% of total revenues for 2000, compared to 33.0% and 2.2% of total revenues for 1999. Revenues from any other single third-party payor were not significant in relation to our total revenues. During 2000, same store inpatient days, outpatient visits, surgical cases and diagnostic cases increased 4.6%, 3.5%, 1.8% and 6.2%, respectively. Revenue per inpatient day, outpatient visit, surgical case and diagnostic case for same store operations (decreased) increased by (2.3)%, 0.4%, 1.8% and (10.2)%, respectively.
Operating unit expenses (expenses excluding corporate general and administrative expenses, provision for doubtful accounts, depreciation and amortization and interest expense) were $2,816,363,000, or 67.1% of revenues, for 2000, compared to 66.0% of revenues for 1999. Same store operating expenses for 2000 were $2,762,795,000, or 67.0% of related revenues. New store operating expenses were $53,568,000, or 72.3% of related revenues. Corporate general and administrative expenses decreased from $149,285,000 in 1999 to $148,023,000 in 2000. As described above, included in corporate general and administrative expenses for the year ended December 31, 1999, is a non-recurring expense item of approximately $29,798,000. Excluding the non-recurring expense, as a percentage of revenues, corporate general and administrative expenses increased from 2.9% in 1999 to 3.5% in 2000. Total operating expenses were $2,964,386,000, or 70.7% of revenues, for 2000, compared to $2,838,134,000, or 69.7% of revenues, for 1999. The provision for doubtful accounts was $98,037,000, or 2.3% of revenues, for 2000, compared to $342,708,000, or 8.4% of revenues, for 1999. Included in the 1999 provision for doubtful accounts is $117,752,000 in expense recognized in the third quarter of 1999 and $139,835,000 in expense recognized in the fourth quarter of 1999.
Depreciation and amortization expense was $360,847,000 for 2000, compared to $374,248,000 for 1999. The decrease was primarily attributable to the full amortization of certain intangible assets. Interest expense increased to $221,595,000 in 2000, compared to $176,652,000 for 1999, primarily attributable to increases in effective interest rates (see "Liquidity and Capital Resources"). For 2000, interest income was $9,104,000, compared to $10,587,000 for 1999.
Income before minority interests and income taxes for 2000 was $559,354,000, compared to $229,915,000 for 1999. Minority interests reduced income before income taxes by $99,081,000 in 2000, compared to $86,469,000 for 1999. The provision for income taxes for 2000 was $181,808,000, compared
to $66,929,000 for 1999. Excluding the tax effects of the impairment and restructuring charges in 1999, the effective tax rate for 1999 and 2000 was 39.5% (see Note 10 of "Notes to Consolidated Financial Statements" for further discussion). Net income for 2000 was $278,465,000.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2000, we had working capital of $1,048,204,000, including cash and marketable securities of $180,407,000. Working capital at December 31, 1999 was $852,711,000, including cash and marketable securities of $132,882,000. For 2000, cash provided by operations was $796,764,000, compared to $704,511,000 for 1999. For 2000, investing activities used $757,304,000, compared to using $614,859,000 for 1999. The change is primarily due to increased purchases of property, plant and equipment. Additions to property, plant and equipment and acquisitions accounted for $583,639,000 and $74,137,000, respectively, during 2000. Those same investing activities accounted for $474,115,000 and $104,304,000, respectively, in 1999. Financing activities provided $11,457,000 and used $99,079,000 during 2000 and 1999, respectively. The change is primarily due to significantly higher purchases of treasury stock in 1999. Net borrowing proceeds for 2000 and 1999 were $89,007,000 and $285,379,000, respectively.
Net accounts receivable were $946,965,000 at December 31, 2000, compared to $891,829,000 at December 31, 1999. The number of days of average quarterly revenues in ending receivables was 80.9 at December 31, 2000, compared to 82.0 at December 31, 1999. See Note 1 of "Notes to Consolidated Financial Statements" for the concentration of net accounts receivable from patients, third-party payors, insurance companies and others at December 31, 2000 and 1999.
We have a $1,750,000,000 revolving credit facility with Bank of America, N.A. ("Bank of America") and other participating banks (the "1998 Credit Agreement"). Interest on the 1998 Credit Agreement is paid based on LIBOR plus a predetermined margin, a base rate, or competitively bid rates from the participating banks. We are required to pay a fee based on the unused portion of the revolving credit facility ranging from 0.09% to 0.25%, depending on certain defined credit ratings. The principal amount is payable in full on June 22, 2003. We have provided a negative pledge on all assets under the 1998 Credit Agreement. The effective interest rate on the average outstanding balance under the 1998 Credit Agreement was 6.92% for the twelve months ended December 31, 2000, compared to the average prime rate of 9.21% during the same period. At December 31, 2000, we had drawn $1,655,000,000 under the 1998 Credit Agreement. For further discussion, see Note 7 of "Notes to Consolidated Financial Statements".
We also had a Short Term Credit Agreement with Bank of America (as amended, the "Short Term Credit Agreement"), providing for a $250,000,000 short term revolving credit facility. The terms of the Short Term Credit Agreement were substantially consistent with those of the 1998 Credit Agreement. Interest on the Short Term Credit Agreement was paid based on LIBOR plus a predetermined margin or a base rate. We were required to pay a fee on the unused portion of the credit facility ranging from 0.30% to 0.50%, depending on certain defined ratios. On October 31, 2000, we terminated the Short Term Credit Agreement and replaced it with a new $400,000,000 Credit Agreement (the "2000 Credit Agreement") with UBS AG and other participating banks. Interest on the 2000 Credit Agreement is paid based on LIBOR plus a predetermined margin or base rate. We are required to pay a fee on the unused portion of the credit facility ranging from 0.25% to 0.50%, depending on certain defined ratios. The principal amount is payable in full in eight quarterly installments ending on June 22, 2003. At December 31, 2000, we had no drawings outstanding under the 2000 Credit Agreement.
On March 24, 1994, we issued $250,000,000 principal amount of 9.5% Senior Subordinated Notes due 2001 (the "9.5% Notes"). We redeemed the 9.5% Notes at par on October 30, 2000.
On March 20, 1998, we issued $500,000,000 in 3.25% Convertible Subordinated Debentures due 2003. An additional $67,750,000 principal amount of the 3.25% Convertible Debentures was issued on March 31, 1998 to cover underwriters' overallotments. Interest is payable on April 1 and October 1. The 3.25% Convertible Debentures are convertible into HEALTHSOUTH common stock at the option of the holder at a conversion price of $36.625 per share. The conversion price is subject to adjustment upon the occurrence of (a) a subdivision, combination or reclassification of outstanding shares of our common
stock, (b) the payment of a stock dividend or stock distribution on any shares of our capital stock, (c) the issuance of rights or warrants to all holders of our common stock entitling them to purchase shares of our common stock at less than the current market price, or (d) the payment of certain other distributions with respect to our common stock. In addition, we may, from time to time, lower the conversion price for periods of not less than 20 days, in our discretion. We used net proceeds from the issuance of the 3.25% Convertible Debentures to pay down indebtedness outstanding under our then-existing credit facilities.
On June 22, 1998, we issued $250,000,000 in 6.875% Senior Notes due 2005 and $250,000,000 in 7.0% Senior Notes due 2008 (collectively, the "Senior Notes"). Interest is payable on June 15 and December 15. The Senior Notes are unsecured, unsubordinated obligations of HEALTHSOUTH. We used the net proceeds from the issuance of the Senior Notes to pay down indebtedness outstanding under our then-existing credit facilities.
On September 25, 2000, we issued $350,000,000 in 10-3/4% Senior Subordinated Notes due 2008 (the "10-3/4% Notes"). Interest is payable on April 1 and October 1. The 10-3/4% Notes are senior subordinated obligations of HEALTHSOUTH and, as such, are subordinated to all our existing and future senior indebtedness, and also are effectively subordinated to all existing and future liabilities of our subsidiaries and partnerships. The net proceeds from the issuance of the 10-3/4% Notes were used to redeem the 9.5% Notes and to pay down indebtedness outstanding under our then-existing credit facilities. The 10-3/4% Notes mature on October 1, 2008.
On February 1, 2001, we issued $375,000,000 in 8-1/2% Senior Notes due 2008 (the "8-1/2% Notes"). Interest is payable on February 1 and August 1. The 8-1/2% Notes are unsecured, unsubordinated obligations of HEALTHSOUTH. The net proceeds from the issuance of the 8-1/2% Notes were used to pay down indebtedness outstanding under our credit facilities. The 8-1/2% Notes mature on February 1, 2008.
We intend to pursue the acquisition or development of additional healthcare operations, including outpatient rehabilitation facilities, inpatient rehabilitation facilities, ambulatory surgery centers, outpatient diagnostic centers and companies engaged in the provision of other complementary services, and to expand certain of our existing facilities. While it is not possible to estimate precisely the amounts which will actually be expended in the foregoing areas, we anticipate that over the next twelve months, we will spend approximately $100,000,000 to $150,000,000 on maintenance and expansion of our existing facilities and approximately $200,000,000 to $250,000,000 on development activities and on continued development of the Integrated Service Model. See Item 1, "Business -- Company Strategy".
Although we are continually considering and evaluating acquisitions and opportunities for future growth, we have not entered into any agreements with respect to material future acquisitions. We believe that existing cash, cash flow from operations and borrowings under existing credit facilities will be sufficient to satisfy our estimated cash requirements for the next twelve months, and for the reasonably foreseeable future.
Inflation in recent years has not had a significant effect on our business, and is not expected to adversely affect us in the future unless it increases significantly.
EXPOSURES TO MARKET RISK
We are exposed to market risk related to changes in interest rates. The impact on earnings and value of market risk-sensitive financial instruments (principally marketable security investments and long-term debt, as well as the interest rate swaps described below) is subject to change as a result of movements in market rates and prices. We use sensitivity analysis models to evaluate these impacts. We do not hold or issue derivative instruments for trading purposes and are not a party to any instruments with leverage features.
Our investment in marketable securities was $90,000 at December 31, 2000, compared to $3,482,000 at December 31, 1999. The investment represents less than 1% of total assets at December 31, 2000 and 1999. These securities are generally short-term, highly-liquid instruments and, accordingly, their fair value approximates cost. Earnings on investments in marketable securities are not significant to our results of operations, and therefore any changes in interest rates would have a minimal impact on future pre-tax earnings.
As described below, a significant portion of our long-term indebtedness is subject to variable rates of interest, generally equal to LIBOR plus a predetermined percentage. In October 2000, we entered into three short-term interest rate swap arrangements intended to hedge our exposure to rising interest rates in the capital markets. Two of these arrangements have a notional amount of $240,000,000 and one has a notional amount of $175,000,000. These mature six months and twelve months, respectively, from the date of the original transaction. The notional amounts are used to measure interest to be paid or received and do not represent an amount of exposure to credit loss. In each of these arrangements, we pay the counterparty a fixed rate of interest on the notional amount, and the counterparty pays us a variable rate of interest equal to the 90-day LIBOR rate. The variable rate paid to us by the counterparty on the six-month maturities and the twelve-month maturity are reset once and three times, respectively, during the term of the swaps. Thus, these interest rate swaps have the effect of fixing the interest rates on an aggregate of $655,000,000 of our variable-rate debt through their maturity dates. The arrangements mature at various dates in April 2001 and November 2001. We would be exposed to credit losses if the counterparties did not perform their obligations under the swap arrangements; however, the counterparties are major commercial banks whom we believe to be creditworthy, and we expect them to fully satisfy their obligations. At December 31, 2000, the weighted average interest rate we were obligated to pay under these interest rate swaps was 6.70%, and the weighted average interest rate we received was 6.76%.
