ITEM 1. BUSINESS
Unless the context otherwise requires, when used herein the term "Company" refers to Horizon Health Corporation and its subsidiaries.
GENERAL
The Company is a provider of employee assistance plans ("EAP") and behavioral health services to business and managed care organizations, as well as a leading contract manager of psychiatric and physical rehabilitation clinical programs offered by general acute care hospitals in the United States. The Company has grown both internally and through acquisitions, increasing both the variety of its treatment programs and services, and the number of its contracts. As of August 31, 2001, the Company had 646 contracts to provide EAP and managed mental health services covering approximately 2.3 million lives. The Company had 138 management contracts as of August 31, 2001, with contract locations in 36 states and the District of Columbia. Of its management contracts, 112 relate to mental health treatment programs and 26 relate to physical rehabilitation programs. The Company has also developed a proprietary mental health outcomes measurement system known as CQI+. At August 31, 2001 the Company had contracts to provide outcome measurement services at 160 contract locations as well as 8 database project contracts. The Company was incorporated in 1989 and is the successor to Horizon Health Management Company, which began the development and contract management of mental health treatment programs for general acute care hospitals in 1981.
The Company's strategies are (1) to further enhance its position as the leader in the contract management of mental health treatment programs, (2) to expand the range of services which it offers to its client hospitals to include other clinical and related services and programs, and (3) to grow its employee assistance programs and managed behavioral care services. A significant challenge in obtaining clinical management contracts is overcoming the initial reservations that many hospital administrators have with outsourcing key clinical services. The Company believes its expertise in working with hospital administrators, its reputation in the industry and its existing hospital contractual relationships provide it with a significant advantage in marketing new contracts. The Company also believes it has opportunities to cross-sell management services of mental health and physical rehabilitation programs to client hospitals by marketing its mental health services to client hospitals for which the Company currently manages only physical rehabilitation programs, and by marketing its physical rehabilitation services to client hospitals for which the Company currently manages only mental health programs. The Company has successfully expanded the breadth of services it offers to include the full continuum of mental health services, including outcome measurement services