With respect to our interest-bearing liabilities, approximately $1,655,000,000 in long-term debt at December 31, 2000 is subject to variable rates of interest before giving effect to the interest rate swaps above, while the remaining balance in long-term debt of $1,556,829,000 is subject to fixed rates of interest. This compares to $1,625,000,000 in long-term debt subject to variable rates of interest and $1,489,648,000 in long-term debt subject to fixed rates of interest at December 31, 1999 (see Note 7 of "Notes to Consolidated Financial Statements" for further description). The fair value of our total long-term debt, based on discounted cash flow analyses, approximates its carrying value at December 31, 2000 except for the 3.25% Convertible Debentures, 6.875% Senior Notes, 7.0% Senior Notes and 10-3/4% Senior Notes. The fair value of the 3.25% Convertible Debentures at December 31, 2000 was approximately $503,765,000. The fair value of the 6.875% Senior Notes due 2005 was approximately $252,025,000 at December 31, 2000. The fair value of the 7% Senior Notes due 2008 was approximately $225,125,000 at December 31, 2000. The fair value of the 10-3/4% Senior Notes due 2008 was approximately $366,625,000 at December 31, 2000. Based on a hypothetical 1% increase in interest rates, the potential losses in future pre-tax earnings would be approximately $16,550,000. The impact of such a change on the carrying value of long-term debt would not be significant. These amounts are determined considering the impact of the hypothetical interest rates on our borrowing cost and long-term debt balances. These analyses do not consider the effects, if any, of the potential changes in the overall level of economic activity that could exist in such an environment. Further, in the event of a change of significant magnitude, management would expect to take actions intended to further mitigate its exposure to such change.
Foreign operations, and the related market risks associated with foreign currency, are currently insignificant to our results of operations and financial position.
FORWARD-LOOKING STATEMENTS
Statements contained in this Annual Report on Form 10-K which are not historical facts are forward-looking statements. Without limiting the generality of the preceding statement, all statements in this Annual Report on Form 10-K concerning or relating to estimated and projected earnings, margins, costs, expenditures, cash flows, growth rates and financial results are forward-looking statements. In addition, HEALTHSOUTH, through its senior management, from time to time makes forward-looking public statements concerning our expected future operations and performance and other developments. Such forward-looking statements are necessarily estimates reflecting our best judgment based upon current information, involve a number of risks and uncertainties and are made pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. There can be no assurance that other factors will not affect the accuracy of such forward-looking statements or that our actual results will not differ materially from the results anticipated in such forward-looking statements. While it is impossible to identify all such factors, factors which could cause actual results to differ materially from
those estimated by us include, but are not limited to, changes in the regulation of the healthcare industry at either or both of the federal and state levels, changes or delays in reimbursement for our services by governmental or private payors, competitive pressures in the healthcare industry and our response thereto, our ability to obtain and retain favorable arrangements with third-party payors, unanticipated delays in the implementation of our Integrated Service Model, general conditions in the economy and capital markets, and other factors which may be identified from time to time in our Securities and Exchange Commission filings and other public announcements.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Consolidated financial statements of HEALTHSOUTH meeting the requirements of Regulation S-X are filed on the following pages of this Item 8 of this Annual Report on Form 10-K, as listed below:
The financial statement schedules required under Regulation S-X are listed in Item 14(a)2, and filed under Item 14(d), of this Annual Report on Form 10-K.
QUARTERLY RESULTS (UNAUDITED)
Set forth below is summary information with respect to HEALTHSOUTH's operations for the last eight fiscal quarters.
REPORT OF INDEPENDENT AUDITORS
The Board of Directors HEALTHSOUTH Corporation
We have audited the accompanying consolidated balance sheets of HEALTHSOUTH Corporation and Subsidiaries as of December 31, 1999 and 2000, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2000. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of HEALTHSOUTH Corporation and Subsidiaries at December 31, 1999 and 2000, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
ERNST & YOUNG LLP
Birmingham, Alabama March 6, 2001
HEALTHSOUTH CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
See accompanying notes.
HEALTHSOUTH CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
See accompanying notes.
HEALTHSOUTH CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1998, 1999 AND 2000
See accompanying notes.
HEALTHSOUTH CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
HEALTHSOUTH CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS - (CONTINUED)
Non-cash investing activities:
The Company assumed liabilities of $107,091,000, $9,529,000 and $9,178,000 during the years ended December 31, 1998, 1999 and 2000, respectively, in connection with its acquisitions.
During the year ended December 31, 1998, the Company issued 699,000 common shares with a market value of $19,397,000 as consideration for acquisitions accounted for as purchases.
See accompanying notes.
HEALTHSOUTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000
1. SIGNIFICANT ACCOUNTING POLICIES
The significant accounting policies followed by HEALTHSOUTH Corporation and its subsidiaries ("the Company") are presented as an integral part of the consolidated financial statements.
NATURE OF OPERATIONS
HEALTHSOUTH is engaged in the business of providing healthcare services through three operating divisions: Inpatient and other clinical services and Outpatient services -- East and Outpatient services -- West. Inpatient and other clinical services consist primarily of services provided through inpatient rehabilitation facilities, specialty medical centers and certain physician practices and other clinical services. Outpatient services consist primarily of services provided through outpatient rehabilitation facilities, outpatient surgery centers and outpatient diagnostic centers. Management operates the outpatient services in two geographic segments, East and West.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of HEALTHSOUTH Corporation ("HEALTHSOUTH") and its wholly-owned subsidiaries, as well as its majority ownership or controlling interest in limited partnerships and limited liability companies. All significant intercompany accounts and transactions have been eliminated in consolidation.
HEALTHSOUTH operates a number of its facilities as general and limited partnerships ("partnerships") or limited liability companies ("LLCs") in which HEALTHSOUTH or a subsidiary serves as the general partner or managing member, as applicable. HEALTHSOUTH's policy is to consolidate the financial position and results of operations of these partnerships and LLCs in cases where HEALTHSOUTH owns the majority interest or in which it otherwise has a controlling interest (see also "Minority Interests" below in Note 1). Investments in partnerships, LLCs and other entities that represent less than a majority interest or otherwise represent a non-controlling interest are accounted for under the equity method or cost method, as appropriate (see also "Minority Interests" below in Note 1 and Note 4).
OPERATING SEGMENTS
Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about Segments of an Enterprise and Related Information" requires the utilization of a "management approach" to define and report the financial results of operating segments. The management approach defines operating segments along the lines used by management to assess performance and make operating and resource allocation decisions. The Company operates in three segments: Inpatient and other clinical services, Outpatient services -- East and Outpatient services -- West.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the accompanying consolidated financial statements and notes. Actual results could differ from those estimates.
MARKETABLE SECURITIES
Marketable securities and debt securities are classified as available-for-sale. Available-for-sale securities are carried at fair value, with the unrealized gains and losses, if material, reported as a separate component of stockholders' equity, net of tax. The cost of the specific security sold method is used to
HEALTHSOUTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
compute gain or loss on the sale of securities. Interest and dividends on securities classified as available-for-sale are included in interest income. Marketable securities and debt securities held by the Company have maturities of less than one year.
ACCOUNTS RECEIVABLE AND THIRD-PARTY REIMBURSEMENT ACTIVITIES
Receivables from patients, insurance companies and third-party contractual insured accounts (primarily Medicare and Medicaid) are based on payment agreements which generally result in the Company's collecting an amount different from the established rates. Net third-party settlement receivables included in accounts receivable were $42,606,000 and $69,480,000 at December 31, 1999 and 2000, respectively. Final determination of the settlement is subject to review by appropriate authorities. It is at least reasonably possible that the recorded estimates will change by material amounts in the near term. The differences between original estimates made by the Company and subsequent revisions (including final settlement) were not material to the Company's operating results. Adequate allowances are provided for doubtful accounts and contractual adjustments. Uncollectible accounts are written off against the allowance for doubtful accounts after adequate collection efforts are made. Net accounts receivable includes only those amounts estimated by management to be collectible.
The concentration of net accounts receivable from third-party contractual payors and others, as a percentage of total net accounts receivable, was as follows:
INVENTORIES
Inventories are stated at the lower of cost or market using the specific identification method.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost. Upon sale or retirement of property, plant or equipment, the cost and related accumulated depreciation are eliminated from the respective account and the resulting gain or loss is included in the results of operations.
Interest cost incurred during the construction of a facility is capitalized. The Company incurred interest costs of $148,793,000, $178,836,000 and $223,321,000 of which $630,000, $2,184,000 and $1,726,000 was capitalized during 1998, 1999 and 2000, respectively.
Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the assets or the term of the lease, as appropriate. The estimated useful life of buildings is 30-40 years and the general range of useful lives for leasehold improvements, furniture, fixtures and equipment is 3-15 years.
INTANGIBLE ASSETS
Costs in excess of the net asset value of purchased facilities are amortized over 20 to 40 years using the straight-line method, with the majority of such costs being amortized over 40 years. Organization and Partnership formation costs are deferred and amortized on a straight-line basis over a period of 36 months. Debt issue costs are amortized over the term of the debt. Noncompete agreements are amortized using the straight-line method over the term of the agreements.
HEALTHSOUTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
Effective July 1, 1997, the Company began expensing amounts reflecting the costs of implementing its clinical and administrative programs and protocols at acquired facilities in the period in which such costs are incurred. Previously, the Company had capitalized such costs and amortized them over 36 months. Such costs at June 30, 1997 aggregated $64,643,000, net of accumulated amortization. These capitalized costs were amortized in accordance with the Company's policy in effect through June 30, 1997 and were fully amortized by June 2000.
Through June 30, 1997, the Company had assigned value to and capitalized organization and partnership formation costs which had been incurred by the Company or obtained by the Company in acquisitions accounted for as purchases. Effective July 1, 1997, the Company no longer assigned value to organization and partnership formation costs obtained in acquisitions accounted for as purchases except to the extent that objective evidence exists that such costs will provide future economic benefits to the Company after the acquisition. Such organization and partnership formation costs at June 30, 1997, which were obtained by the Company in purchase transactions, aggregated $8,380,000, net of accumulated amortization. Such costs at June 30, 1997 were amortized in accordance with the Company's policy in effect through June 30, 1997 and were fully amortized by June 2000.
In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of Start-Up Activities." SOP 98-5 requires that the costs of start-up activities be expensed as incurred. The SOP broadly defines start-up activities as those one-time activities related to opening a new facility, introducing a new product or service, conducting business in a new territory, conducting business with a new class of customer, initiating a new process in an existing facility, or beginning some new operation. SOP 98-5 is effective for years beginning after December 15, 1998. In 1997, the Company began expensing as incurred all costs related to start-up activities. Therefore, the adoption of SOP 98-5 did not have a material effect on the Company's financial statements.
MINORITY INTERESTS
The equity of minority investors in partnerships and LLCs of the Company is reported on the consolidated balance sheets as minority interests. Minority interests reported in the consolidated income statements reflect the respective interests in the income or loss of the limited partnerships or limited liability companies attributable to the minority investors (ranging from 1% to 50% at December 31, 2000), the effect of which is removed from the results of operations of the Company.
REVENUES
Revenues include net patient service revenues and other operating revenues. Other operating revenues include cafeteria revenue, gift shop revenue, rental income, trainer/contract revenue, management and administrative fee revenue (related to non-consolidated subsidiaries and affiliates) and transcriptionist fees which are insignificant to total revenues. Net patient service revenues are reported at the estimated net realizable amounts from patients, third-party payors and others for services rendered, including estimated retroactive adjustments under reimbursement agreements with third-party payors.
HEALTHSOUTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
INCOME PER COMMON SHARE
The following table sets forth the computation of basic and diluted earnings per share:
IMPAIRMENT OF ASSETS
The Company records impairment losses on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amount of those assets. In such cases, the impaired assets are written down to fair value. Fair value is determined based on the individual facts and circumstances of the impairment event, and the available information related to it. Such information might include quoted market prices, prices for comparable assets, estimated future cash flows discounted at a rate commensurate with the risks involved and independent appraisals. For purposes of analyzing impairment, assets are generally grouped at the individual operational facility level, which is the lowest level for which there are identifiable cash flows. If the group of assets being tested was acquired by the Company as part of a purchase business combination, any goodwill that arose as part of the transaction is included as part of the asset grouping.
With respect to the carrying value of goodwill and other intangible assets, the Company determines on a quarterly basis whether an impairment event has occurred by considering factors such as the market value of the asset, a significant adverse change in legal factors or in the business climate, adverse action by regulators, a history of operating losses or cash flow losses, or a projection of continuing losses associated with an operating entity. The carrying value of goodwill and other intangible assets will be evaluated if the facts and circumstances suggest that it has been impaired. If this evaluation indicates that the value of the asset will not be recoverable, as determined based on the undiscounted cash flows of the entity over the remaining amortization period, an impairment loss is calculated based on the excess of the carrying amount of the asset over the asset's fair value (see Note 13).
HEALTHSOUTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
SELF-INSURANCE
The Company is self-insured for professional liability and comprehensive general liability. Liabilities for asserted and unasserted claims are accrued based upon specific claims and incidents and the claims history of the Company. The reserves for estimated liabilities for asserted and unasserted claims, which are not material in relation to the Company's consolidated financial position at December 31, 1999 and 2000, are included with accrued interest payable and other liabilities in the accompanying consolidated balance sheets.
RECLASSIFICATIONS
Certain amounts in 1998 and 1999 financial statements have been reclassified to conform with the 2000 presentation. Such reclassifications had no effect on previously reported consolidated financial position and consolidated net income.
FOREIGN CURRENCY TRANSLATION
The Company translates the assets and liabilities of its foreign subsidiaries stated in local functional currencies to U.S. dollars at the rates of exchange in effect at the end of the period. Revenues and expenses are translated using rates of exchange in effect during the period. Gains and losses from currency translation are included in stockholders' equity. Currency transaction gains or losses are recognized in current operations as operating unit expenses and have not been significant to the Company's operating results in any period.
2. MERGERS
Effective July 22, 1998, a wholly-owned subsidiary of the Company merged with National Surgery Centers, Inc. ("NSC"), and in connection therewith the Company issued 20,426,261 shares of its common stock in exchange for all of NSC's outstanding common stock. Prior to the merger, NSC operated 40 outpatient surgery centers in 14 states. Costs and expenses of approximately $25,630,000, primarily legal, accounting and financial advisory fees, incurred by the Company in connection with the NSC merger have been recorded in operations during 1998 and reported as merger expenses in the accompanying consolidated statements of income.
The merger of the Company with NSC was accounted for as a pooling of interests. There were no material transactions between the Company and NSC prior to the merger. The effects of conforming the accounting policies of the combined companies are not material.
HEALTHSOUTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. CASH, CASH EQUIVALENTS AND OTHER MARKETABLE SECURITIES
Cash, cash equivalents and other marketable securities consisted of the following:
For purposes of the consolidated balance sheets and statements of cash flows, marketable securities with a maturity of ninety days or less when purchased are considered cash equivalents.
4. OTHER ASSETS
Other assets consisted of the following:
The Company has various investments, with ownership percentages ranging from 24% to 49%, which are accounted for using the equity method of accounting. The Company's equity in earnings of these investments was not material to the Company's consolidated results of operations for the years ended 1998, 1999 and 2000. At December 31, 2000, the investment balance on the Company's books was not materially different than the underlying equity in net assets of the unconsolidated entities.
Other investments consist of investments in companies involved in operations similar to those of the Company. For those investments with a quoted market price, the Company's investment balance is based on the quoted market price. For all other investments in this category, it was not practicable to estimate the fair value because of the lack of a quoted market price and the inability to estimate the fair value without incurring excessive costs. The carrying amount at December 31, 2000 represents the original cost of the investments, which management believes is not impaired.
HEALTHSOUTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. OTHER ASSETS - (CONTINUED)
During 1998, the Company sold four inpatient rehabilitation hospital facilities. Because the Company is leasing back all of the properties, the resulting loss on sale of approximately $19,500,000 has been recorded on the accompanying consolidated balance sheet in other assets as deferred loss on leases and will be amortized into expense over the initial lease term of 15 years in accordance with SFAS 28. Aggregate annual lease payments for these properties total $6,000,000. During 1995, the Company sold another inpatient rehabilitation hospital property under terms similar to those described above. Aggregate annual lease payments for this property total $1,700,000. The resulting loss of approximately $4,000,000 is being amortized to expense over the initial lease term of 15 years.
5. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consisted of the following:
6. INTANGIBLE ASSETS
Intangible assets consisted of the following:
HEALTHSOUTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. LONG-TERM DEBT
Long-term debt consisted of the following:
The fair value of the total long-term debt approximates book value at December 31, 2000 except for the 3.25% Convertible Subordinated Debentures due 2003, the 6.875% Senior Notes due 2005, the 7.0% Senior Notes due 2008 and the 10-3/4% Senior Subordinated Notes due 2008. The fair value of the 3.25% Convertible Subordinated Debentures due 2003 was approximately $503,765,000 at December 31, 2000. The fair value of the 6.875% Senior Notes due 2005 was approximately $252,025,000 at December 31, 2000. The fair value of the 7% Senior Notes due 2008 was approximately $225,125,000 at December 31, 2000. The fair value of the 10-3/4% Senior Subordinated Notes due 2008 was approximately $366,625,000 at December 31, 2000. The fair values of the Company's long-term debt are estimated using discounted cash flow analysis, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.
The Company has a $1,750,000,000 revolving credit facility with Bank of America, N.A. ("Bank of America") and other participating banks (the "1998 Credit Agreement"). The 1998 Credit Agreement replaced a previous $1,250,000,000 revolving credit agreement, also with Bank of America. Interest on the 1998 Credit Agreement is paid based on LIBOR plus a predetermined margin, a base rate, or competitively bid rates from the participating banks. The Company is required to pay a fee on the unused portion of the revolving credit facility ranging from 0.09% to 0.25%, depending on certain defined credit ratings. The principal amount is payable in full on June 22, 2003. The Company has provided a negative pledge on all assets under the 1998 Credit Agreement. At December 31, 2000, the effective interest rate associated with the 1998 Credit Agreement was approximately 7.18%.
The Company also had a Short Term Credit Agreement with Bank of America and other participating banks (as amended, the "Short Term Credit Agreement"), providing for a $250,000,000 short term revolving credit facility. The terms of the Short Term Credit Agreement were substantially
HEALTHSOUTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. LONG-TERM DEBT - (CONTINUED)
consistent with those of the 1998 Credit Agreement. Interest on the Short Term Credit Agreement was paid based on LIBOR plus a predetermined margin or a base rate. The Company was required to pay a fee on the unused portion of the credit facility ranging from 0.30% to 0.50%, depending on certain defined credit ratings. On October 31, 2000, the Company terminated the Short Term Credit Agreement and replaced it with a new $400,000,000 Credit Agreement (the "2000 Credit Agreement") with UBS AG and other participating banks. Interest on the 2000 Credit Agreement is paid based on LIBOR plus a predetermined margin or base rate. The Company is required to pay a fee on the unused portion of the credit facility ranging from 0.25% to 0.50%, depending on certain defined ratios. The principal amount is payable in full in eight quarterly installments ending on June 22, 2003. At December 31, 2000, the Company had no drawings outstanding under the 2000 Credit Agreement.
On March 24, 1994, the Company issued $250,000,000 principal amount of 9.5% Senior Subordinated Notes due 2001 (the "9.5% Notes"). The Company redeemed the 9.5% Notes at par on October 30, 2000.
On March 20, 1998, the Company issued $500,000,000 in 3.25% Convertible Subordinated Debentures due 2003 (the "3.25% Convertible Debentures") in a private placement. An additional $67,750,000 principal amount of the 3.25% Convertible Debentures was issued on March 31, 1998 to cover underwriters' overallotments. Interest is payable on April 1 and October 1. The 3.25% Convertible Debentures are convertible into common stock of the Company at the option of the holder at a conversion price of $36.625 per share. The conversion price is subject to adjustment upon the occurrence of (a) a subdivision, combination or reclassification of outstanding shares of common stock, (b) the payment of a stock dividend or stock distribution on any shares of the Company's capital stock, (c) the issuance of rights or warrants to all holders of common stock entitling them to purchase shares of common stock at less than the current market price, or (d) the payment of certain other distributions with respect to the Company's common stock. In addition, the Company may, from time to time, lower the conversion price for periods of not less than 20 days, in its discretion. The net proceeds from the issuance of the 3.25% Convertible Debentures were used by the Company to pay down indebtedness outstanding under its then-existing credit facilities.
On June 22, 1998, the Company issued $250,000,000 in 6.875% Senior Notes due 2005 and $250,000,000 in 7.0% Senior Notes due 2008 (collectively, the "Senior Notes"). Interest is payable on June 15 and December 15. The Senior Notes are unsecured, unsubordinated obligations of the Company. The net proceeds from the issuance of the Senior Notes were used by the Company to pay down indebtedness outstanding under its then-existing credit facilities.
On September 25, 2000, the Company issued $350,000,000 in 10-3/4% Senior Subordinated Notes due 2008 (the "10-3/4% Notes"). Interest is payable on April 1 and October 1. The 10-3/4% Notes are senior subordinated obligations of the Company and, as such, are subordinated to all existing and future senior indebtedness of the Company, and also are effectively subordinated to all existing and future liabilities of the Company's subsidiaries and partnerships. The net proceeds from the issuance of the 10-3/4% Notes were used by the Company to redeem the 9.5% Notes and to pay down indebtedness outstanding under its then-existing credit facilities. The 10-3/4% Notes mature on October 1, 2008.
In October 2000, the Company entered into two six-month and one twelve-month interest rate swap arrangements with notional amounts of $240,000,000, $240,000,000 and $175,000,000 each. The swaps expire on various dates in April 2001 and November 2001. These arrangements have the effect of converting a portion of the Company's variable rate debt to a fixed rate. The arrangements did not have a material effect on the Company's operations.
HEALTHSOUTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. LONG-TERM DEBT - (CONTINUED)
Principal maturities of long-term debt are as follows:
8. STOCK OPTIONS
The Company has various stockholder-approved stock option plans which provide for the grant of options to directors, officers and other key employees to purchase common stock at 100% of the fair market value as of the date of grant. The Compensation Committee of the Board of Directors administers the stock option plans. Options may be granted as incentive stock options or as non-qualified stock options. Incentive stock options vest 25% annually, commencing upon completion of one year of employment subsequent to the date of grant. Certain of the non-qualified stock options are not subject to any vesting provisions, while others vest on the same schedule as the incentive stock options. The options expire ten years from the date of grant.
In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). SFAS 123 is effective for fiscal years beginning after December 15, 1995 and allows for the option of continuing to account for stock-based compensation under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and related interpretations, or selecting the fair value method of expense recognition as described in SFAS 123. The Company has elected to follow APB 25 in accounting for its employee stock options. The Company follows SFAS 123 in accounting for its non-employee stock options. The total compensation expense associated with non-employee stock options granted in 1998, 1999 and 2000 was not material.
Pro forma information regarding net income and earnings per share is required by SFAS 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of SFAS 123. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1998, 1999 and 2000, respectively: risk-free interest rates of 6.10%, 6.21% and 5.11%; dividend yield of 0%; volatility factors of the expected market price of the Company's common stock of .76, .77 and .71; and a weighted-average expected life of the options of 5.5 years, 5.0 years and 5.2 years.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
HEALTHSOUTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. STOCK OPTIONS - (CONTINUED)
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows:
A summary of the Company's stock option activity and related information for the years ended December 31 follows:
The following table summarizes information about stock options outstanding at December 31, 2000:
9. ACQUISITIONS
The Company evaluates each of its acquisitions independently to determine the appropriate amortization period for the cost in excess of net asset value of purchased facilities. Each evaluation includes an analysis of historic and projected financial performance, evaluation of the estimated useful lives of buildings and fixed assets acquired, the indefinite lives of certificates of need and licenses acquired, the competition within local markets, lease terms where applicable, and the legal term of partnerships where applicable.
1998 ACQUISITIONS
Effective July 1, 1998, the Company acquired Columbia/HCA Healthcare Corporation's interests in 33 ambulatory surgery centers (subject to certain outstanding consents and approvals with respect to three of the centers, as to which the parties entered into management agreements) in a transaction
HEALTHSOUTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. ACQUISITIONS - (CONTINUED)
accounted for as a purchase. Effective July 31, 1998, the Company entered into certain other arrangements to acquire substantially all of the economic benefit of Columbia/HCA's interests in one additional ambulatory surgery center, which interests the Company later acquired outright. The purchase price was approximately $550,402,000 in cash.
At various dates and in separate transactions throughout 1998, the Company acquired 112 outpatient rehabilitation facilities, four outpatient surgery centers, one inpatient rehabilitation hospital and 27 diagnostic imaging centers. The acquired operations are located throughout the United States. The total purchase price of the acquired operations was approximately $216,305,000. The form of consideration constituting the total purchase price was approximately $179,038,000 in cash, $17,870,000 in notes payable and the issuance of approximately 699,000 shares of the Company's common stock valued at $19,397,000.
In connection with these transactions, the Company entered into noncompete agreements with former owners totaling $25,926,000. In general, these noncompete agreements are payable in monthly or quarterly installments over periods ranging from five to ten years.
The fair value of the total net assets relating to the 1998 acquisitions described above was approximately $15,570,000. The total cost of the 1998 acquisitions exceeded the fair value of the net assets acquired by approximately $751,137,000. Based on the evaluation of each acquisition utilizing the criteria described above, the Company determined that the costs in excess of net asset value of purchased facilities relating to the 1998 acquisitions should be amortized over periods ranging from 25 to 40 years on a straight-line basis. No other identifiable intangible assets were recorded in the acquisitions described above.
The Company sold its physical therapy staffing business, which had been acquired by the Company as part of a larger strategic acquisition in 1994. The loss on the sale of the physical therapy staffing business was $31,232,000 and was recorded by the Company in the fourth quarter of 1998.
1999 ACQUISITIONS
Effective June 29, 1999, the Company acquired from Mariner Post-Acute Network, Inc. ("Mariner") substantially all of the assets of Mariner's American Rehability Services division in a transaction accounted for as a purchase. At the time of the acquisition, Mariner operated approximately 160 outpatient rehabilitation centers in 18 states. The purchase price was approximately $54,521,000 in cash.
At various dates and in separate transactions throughout 1999, the Company acquired ten outpatient rehabilitation facilities, eight outpatient surgery centers, two inpatient rehabilitation hospitals and four diagnostic imaging centers. The acquired operations are located throughout the United States. The total purchase price of the acquired operations was approximately $49,844,000. The form of consideration constituting the total purchase price was approximately $49,684,000 in cash and $160,000 in notes payable.
In connection with these transactions, the Company entered into noncompete agreements with former owners totaling $2,996,000. In general, these noncompete agreements are payable in monthly or quarterly installments over periods ranging from five to ten years.
The fair value of the total net assets relating to the 1999 acquisitions described above was approximately $23,245,000. The total cost of the 1999 acquisitions exceeded the fair value of the net assets acquired by approximately $81,120,000. Based on the evaluation of each acquisition utilizing the criteria described above, the Company determined that the cost in excess of net asset value of purchased facilities relating to the 1999 acquisitions should be amortized over periods ranging from 20 to 40 years on a straight-line basis. No other identifiable intangible assets were recorded in the acquisitions described above.
HEALTHSOUTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. ACQUISITIONS - (CONTINUED)
2000 ACQUISITIONS
At various dates and in separate transactions throughout 2000, the Company acquired thirteen outpatient rehabilitation facilities, three outpatient surgery centers, three inpatient rehabilitation hospitals and thirteen diagnostic imaging centers. The acquired operations are located throughout the United States. The total purchase price of the acquired operations was approximately $75,365,000. The form of consideration constituting the total purchase price was approximately $74,137,000 in cash and $1,228,000 in notes payable.
In connection with these transactions, the Company entered into noncompete agreements with former owners totaling $5,520,000. In general, these noncompete agreements are payable in monthly or quarterly installments over periods ranging from five to ten years.
The fair value of the total net assets relating to the 2000 acquisitions described above was approximately $8,174,000. The total cost of the 2000 acquisitions exceeded the fair value of the net assets acquired by approximately $67,191,000. Based on the evaluation of each acquisition utilizing the criteria described above, the Company determined that the cost in excess of net asset value of purchased facilities relating to the 2000 acquisitions should be amortized over periods ranging from 20 to 40 years on a straight-line basis. No other identifiable intangible assets were recorded in the acquisitions described above. At December 31, 2000, the purchase price allocation associated with the 2000 acquisitions is preliminary in nature. During 2001 the Company will make adjustments, if necessary, to the purchase price allocation based on revisions to the fair value of the assets acquired.
All of the acquisitions described above were accounted for as purchases and, accordingly, the results of operations of the acquired businesses (not material individually or in the aggregate) are included in the accompanying consolidated financial statements from their respective dates of acquisition.
10. INCOME TAXES
HEALTHSOUTH and its subsidiaries file a consolidated federal income tax return. The partnerships and LLCs file separate income tax returns. HEALTHSOUTH's allocable portion of each partnership's income or loss is included in the taxable income of the Company. The remaining income or loss of each partnership and LLC is allocated to the other partners.
HEALTHSOUTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. INCOME TAXES - (CONTINUED)
The Company utilizes the liability method of accounting for income taxes, as required by Financial Accounting Standards Board Statement No. 109, "Accounting for Income Taxes". Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities as of December 31, 1999 are as follows:
Significant components of the Company's deferred tax assets and liabilities as of December 31, 2000 are as follows:
At December 31, 2000, the Company has net operating loss carryforwards of approximately $15,275,000 for income tax purposes expiring through the year 2020. Those carryforwards resulted from the Company's acquisitions of Rebound, Inc., Horizon/CMS Healthcare Corporation, ASC Network Corporation, The Company Doctor and National Imaging Affiliates.
HEALTHSOUTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. INCOME TAXES - (CONTINUED)
The provision for income taxes was as follows:
The difference between the provision for income taxes and the amount computed by applying the statutory federal income tax rate to income before taxes was as follows:
11. COMMITMENTS AND CONTINGENCIES
The Company is a party to legal proceedings incidental to its business. In the opinion of management, any ultimate liability with respect to these actions will not materially affect the consolidated financial position or results of operations of the Company.
Beginning December 1, 1993, the Company became self-insured for professional liability and comprehensive general liability. The Company purchased coverage for all claims incurred prior to December 1, 1993. In addition, the Company purchased underlying insurance which would cover all claims once established limits have been exceeded. It is the opinion of management that at December 31, 2000 the Company has adequate reserves to cover losses on asserted and unasserted claims. In the fourth quarter of 2000, the Company formed an offshore captive insurance subsidiary to which it expects to transition the administration of its self-insurance programs.
In connection with the Horizon/CMS acquisition in 1997, the Company assumed Horizon/CMS's open professional and general liability claims. The Company has entered into an agreement with an insurance carrier to assume responsibility for the majority of open claims. Under this agreement, a "risk transfer" was conducted which converted Horizon/CMS's self-insured claims to insured liabilities consistent with the terms of the underlying insurance policy.
HEALTHSOUTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
11. COMMITMENTS AND CONTINGENCIES - (CONTINUED)
Horizon/CMS is currently a party, or is subject, to certain litigation matters and disputes. The Company itself is, in general, not a party to such litigation. These matters include actions or investigations initiated by the Securities and Exchange Commission, New York Stock Exchange, various federal and state regulatory agencies, stockholders of Horizon/CMS and other parties. Both Horizon/CMS and the Company are working to resolve these matters and cooperating fully with the various regulatory agencies involved. As of December 31, 2000, it was not possible for the Company to predict the ultimate outcome or effect of these matters. In management's opinion, the ultimate resolution of these matters will not have a material effect on the Company's consolidated financial position or results of operations.
The Company was served with certain lawsuits filed beginning September 30, 1998, purporting to be class actions under the federal and Alabama securities laws. These lawsuits were filed following a decline in the Company's stock price at the end of the third quarter of 1998. Seven such suits were filed in the United States District Court for the Northern District of Alabama. In January 1999, those suits were ordered consolidated under the case style In re HEALTHSOUTH Corporation Securities Litigation, Master File No. CV98-O-2634-S. On April 12, 1999, the plaintiffs filed a consolidated amended complaint against the Company and certain of its officers and directors alleging that, during the period April 24, 1997 through September 30, 1998, the defendants misrepresented or failed to disclose certain material facts concerning the Company's business and financial condition and the impact of the Balanced Budget Act of 1997 on our operations 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 the consolidated amended complaint 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 such acquisitions and who assert additional claims under Section 11 of the Securities Act of 1933 with respect to the registration of securities issued in those acquisitions.
Additionally, another suit has been filed in the Circuit Court of Jefferson County, Alabama, purportedly as a derivative action on behalf of the Company. This suit largely replicates the allegations of the federal actions described in the preceding paragraph and alleges that the current directors of the Company, certain former directors and certain officers of the Company breached their fiduciary duties to the Company and engaged in other allegedly tortious conduct. The plaintiff in that case has forborne pursuing its claim thus far pending further progress in the federal actions, and the Company has not yet been required to file a responsive pleading in the case. Another non-derivative state court action was voluntarily dismissed by the plaintiff, without prejudice.
The Company filed its motion to dismiss the consolidated amended complaint in the federal action in late June 1999. The court denied that motion to dismiss in December 2000. 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 remain at an early stage, the Company cannot predict the outcome of any such suits or the magnitude of any potential loss if the Company's defense is unsuccessful.
At December 31, 2000, committed capital expenditures for the next twelve months are $41,281,000.
Operating leases generally consist of short-term lease agreements for buildings where facilities are located. These leases generally have 5-year terms, with one or more renewal options, with terms to be negotiated at the time of renewal. Total rental expense for all operating leases was $238,937,000, $233,895,000 and $248,782,000 for the years ended December 31, 1998, 1999 and 2000, respectively.
The Company has entered into two tax retention operating leases for certain of its facilities. The Company is required to renegotiate the leases or purchase, or obtain a purchaser, for the facilities at its termination in 2003. The minimum sales price guarantee is approximately $119,190,000.
HEALTHSOUTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
11. COMMITMENTS AND CONTINGENCIES - (CONTINUED)
The following is a schedule of future minimum lease payments under all operating leases having initial or remaining non-cancelable lease terms in excess of one year:
12. EMPLOYEE BENEFIT PLANS
The Company has a 401(k) savings plan which matches 15% of the first 4% of earnings that an employee contributes. All contributions are in the form of cash. All employees who have completed one year of service with a minimum of 1,000 hours worked are eligible to participate in the plan. Company contributions are gradually vested over a seven-year service period. Contributions to the plan by the Company were approximately $4,121,000, $4,608,000 and $4,712,000 in 1998, 1999 and 2000, respectively.
In 1991, the Company established an Employee Stock Ownership Plan ("ESOP") for the purpose of providing substantially all employees of the Company the opportunity to save for their retirement and acquire a proprietary interest in the Company. The ESOP currently owns approximately 3,320,000 shares of the Company's common stock, which were purchased with funds borrowed from the Company, $10,000,000 in 1991 (the "1991 ESOP Loan") and $10,000,000 in 1992 (the "1992 ESOP Loan"). At December 31, 2000, the combined ESOP Loans had a balance of $5,415,000. The 1991 ESOP Loan, which bears an interest rate of 10%, is payable in annual installments covering interest and principal over a ten-year period beginning in 1992. The 1992 ESOP Loan, which bears an interest rate of 8.5%, is payable in annual installments covering interest and principal over a ten-year period beginning in 1993. Company contributions to the ESOP began in 1992 and shall at least equal the amount required to make all ESOP loan amortization payments for each plan year. The Company recognizes compensation expense based on the shares allocated method. Compensation expense related to the ESOP recognized by the Company was $3,195,000, $3,197,000 and $3,176,000 in 1998, 1999 and 2000, respectively. Interest incurred on the ESOP Loans was approximately $927,000, $715,000 and $483,000 in 1998, 1999 and 2000, respectively. Approximately 2,451,000 shares owned by the ESOP have been allocated to participants at December 31, 2000.
During 1993, the American Institute of Certified Public Accountants issued Statement of Position 93-6, "Employers Accounting for Employee Stock Ownership Plans" ("SOP 93-6"). Among other provisions, SOP 93-6 requires that compensation expense relating to employee stock ownership plans be measured based on the fair market value of the shares when allocated to the employees. The provisions of SOP 93-6 apply only to leveraged ESOPs formed after December 31, 1992, or shares newly acquired by an existing leveraged ESOP after December 31, 1992. Because all shares owned by the Company's ESOP were acquired prior to December 31, 1992, the Company's accounting policies for the shares currently owned by the ESOP are not affected by SOP 93-6.
13. IMPAIRMENT AND RESTRUCTURING CHARGES
During the third quarter of 1998, the Company recorded impairment and restructuring charges of approximately $72,000,000 related to the Company's decision to dispose of or otherwise discontinue substantially all of its home health operations. The decision was prompted in large part by the negative
HEALTHSOUTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. IMPAIRMENT AND RESTRUCTURING CHARGES - (CONTINUED)
impact of the 1997 Balanced Budget Act, which placed reimbursement limits on home health businesses. The limits were announced in March 1998, and the Company began to see the adverse affect on home health margins. Based on this unfavorable trend, management prepared a plan to exit the home health operations described above. The plan was approved by the Board of Directors on September 16, 1998. Revenues and losses before income taxes and minority interests for the home health operations were $71,163,000 and $(4,261,000), respectively. The home health operations have been included in the inpatient and other clinical services segment. The home health operations covered by the plan included approximately 35 locations, all of which were closed by December 31, 1998.
The $72,000,000 third quarter charge consists of the following components:
(i) A $62,748,000 impairment charge was recorded to reduce the carrying amount of selected long-lived assets to estimated fair value. All of the assets written down, including fixed assets of $8,363,000 and intangible assets of $54,385,000, were associated with the discontinued home health operations and are detailed further in the table below.
(ii) A $4,908,000 charge was recorded to write down other assets, primarily inventories and prepaid expenses, which were negatively impacted by the Company's decision to discontinue the home health operations.
(iii) The remaining components of the charge included $2,618,000 in lease abandonment costs and $1,435,000 in other incremental costs, representing primarily legal and asset disposal costs.
The Company has developed a strategic plan to provide integrated services in major markets throughout the United States. In the fourth quarter of 1998, the Company recorded a restructuring charge of approximately $404,000,000 as a result of its decision to close certain facilities that did not fit with the Company's strategic vision, underperforming facilities and facilities not located in target markets. The Company's Board of Directors approved the restructuring plan on December 10, 1998. A total of 167 facilities were included in the plan, including 110 outpatient rehabilitation facilities, 7 inpatient rehabilitation hospitals, 29 outpatient surgery centers, and 21 diagnostic centers. Some of these facilities had multiple business units associated with the operation. The identified facilities contributed $140,087,000 to the Company's revenue and $(9,907,000) to the Company's income before income taxes and minority interests during 1998. At March 21, 2001, approximately 97% of the locations identified in the fourth quarter restructuring plan had been closed.
The $404,000,000 fourth quarter charge consists of the following components:
(i) A $304,624,000 impairment charge was recorded to reduce the carrying amount of selected long-lived assets to estimated fair value. All of the assets written down, including fixed assets of $137,880,000 and intangible assets of $166,744,000, were associated with the facilities identified in the fourth quarter restructuring plan. These assets are detailed further in the table below.
(ii) A $19,857,000 charge was recorded to write down other assets, primarily inventories and prepaid expenses, which were negatively impacted by the Company's decision to close the affected facilities.
(iii) Approximately $6,027,000 of the charge related to involuntary severance packages paid or payable to approximately 7,900 employees. These employees worked primarily in the Company's discontinued home health operations described above. The terminations were communicated to the affected employees during the fourth quarter. Approximately 7,880 of the affected employees had left the Company as of December 31, 1998. The remaining employees left the Company during the first half of 1999.
HEALTHSOUTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. IMPAIRMENT AND RESTRUCTURING CHARGES - (CONTINUED)
(iv) Approximately $49,476,000 of the charge related to lease abandonment costs primarily for office and clinical space that was or was to be vacated as a result of the restructuring plan.
(v) The Company recognized $24,089,000 in estimated other incremental costs, generally representing costs that are a direct result of the restructuring plan and have no future economic benefit. These costs include primarily (a) $7,818,000 in legal costs associated with closing the facilities, (b) $7,275,000 in disposal costs, including costs associated with de-installation of signage and equipment, moving costs, refurbishing costs and exit cleaning costs, (c) $2,777,000 in ongoing security costs at abandoned or closed facilities, (d) $4,591,000 storage rental costs and (e) $1,628,000 in utility costs incurred at abandoned or closed facilities.
The restructuring activities (shown below in tabular form) primarily relate to asset write-downs, lease abandonments and the elimination of job responsibilities resulting in costs incurred to sever employees. Details of the impairment and restructuring charges, separated by the amounts recorded in the third and fourth quarter of 1998, respectively, are as follows:
The remaining balances at December 31, 1999 and 2000, are included in accrued interest payable and other liabilities in the accompanying consolidated balance sheets.
HEALTHSOUTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. IMPAIRMENT AND RESTRUCTURING CHARGES - (CONTINUED)
In addition to the third and fourth quarter charges described above, the Company recorded an impairment charge of approximately $8,000,000 in the fourth quarter of 1998 related to a rehabilitation hospital it had closed. The write-down was based on a recently obtained independent appraisal, which reflected a decline in valuation since the original closure. The hospital was closed in 1995 as a result of duplicative services in a single market. At that time, the hospital was written down to its then-estimated fair value and classified as assets held for sale.
The Company abandoned certain equipment and sold certain properties and equipment during 2000, associated with the 1998 closed facilities. The fair value of assets remaining to be sold is approximately $24,559,000 compared to $27,273,000 as of December 31, 1999. The Company expects to have all properties sold by the end of 2001. The effect of suspending depreciation is immaterial. For assets that will not be abandoned, the fair values were based on independent appraisals or estimates of recoverability for similar closings.
Goodwill and other related intangible assets included in the third and fourth quarter 1998 charges were allocated to the impaired assets based on the relative fair values of those assets at their respective acquisition dates.
Lease abandonment costs were based on the lease terms remaining, which range from one to fifteen years, net of any anticipated sublease income, where applicable.
During the fourth quarter of 1999, in accordance with FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, the Company recorded an asset impairment charge of $121,037,000. Management evaluated the financial performance of each of its facilities to determine if there are trends which would indicate that a facility's ability to recover its investment in its long-lived assets had been impaired. Based on this evaluation, the Company determined that property, plant and equipment with a carrying value of $38,050,000 and intangibles with a carrying value of $95,091,000 were impaired and wrote them down by $25,807,000 and $95,091,000 respectively, to their fair market value. In addition, the Company plans to sell certain property, plant and equipment with a carrying amount of $2,339,000 in 2001 and has estimated the sales value, net of related costs to sell, at $2,200,000. Accordingly, the Company recorded an impairment loss of $139,000 on these assets, which is included in the 1999 impairment and restructuring charge. See Note 14 for the impact of impairment losses on operating segments.
14. OPERATING SEGMENTS
The accounting policies of the segments are the same as those for the Company described in Note 1, Significant Accounting Policies. Intrasegment revenues are not significant. The Company's Chief Operating Decision Maker evaluates the performance of its segments and allocates resources to them based on income before minority interests and income taxes and earnings before interest, income taxes, depreciation and amortization ("EBITDA"). In addition, certain revenue producing functions are managed directly from the Corporate office and are not included in operating results for management reporting. Unallocated assets represent those assets under the direct management of Corporate office personnel.
HEALTHSOUTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
14. OPERATING SEGMENTS - (CONTINUED)
Operating results and other financial data are presented for the principal operating segments as follows:
HEALTHSOUTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
14. OPERATING SEGMENTS - (CONTINUED)
HEALTHSOUTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
15. RELATED PARTY
In December 1999, the Company acquired 6,390,583 shares of Series A Convertible Preferred Stock of MedCenterDirect.com, inc., a development-stage healthcare e-procurement company, in a private placement for a purchase price of $0.3458 per share. Various persons affiliated or associated with the Company, including various of the Company's Directors and executive officers, also purchased shares in the private placement. Under a Stockholders Agreement, the Company and the other holders of the Series A Convertible Preferred Stock, substantially all of whom may be deemed to be Company affiliates or associates, have the right to elect 50% of the directors of MedCenterDirect.com. During 2001, the Company expects to enter into a definitive long-term exclusive agreement under which MedCenterDirect.com will be the Company's exclusive e-procurement vendor of medical products and supplies. The Company expects that the terms of such agreement will be no less favorable than those the Company could obtain from an unrelated vendor.
16. SUBSEQUENT EVENT
On February 1, 2001, the Company issued $375,000,000 in 8-1/2% Senior Notes due 2008 (the "8-1/2% Notes"). The 8-1/2% Notes are unsecured, unsubordinated obligations of the Company. The net proceeds from the issuance of the 8-1/2% Notes were used to pay down indebtedness outstanding under the Company's credit facilities.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
HEALTHSOUTH has not changed independent accountants within the 24 months prior to December 31, 2000.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS.
DIRECTORS
The following table provides information with respect to our Directors.
Richard M. Scrushy, one of HEALTHSOUTH's management founders, has served as Chairman of the Board and Chief Executive Officer of HEALTHSOUTH since 1984, and also served as President of HEALTHSOUTH from 1984 until March 1995. From 1979 to 1984, Mr. Scrushy was with Lifemark Corporation, a publicly-owned healthcare corporation, serving in various operational and management positions. Mr. Scrushy was until February 2001 a director of CaremarkRx, Inc., a publicly-traded pharmacy benefits management company, for which he also served as Acting Chief Executive Officer from January 16 through March 18, 1998 and as Chairman of the Board from January 16 through December 1, 1998.
Phillip C. Watkins, M.D., FACC, is and has been for more than five years in the private practice of medicine in Birmingham, Alabama. A graduate of The Medical College of Alabama, Dr. Watkins is a Diplomate of the American Board of Internal Medicine. He is also a Fellow of the American College of Cardiology and the Subspecialty Board of Cardiovascular Disease.
George H. Strong retired as senior vice president and chief financial officer of Universal Health Services, Inc. in December 1984, a position he held for more than six years. Mr. Strong is a private investor and continued to act as a director of Universal Health Services, Inc., a publicly-traded hospital management corporation, until 1993. Mr. Strong is also a director of AmeriSource, Inc., a large drug wholesaler.
C. Sage Givens is a founder and managing general partner of Acacia Venture Partners, a private venture capital fund. From 1983 to June 30, 1995, Ms. Givens was a general partner of First Century Partners, also a private venture capital fund. Ms. Givens managed the fund's healthcare investments. Ms. Givens also serves on the boards of directors of several privately-held healthcare companies.
Charles W. Newhall III is a general partner and founder of New Enterprise Associates Limited Partnerships, Baltimore, Maryland, where he has been engaged in the venture capital business since 1978. Mr. Newhall is also a director of CaremarkRx, Inc.
John S. Chamberlin retired in 1988 as president and chief operating officer of Avon Products, Inc., a position he had held since 1985. From 1976 until 1985, he served as chairman and chief executive officer of Lenox, Incorporated, after 22 years in various assignments for General Electric. From 1990 to 1991, he served as chairman and chief executive officer of New Jersey Publishing Co. Mr. Chamberlin is chairman of the board of WNS, Inc. He is a member of the Board of Trustees of the Medical Center at Princeton and is a trustee of the Woodrow Wilson National Fellowship Foundation.
Joel C. Gordon served as Chairman of the Board of Directors of Surgical Care Affiliates, Inc. from its founding in 1982 until January 17, 1996, when SCA was acquired by HEALTHSOUTH. Mr. Gordon also served as Chief Executive Officer of SCA from 1987 until January 17, 1996. Mr. Gordon is a private investor and serves on the boards of directors of Genesco, Inc., an apparel manufacturer, and SunTrust Bank of Nashville, N.A.
Larry D. Striplin, Jr. has been the Chairman and Chief Executive Officer of Nelson-Brantley Glass Contractors, Inc. and Chairman and Chief Executive Officer of Circle "S" Industries for more than five years. Mr. Striplin is a member of the boards of directors of Kulicke & Suffa Industries, Inc., a publicly traded manufacturer of electronic equipment and The Banc Corporation.
William T. Owens, C.P.A., joined HEALTHSOUTH in March 1986 as Controller and was appointed Vice President and Controller in December 1986. He was appointed Group Vice President -- Finance and Controller, June 1992 and Senior Vice President -- Finance and Controller in February 1994 and Group Senior Vice President -- Finance and Controller in March 1998. In February 2000, he was named Executive Vice President and Chief Financial Officer, and in March 2001 he was named a Director. Prior to joining HEALTHSOUTH, Mr. Owens served as a certified public accountant on the audit staff of the Birmingham, Alabama office of Ernst & Whinney (now Ernst & Young LLP) from 1981 to 1986.
EXECUTIVE OFFICERS
The following table provides information with respect to our executive officers.
Biographical information for Mr. Scrushy and Mr. Owens is set forth above under this Item, "Directors and Executive Officers -- Directors".
Thomas W. Carman joined HEALTHSOUTH in 1985 as Regional Director -- Corporate Development, and now serves as Executive Vice President -- Corporate Development. From 1983 to 1985, Mr. Carman was director of development for Medical Care International. From 1981 to 1983, Mr. Carman was assistant administrator at the Children's Hospital of Birmingham, Alabama.
William W. Horton joined HEALTHSOUTH in July 1994 as Group Vice President - -- Legal Services and was named Senior Vice President and Corporate Counsel in May 1996 and Executive Vice President and Corporate Counsel in March 2001. From August 1986 through June 1994, Mr. Horton practiced corporate, securities and healthcare law with the Birmingham, Alabama-based firm now known as Haskell Slaughter & Young, L.L.C., where he served as Chairman of the Healthcare Practice Group.
Robert E. Thomson joined HEALTHSOUTH in August 1985 as administrator of its Florence, South Carolina inpatient rehabilitation facility, and subsequently served as Regional Vice President -- Inpatient Operations, Vice President -- Inpatient Operations, Group Vice President -- Inpatient Operations, and Senior Vice President -- Inpatient Operations. Mr. Thomson was named President -- Inpatient Operations in February 1996.
Patrick A. Foster joined HEALTHSOUTH in February 1994 as Director of Operations and subsequently served as Group Vice President -- Inpatient Operations and Senior Vice President -- Inpatient Operations. He was named President -- HEALTHSOUTH Surgery Centers in October 1997 and President -- Ambulatory Services --West in September 1999. From August 1992 until February 1994, he served as Senior Vice President of the Rehabilitation/Medical Division of The Mediplex Group.
Larry D. Taylor joined HEALTHSOUTH in May 1987 as an outpatient rehabilitation facility administrator. He was subsequently named Area Manager in July 1989, Regional Vice President -- Outpatient Operations in October 1991, Group Vice President -- Outpatient Operations in July 1992, Senior Vice President -- Outpatient Operations in February 1994, and Senior Vice President - -- Ambulatory Services -- East in September 1999. In July 2000, he became President -- Ambulatory Services -- East.
Brandon O. Hale joined HEALTHSOUTH in July 1986 as Director of Human Resources and subsequently served as Vice President - Human Resources and Group Vice President - Human Resources. In December 1999, Mr. Hale was named Senior Vice President - Administration and Secretary of HEALTHSOUTH, and he also serves as HEALTHSOUTH's Corporate Compliance Officer.
Weston L. Smith, C.P.A., joined HEALTHSOUTH in February 1987 as Director of Reimbursement and subsequently served as Assistant Vice President - Finance - - Reimbursement, Vice President - Finance - Reimbursement, Group Vice President - - Finance - Reimbursement and Senior Vice President - Finance - Reimbursement. In March 2000, he was named Senior Vice President - Finance and Controller. Prior to joining HEALTHSOUTH, Mr. Smith served as a certified public accountant on the audit staff of the Birmingham, Alabama office of Ernst & Whinney (now Ernst & Young LLP) from 1982 to 1987.
Malcolm E. McVay joined HEALTHSOUTH in September 1999 as Vice President - Finance, and was named Senior Vice President - Finance and Treasurer in February 2000. From October 1998 until September 1999, he served as Senior Vice President of Investor Relations at CaremarkRx, Inc., and from 1996 until October 1998, he served as Chief Financial Officer, Secretary and Treasurer of Capstone Capital Corporation, a healthcare real estate investment trust. Prior to 1996, he worked for ten years in commercial banking, most recently as a Senior Vice President of SouthTrust Bank.
GENERAL
Directors of HEALTHSOUTH hold office until the next Annual Meeting of Stockholders of HEALTHSOUTH and until their successors are elected and qualified. Executive officers are elected annually by, and serve at the discretion of the Board of Directors. There are no arrangements or understandings known to us between any of our Directors, nominees for Director or executive officers and any other person pursuant to which any of those persons was elected as a Director or an executive
officer, except the Employment Agreement between HEALTHSOUTH and Richard M. Scrushy (see Item 11, "Executive Compensation -- Chief Executive Officer Employment Agreement"), and except that we initially agreed to appoint Mr. Gordon to the Board of Directors in connection with the Surgical Care Affiliates merger. There are no family relationships between any Directors or executive officers of HEALTHSOUTH.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires our executive officers and Directors, and persons who beneficially own more than 10% of a registered class of our equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission and the New York Stock Exchange. Executive officers, Directors and beneficial owners of more than 10% of HEALTHSOUTH's common stock are required by Securities and Exchange Commission regulations to furnish us with copies of all Section 16(a) forms that they file. Based solely on review of the copies of such forms furnished to us, or written representations that no reports on Form 5 were required, we believe that for the period from January 1, 2000, through December 31, 2000, all of our executive officers, Directors and greater-than-10% beneficial owners complied with all Section 16(a) filing requirements applicable to them, except that Larry D. Striplin, Jr., an outside Director, failed to timely report the purchase of 5,000 shares of our common stock at $5.1875 per share on February 28, 2000. Mr. Striplin reported such purchase on Form 5 in February 2001.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
EXECUTIVE COMPENSATION -- GENERAL
The following table sets forth compensation paid or awarded to our Chief Executive Officer, as well as each of our other four most highly compensated executive officers and two former executive officers for whom disclosure would have been required had they been serving as executive officers at December 31, 2000, for all services rendered to HEALTHSOUTH and its subsidiaries in 1998, 1999 and 2000.
SUMMARY COMPENSATION TABLE
- ---------- (1) For the year ending December 31, 2000, this category includes (a) matching contributions under the HEALTHSOUTH Retirement Investment Plan of $1,020 for Mr. Scrushy, $1,575 for Mr. Bennett, $0 for Mr. Owens, $1,276 for Mr. Brown, $738 for Mr. Thomson, $1,050 for Mr. Carman and $1,260 for Mr. Foster; (b) awards under our Employee Stock Benefit Plan of $416 for Mr. Scrushy, $416 for Mr. Bennett, $416 for Mr. Owens, $416 for Mr. Brown, $416 for Mr. Thomson, $416 for Mr. Carman and $416 for Mr. Foster; and (c) split-dollar life insurance premiums paid of $54,039 with respect to Mr. Scrushy, $1,146 with respect to Mr. Bennett, $1,492 with respect to Mr. Owens, $2,153 with respect to Mr. Brown, $1,695 with respect to Mr. Thomson, $804 with respect to Mr. Carman, and $758 with respect to Mr. Foster. See this Item, "Executive Compensation -- Retirement Investment Plan" and "Executive Compensation -- Employee Stock Benefit Plan".
(2) Salary amounts for Mr. Scrushy include monthly incentive compensation amounts payable upon achievement of certain budget targets. Effective November 1, 1998, Mr. Scrushy voluntarily suspended receipt of his base salary and monthly incentive compensation through March 31, 1999, and voluntarily took reduced compensation through January 2, 2000. See this Item,"Executive Compensation -- Chief Executive Officer Employment Agreement".
(3) The value of restricted stock awards in 1999 reflects the closing price of HEALTHSOUTH common stock at the date of the award. The value of these awards measured at December 31, 2000 was $1,631,250 for the awards to each of Messrs. Scrushy and Bennett (100,000 shares each) and $1,223,438 for the awards to each of Messrs. Owens, Brown, Thomson, Carman and Foster (75,000 shares each). The awards vest five years from the date of grant, except as otherwise provided in our 1998 Restricted Stock Plan. See this Item, "Executive Compensation - 1998 Restricted Stock Plan"
(4) Includes $200,000 withdrawn by Mr. Brown in 1999 from his deferred compensation account. See this Item, "Executive Compensation - Deferred Compensation Plan".
STOCK OPTION GRANTS IN 2000
- ---------- (1) Based on the Black-Scholes option pricing model adapted for use in valuing executive stock options. The actual value, if any, an executive may realize will depend upon the excess of the stock price over the exercise price on the date the option is exercised, so that there is no assurance that the value realized by an executive will be at or near the value estimated by the Black-Scholes model. The estimated values under that model are based on arbitrary assumptions as to certain variables, including the following: (i) stock price volatility is assumed to be 71%; (ii) the risk-free rate of return is assumed to be 5.11%; (iii) dividend yield is assumed to be 0; and (iv) the time of exercise is assumed to be 4.5 years from the date of grant.
STOCK OPTION EXERCISES IN 2000 AND OPTION VALUES AT DECEMBER 31, 2000
- ---------- (1) Does not reflect any options granted and/or exercised after December 31, 2000. The net effect of any such grants and exercises is reflected in the table appearing under Item 12, "Security Ownership of Certain Beneficial Owners and Management".
(2) Represents the difference between market price of HEALTHSOUTH common stock and the respective exercise prices of the options at December 31, 2000. Such amounts may not necessarily be realized. Actual values which may be realized, if any, upon any exercise of such options will be based on the market price of the common stock at the time of any such exercise and thus are dependent upon future performance of the common stock.
STOCK OPTION PLANS
Set forth below is information concerning our various stock option plans at December 31, 2000. All share numbers and exercise prices have been adjusted as necessary to reflect previous stock splits.
1984 Incentive Stock Option Plan
In 1984 we adopted the 1984 Incentive Stock Option Plan. Under this plan, our Board of Directors, which administered the plan, had discretion to grant to key employees of HEALTHSOUTH options to purchase shares of HEALTHSOUTH common stock at the fair market value attributed to shares of HEALTHSOUTH common stock on the date the option was granted or, in the case of a key employee who was also a beneficial holder of at least 10% of the total number of shares of HEALTHSOUTH common stock that were issued and outstanding at the time of the option grant, at 110% of such fair market value. The total number of shares of HEALTHSOUTH common stock covered by this plan was 4,800,000. The plan expired on February 28, 1994, in accordance with its terms. As of December 31, 2000, options granted under this plan to purchase 15,000 shares of HEALTHSOUTH common stock remained outstanding at an exercise price of $3.7825 per share. All of these outstanding options remain valid and in full force and must be held and exercised in accordance with the terms of the plan. All of the options granted must be exercised within ten years after they were granted and options granted under the plan terminate automatically within three months after termination of employment, unless such termination is by reason of death. In addition, the options may not be transferred, except pursuant to the terms of a valid will or applicable laws of descent and distribution, and in the event additional shares of HEALTHSOUTH common stock are issued they are protected from dilution.
1988 Non-Qualified Stock Option Plan
In 1988 we adopted the 1998 Non-Qualified Stock Option Plan. Under this plan, the Audit and Compensation Committee of our Board of Directors, which administered the plan, had discretion to grant to the Directors, officers and other key employees of HEALTHSOUTH options to purchase shares of HEALTHSOUTH common stock at the fair market value attributed to shares of HEALTHSOUTH common stock on the date the option was granted. The total number of shares of HEALTHSOUTH common stock covered by this plan was 4,800,000. The plan expired on February 28, 1998, in accordance with its terms. As of December 31, 2000, options granted under this plan to purchase 7,300 shares of HEALTHSOUTH common stock remained outstanding at an exercise price of $16.25 per share. All of these outstanding options remain valid and in full force and must be held and exercised in accordance with the terms of the plan. All of the options must be exercised within ten years after they were granted. All of the options granted under this plan terminate automatically within three months after termination of association as a Director or of employment, unless such termination is by reason of death. In addition, the options may not be transferred, except pursuant to the terms of a valid will or applicable laws of descent and distribution, and in the event additional shares of HEALTHSOUTH common stock are issued they are protected from dilution.
1989, 1990, 1991, 1992, 1993, 1995 and 1997 Stock Option Plans
In each of 1989, 1990, 1991, 1992, 1993, 1995 and 1997 we adopted stock option plans to provide incentives to our Directors, officers and other key employees. Under each of these plans, the Compensation Committee of our Board of Directors, which administers each of the plans, has the discretion to grant to our Directors, officers and other key employees incentive or non-qualified options to purchase shares of HEALTHSOUTH common stock at the fair market value attributed to shares of HEALTHSOUTH common stock on the date the option is granted. The table below sets forth information regarding each plan, including the total number of shares of HEALTHSOUTH common stock which may be purchased under each of the plans, the total number of additional shares of HEALTHSOUTH common stock which have been reserved for future use under each plan, the total number of shares of HEALTHSOUTH common stock which may be purchased under options which have been granted under each plan and which were outstanding on December 31, 2000 and the price or range of prices at which shares may be purchased if the options are exercised.
- ---------- (1) At December 31, 2000; to be increased by 0.9% of the outstanding shares of HEALTHSOUTH common stock as of January 1 of each calendar year thereafter until the plan terminates.
Until options granted under each of these plans expire or terminate, they remain valid and in full force and must be held and exercised in accordance with the terms of the plan under which they were issued. Each option granted under each of these plans, whether incentive or non-qualified, must be exercised within ten years after the date it was granted and each option granted under these plans, whether incentive or non-qualified, will terminate automatically within three months after a Director no longer is associated with us or an officer or key employee is no longer employed with us, except if the termination of association or employment is by reason of death. In addition, the options may not be transferred, except pursuant to the terms of a valid will or applicable laws of descent and distribution (except for various permitted transfers to family members or charities). In the event additional shares of HEALTHSOUTH common stock are issued, each option granted under these plans is protected from dilution.
1993 Consultants' Stock Option Plan
In 1993 we adopted the 1993 Consultants' Stock Option Plan to provide incentives to non-employee consultants who provide significant services to us. Under this plan, our Board of Directors, which administers the plan, has the discretion to grant to these non-employee consultants options to purchase shares of HEALTHSOUTH common stock at prices to be determined by our Board of Directors or a committee of our Board of Directors to whom this discretion has been delegated. The plan will expire on February 25, 2003 unless terminated earlier at the discretion of our Board of Directors or as a result of all of the shares of HEALTHSOUTH common stock reserved under this plan having been purchased by the exercise of options granted under this plan. The total number of shares of HEALTHSOUTH common stock covered by this plan is 3,500,000. As of December 31, 2000, options granted under this plan to purchase 1,528,633 shares of HEALTHSOUTH common stock remained outstanding at exercise prices ranging from $3.375 to $28.00 per share, and 76,000 shares remain available for the grant of options under this plan. All of these options remain valid and in full force and must be held and exercised in accordance with the terms of the plan. All of these options must be exercised within ten years after they were granted, although they may be exercised at any time during this ten-year period. All of these options terminate automatically within three months after termination of association with us, unless such termination is by reason of death. In addition, the options may not be transferred, except pursuant to the terms of a valid will or applicable laws of descent and distribution, and in the event additional shares of HEALTHSOUTH common stock are issued the options are protected from dilution.
1999 Exchange Stock Option Plan
In 1999, we adopted our 1999 Exchange Stock Option Plan (the "Exchange Plan") under which NQSOs could be granted, covering a maximum of 2,750,000 shares of common stock. The Exchange Plan was approved by our stockholders on May 20, 1999. The Exchange Plan was adopted after a protracted period of depression in the price of HEALTHSOUTH common stock and provided that HEALTHSOUTH employees (other than Directors and executive officers, who were eligible to participate) who held outstanding stock options with an exercise price equal to or greater than $16.00 could exchange such options for NQSOs issued under the Exchange Plan. Options granted under the Exchange Plan would have an exercise price equal to the closing price per share of our common stock on the New York Stock Exchange Composite Transactions Tape on May 20, 1999, would be deemed to have been granted on May 20, 1999, and would have durations and vesting restrictions identical to those affecting the options surrendered. Eligible options with an exercise price between $16.00 and $22.00 per share could be surrendered in exchange for an option under the Exchange Plan covering two shares of common stock for each three shares of common stock covered by the surrendered options, and eligible options having an exercise price of $22.00 per share or greater could be surrendered in exchange for an option under the Exchange Plan covering three shares of common stock for each four shares of common stock covered by the surrendered option. Each optionholder surrendering options was required to retain eligible options covering 10% of the aggregate number of shares covered by the options eligible for surrender. The Exchange Plan expired on September 30, 1999, at which time options covering 1,716,707 shares of common stock had been issued under the Exchange Plan at an exercise price of $13.3125 per share. Options covering 1,461,378 shares remained outstanding at December 31, 2000. Options granted under the Exchange Plan are nontransferable except by will or pursuant to the laws of descent and distribution (except for certain permitted transfers to family members or charities), are protected against dilution and expire within three months of termination of employment, unless such termination is by reason of death.
Other Stock Option Plans
In connection with some of our major acquisitions, we assumed existing stock option plans of the acquired companies, and outstanding options to purchase stock of the acquired companies under such plans were converted into options to acquire common stock in accordance with the exchange ratios applicable to such mergers. At December 31, 2000, there were outstanding under these assumed plans options to purchase 711,321 shares of HEALTHSOUTH common stock at exercise prices ranging from $5.28 to $36.9718 per share. No additional options are being granted under any such assumed plans.
1998 RESTRICTED STOCK PLAN
In 1998, we adopted the 1998 Restricted Stock Plan (the "Restricted Stock Plan"), covering a maximum of 3,000,000 shares of HEALTHSOUTH common stock. The Restricted Stock Plan, which is administered by the Compensation Committee of our Board of Directors, provides that executives and other key employees of HEALTHSOUTH and its subsidiaries may be granted restricted stock awards vesting over a period of not less than one year and no more than ten years, as determined by the Committee. The Restricted Stock Plan terminates on the earliest of (a) May 28, 2008, (b) the date on which awards covering all shares of common stock reserved for issuance thereunder have been granted and are fully vested thereunder, or (c) such earlier time as the Board of Directors may determine. Awards under the Restricted Stock Plan are nontransferable except by will or pursuant to the laws of descent and distribution (except for certain permitted transfers to family members), are protected against dilution and are forfeitable upon termination of a participant's employment to the extent not vested. On May 17, 1999, the Audit and Compensation Committee of the Board of Directors granted restricted stock awards covering 850,000 shares of HEALTHSOUTH common stock to various executive officers of HEALTHSOUTH. These shares vest in full upon the earliest to occur of (a) five years from the date of the award, (b) a Change in Control (as defined) of HEALTHSOUTH, or (c) unless the Compensation Committee otherwise determines, upon the recipient's termination of employment by reason of death, disability or retirement. Awards covering 200,000 of such shares lapsed without vesting in 2000, and an award covering 100,000 shares vested upon the retirement of the recipient.
RETIREMENT INVESTMENT PLAN
Effective January 1, 1990, we adopted the HEALTHSOUTH Retirement Investment Plan (the "401(k) Plan"), a retirement plan intended to qualify under Section 401(k) of the Code. The 401(k) Plan is open to all full-time and part-time employees of HEALTHSOUTH who are over the age of 21, have one full year of service with HEALTHSOUTH and have at least 1,000 hours of service in the year in which they enter the 401(k) Plan. Eligible employees may elect to participate in the Plan on January 1 and July 1 in each year.
Under the 401(k) Plan, participants may elect to defer up to 15% of their annual compensation (subject to nondiscrimination rules under the Code). The deferred amounts may be invested among four options, at the participant's direction: a money market fund, a bond fund, a guaranteed insurance contract or an equity fund. HEALTHSOUTH will match a minimum of 15% of the amount deferred by each participant, up to 4% of such participant's total compensation, with the matched amount also directed by the participant. See Note 12 of "Notes to Consolidated Financial Statements".
William T. Owens, Executive Vice President and Chief Financial Officer, and Brandon O. Hale, Senior Vice President -- Administration and Secretary, serve as Trustees of the 401(k) Plan, which is administered by HEALTHSOUTH.
EMPLOYEE STOCK BENEFIT PLAN
Effective January 1, 1991, we adopted the HEALTHSOUTH Rehabilitation Corporation and Subsidiaries Employee Stock Benefit Plan (the "ESOP"), a retirement plan intended to qualify under sections 401(a) and 4975(e)(7) of the Code. The ESOP is open to all full-time and part-time employees of HEALTHSOUTH who are over the age of 21, have one full year of service with HEALTHSOUTH and have at least 1,000 hours of service in the year in which they begin participation in the ESOP on the next January 1 or July 1 after the date on which such employee satisfies the conditions mentioned above.
The ESOP was established with a $10,000,000 loan from HEALTHSOUTH, the proceeds of which were used to purchase 1,655,172 shares of HEALTHSOUTH common stock. In 1992, an additional $10,000,000 loan was made to the ESOP, which was used to purchase an additional 1,666,664 shares of common stock. Under the ESOP, a company stock account is established and maintained for each eligible employee who participates in the ESOP. In each plan year, this account is credited with such employee's allocable share of the common stock held by the ESOP and allocated with respect to that plan year. Each employee's allocable share for any given plan year is determined according to the ratio which such employee's compensation for such plan year bears to the compensation of all eligible participating employees for the same plan year.
Eligible employees who participate in the ESOP and who have attained age 55 and have completed 10 years of participation in the ESOP may elect to diversify the assets in their company stock account by directing the plan administrator to transfer to the 401(k) Plan a portion of their company stock account to be invested, as the eligible employee directs, in one or more of the investment options available under the 401(k) Plan. See Note 12 of "Notes to Consolidated Financial Statements".
Richard M. Scrushy, Chairman of the Board and Chief Executive Officer, William T. Owens, Executive Vice President and Chief Financial Officer, and Brandon O. Hale, Senior Vice President -- Administration and Secretary of the Company, serve as Trustees of the ESOP, which is administered by HEALTHSOUTH.
STOCK PURCHASE PLAN
In order to further encourage employees to obtain equity ownership in HEALTHSOUTH, the Board of Directors adopted an Employee Stock Purchase Plan effective January 1, 1994. Under the Stock Purchase Plan, participating employees may contribute $10 to $200 per pay period toward the purchase of HEALTHSOUTH common stock in open-market transactions. The Stock Purchase Plan is open to regular full-time or part-time employees who have been employed for six months and are at least 21 years old. After six months of participation in the Stock Purchase Plan, we currently provide a 20% matching
contribution to be applied to purchases under the Stock Purchase Plan. We also pay all fees and brokerage commissions associated with the purchase of the stock. The Stock Purchase Plan is administered by a broker-dealer firm not affiliated with HEALTHSOUTH.
DEFERRED COMPENSATION PLAN
In 1997, the Board of Directors adopted an Executive Deferred Compensation Plan, which allows senior management personnel to elect, on an annual basis, to defer receipt of up to 50% of their base salary and up to 100% of their annual bonus, if any (but not less than an aggregate of $2,400 per year) for a minimum of five years from the date such compensation would otherwise have been received. Amounts deferred are held by HEALTHSOUTH pursuant to a "rabbi trust" arrangement, and amounts deferred are credited with earnings at an annual rate equal to the Moody's Average Corporate Bond Yield Index (the "Moody's Rate"), as adjusted from time to time, or the Moody's Rate plus 2% if a participant's employment is terminated by reason of retirement, disability or death or within 24 months of a change in control of HEALTHSOUTH. Amounts deferred may be withdrawn upon retirement, termination of employment or death, upon a showing of financial hardship, or voluntarily with certain penalties. The Deferred Compensation Plan is administered by an Administrative Committee, currently consisting of William T. Owens, Executive Vice President and Chief Financial Officer, and Brandon O. Hale, Senior Vice President -- Administration and Secretary.
1999 EXECUTIVE EQUITY LOAN PLAN
In order to provide its executive officers and other key employees with additional incentive for future endeavor and to align the interests of our management and our stockholders by providing a mechanism to enhance ownership of HEALTHSOUTH common stock by executives and key employees, we adopted the 1999 Executive Equity Loan Plan (the "Loan Plan"), which was approved by our stockholders on May 20, 1999. Under the Loan Plan, the Compensation Committee of the Board of Directors may approve loans to executive and key employees of HEALTHSOUTH to be used for purchases of HEALTHSOUTH common stock. The maximum aggregate principal amount of loans outstanding under the Loan Plan may not exceed $50,000,000. Loans under the Loan Plan have a maturity date of seven years from the date of the loan, subject to acceleration and termination as provided in the Loan Plan. The maturity date may be extended for up to one additional year by the Audit and Compensation Committee, acting in its discretion. The unpaid principal balance of each loan bears interest at a rate equal to the effective interest rate on the average outstanding balance under HEALTHSOUTH's principal credit agreement for each calendar quarter, adjustable as of the end of each calendar quarter. Interest compounds annually. Each loan is secured by a pledge of all the shares of HEALTHSOUTH common stock purchased with the proceeds of the loan. The pledged shares may not be sold for one year after the date on which they were acquired. Thereafter, one-third of the aggregate number of shares may be sold during each of the second, third and fourth years after the date of acquisitions, with any unsold portion carrying forward from year to year. The proceeds from any such sale must be used to repay a corresponding percentage of the principal amount of the loan. In addition, HEALTHSOUTH may, but is not required to, repurchase the shares of a participant at such participant's original acquisition cost if the participant's employment is terminated, voluntarily or involuntarily or by reason of death or disability, within the first three years after the acquisition date, all as more fully described in the Loan Plan. Loans under the Loan Plan are made with full recourse, and each participant is required to repay all principal and accrued but unpaid interest upon the maturity of the loan, or its earlier acceleration or termination, irrespective of whether the participant has sold the underlying shares or whether the proceeds of such sale were sufficient to repay all principal and interest with respect to the loan. The Loan Plan terminates on the earlier of May 19, 2009 or such earlier time as the Board of Directors may determine.
On September 10, 1999, loans aggregating $39,334,104 were made under the Loan Plan. Included in this amount were loans in the following amounts to then-serving executive officers:
The loans made to Messrs. Bennett and Martin were repaid in full in 2000. The loan made to Mr. McVay and one-third of the loan made to Mr. Foster were repaid in the first quarter of 2001.
BOARD COMPENSATION
Directors who are not also employed by HEALTHSOUTH are paid Directors' fees of $10,000 per year, plus $3,000 for each meeting of the Board of Directors and $1,000 for each Committee meeting attended. In addition, Directors are reimbursed for all out-of-pocket expenses incurred in connection with their duties as Directors. Our Directors, including employee Directors, have been granted non-qualified stock options to purchase shares of HEALTHSOUTH common stock. Under our existing stock option plans, each non-employee Director is granted an option covering 25,000 shares of common stock on the first business day in January of each year. See this Item, "Executive Compensation -- Stock Option Plans" above.
CHIEF EXECUTIVE OFFICER EMPLOYMENT AGREEMENT
We have an Amended and Restated Employment Agreement, dated April 1, 1998, with Richard M. Scrushy, under which Mr. Scrushy, a management founder, is employed as Chairman of the Board and Chief Executive Officer for a five-year term originally scheduled to expire on April 1, 2003. This term is automatically extended for an additional year on each April 1 unless the Agreement is terminated as provided therein. In addition, we have agreed to use our best efforts to cause Mr. Scrushy to be elected as a Director during the term of the Agreement. The Agreement provides for Mr. Scrushy to receive an annual base salary of at least $1,200,000, as well as an "Annual Target Bonus" equal to at least $2,400,000, based upon our success in meeting certain monthly and annual performance standards determined by the Compensation Committee of the Board of Directors. Mr. Scrushy's base salary for 2001 has been set at $1,500,000. The Annual Target Bonus is earned at the rate of $200,000 per month if the monthly performance standards are met, provided that if any monthly performance standards are not met but the annual performance standards are met, Mr. Scrushy will be entitled to any payments which were withheld as a result of failure to meet the monthly performance standards. The Agreement further provides that Mr. Scrushy is eligible for participation in all other management bonus or incentive plans and stock option, stock purchase or equity-based incentive compensation plans in which other senior executives of HEALTHSOUTH are eligible to participate. Under the Agreement, Mr. Scrushy is entitled to receive long-term disability insurance coverage, a non-qualified retirement plan providing for annual retirement benefits equal to 60% of his base compensation, use of a company-owned automobile, certain personal security services, and various other retirement, insurance and fringe benefits, as well as to generally participate in all employee benefit programs we maintain.
The Agreement may be terminated by Mr. Scrushy for "Good Reason" (as defined), by the Company for "Cause" (as defined), upon Mr. Scrushy's "Disability" (as defined) or death, or by either party at any time subject to the consequences of such termination as described in the Agreement. If the Agreement is terminated by Mr. Scrushy for Good Reason, we are required to pay him a lump-sum severance payment equal to the discounted value of the sum of his then-current base salary and Annual Target Bonus over the remaining term of the Agreement and to continue certain employee and fringe
benefits for the remaining term of the Agreement. If the Agreement is terminated by Mr. Scrushy otherwise than for Good Reason, we are required to pay him a lump-sum severance amount equal to the discounted value of two times the sum of his then-current base salary and Annual Target Bonus. If the Agreement is terminated by HEALTHSOUTH for Cause, Mr. Scrushy is not entitled to any severance or continuation of benefits. If the Agreement is terminated by reason of Mr. Scrushy's Disability, we are required to continue the payment of his then-current base salary and Annual Target Bonus for three years as if all relevant performance standards had been met, and if the Agreement is terminated by Mr. Scrushy's death, we are required to pay his representatives or estate a lump-sum payment equal to his then-current base salary and Annual Target Bonus. In the event of a voluntary termination by Mr. Scrushy following a Change in Control (as defined) of HEALTHSOUTH, other than for Cause, we are required to pay Mr. Scrushy an additional lump-sum severance payment equal to his then-current base salary and Annual Target Bonus. The Agreement provides for us to indemnify Mr. Scrushy against certain "parachute payment" excise taxes which may be imposed upon payments under the Agreement. The Agreement restricts Mr. Scrushy from engaging in certain activities competitive with our business during, and for 24 months after termination of, his employment with HEALTHSOUTH, unless such termination occurs after a Change in Control.
OTHER EXECUTIVE EMPLOYMENT AGREEMENTS
We also have Employment Agreements, dated April 1, 1998, with Thomas W. Carman, Executive Vice President -- Corporate Development, Robert E. Thomson, President -- Inpatient Operations, and Patrick A. Foster, President -- Ambulatory Services -- West, under which each of these persons is employed in these capacities for a three-year term originally scheduled to expire on April 1, 2001. Such terms are automatically extended for an additional year on each April 1 unless the Agreements are terminated in accordance with their terms. The Agreements currently provide for the payment of an annual base salary of $360,000 to Mr. Carman, $450,000 to Mr. Thomson, and $450,000 to Mr. Foster. The Agreements further provide that each of these officers is eligible for participation in all management bonus or incentive plans and stock option, stock purchase or equity-based incentive compensation plans in which other senior executives of HEALTHSOUTH are eligible to participate, and provide for various specified fringe benefits.
If the Agreements are terminated by HEALTHSOUTH other than for Cause (as defined), Disability (as defined) or death, we are required to continue the officers' base salary in effect for a period of one year after termination, as severance compensation. In addition, in the event of a voluntary termination of employment by the officer within six months after a Change in Control (as defined), we are also required to continue the officer's salary for the same period. The Agreements restrict the officers from engaging in activities competitive with our business during their employment with HEALTHSOUTH and for any period during which the officer is receiving severance compensation, unless such termination occurs after a Change in Control.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth certain information regarding beneficial ownership of HEALTHSOUTH common stock as of March 26, 2001, (a) by each person who is known by us to own beneficially more than 5% of our common stock, (b) by each of our Directors, (c) by our five most highly compensated executive officers, (d) by two former executive officers who would have been among our five most highly compensated executive officers had they held such positions at December 31, 2000 and (e) by all executive officers and Directors as a group.
- ---------- (1) The persons named in the table have sole voting and investment power with respect to all shares of HEALTHSOUTH common stock shown as beneficially owned by them, except as otherwise indicated.
(2) Includes 9,000 shares held by trusts for Mr. Scrushy's children, 31,000 shares held by a charitable foundation of which Mr. Scrushy is an officer and director and 15,522,524 shares subject to currently exercisable stock options.
(3) Includes 250,000 shares subject to currently exercisable stock options.
(4) Includes 2,100 shares owned by Ms. Givens's spouse and 410,000 shares subject to currently exercisable stock options.
(5) Includes 460 shares owned by members of Mr. Newhall's immediate family, and 685,000 shares subject to currently exercisable stock options. Mr. Newhall disclaims beneficial ownership of the shares owned by his family members, except to the extent of his pecuniary interest therein.
(6) Includes 220,665 shares owned by trusts of which Mr. Strong is a trustee and claims shared voting and investment power and 300,000 shares subject to currently exercisable stock options.
(7) Includes 547,500 shares subject to currently exercisable stock options.
(8) Includes 812,500 shares subject to currently exercisable stock options.
(9) Includes 127,396 shares owned by Mr. Gordon's spouse and 484,520 shares subject to currently exercisable stock options.
(10) Includes 855,000 shares subject to currently exercisable stock options.
(11) Includes 60,000 shares subject to currently exercisable stock options.
(12) Includes 900,000 shares subject to currently exercisable stock options.
(13) Includes 613,800 shares subject to currently exercisable stock options.
(14) Includes 1,490,000 shares subject to currently exercisable stock options.
(15) Includes 1,100,000 shares subject to currently exercisable stock options.
(16) Shares held by various investment funds for which affiliates of FMR Corp. act as investment advisor. FMR Corp. or its affiliates claim sole power to vote 936,510 shares and sole power to dispose of all of the shares.
(17) Includes 23,119,857 shares subject to currently exercisable stock options held by executive officers and Directors.
* Less than 1%
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
In December 1999, we acquired 6,390,583 shares of Series A Convertible Preferred Stock of MedCenterDirect.com, inc., a development-stage healthcare e-procurement company, in a private placement for a purchase price of $0.3458 per share. Various persons affiliated or associated with us, including various of our Directors and executive officers, also purchased shares in the private placement. Under a Stockholders Agreement, we and the other holders of Series A Convertible Preferred Stock, substantially all of whom may be deemed to be our affiliates or associates, have the right to elect 50% of the directors of MedCenterDirect.com. During 2000, we purchased $74,587,873 in goods, supplies and related services through MedCenterDirect.com on terms we believe to be no less favorable than those we could have obtained from an unrelated vendor. During 2001, we expect to enter into a definitive long-term exclusive agreement under which MedCenterDirect.com will be our exclusive e-procurement vendor of medical products and supplies. We expect that the terms of such agreement will be no less favorable than those we could obtain from an unrelated vendor.
At times, we have made loans to executive officers to assist them in meeting various financial obligations or for other purposes. At December 31, 2000, a loan in the principal amount of $476,000 was outstanding to William T. Owens, Executive Vice President and Chief Financial Officer and a Director of the Corporation. This loan bears interest at the rate of 1 1/4% per annum below the prime rate of AmSouth Bank of Alabama, Birmingham, Alabama, and is payable on demand. See Item 11, "Executive Compensation -- 1999 Executive Equity Loan Plan", for information concerning loans to executive officers to purchase HEALTHSOUTH common stock.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) Financial Statements, Financial Statement Schedules and Exhibits.
1. Financial Statements.
The consolidated financial statements of HEALTHSOUTH and its subsidiaries filed as a part of this Annual Report on Form 10-K are listed in Item 8 of this Annual Report on Form 10-K, which listing is hereby incorporated herein by reference.
2. Financial Statement Schedules.
The financial statement schedules required by Regulation S-X are filed under Item 14(d) of this Annual Report on Form 10-K, as listed below:
Schedules Supporting the Financial Statements
Schedule II Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission have been omitted because they are not required under the related instructions or are inapplicable, or because the information has been provided in the Consolidated Financial Statements or the Notes thereto.
3. Exhibits.
The Exhibits filed as a part of this Annual Report are listed in Item 14(c) of this Annual Report on Form 10-K, which listing is hereby incorporated herein by reference.
(b) Reports on Form 8-K.
HEALTHSOUTH filed no Current Reports on Form 8-K during the three months ended December 31, 2000.
(c) Exhibits.
The Exhibits required by Regulation S-K are set forth in the following list and are filed either by incorporation by reference from previous filings with the Securities and Exchange Commission or by attachment to this Annual Report on Form 10-K as so indicated in such list.
(d) Financial Statement Schedules.
Schedule II: Valuation and Qualifying Accounts
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
- ---------- (1) Allowances of acquisitions in years 1998, 1999 and 2000, respectively.
(2) Write-offs of uncollectible patient accounts receivable.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
HEALTHSOUTH CORPORATION
By: RICHARD M. SCRUSHY ------------------------------------ Richard M. Scrushy, Chairman of the Board and Chief Executive Officer
Date: March 29, 2001
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.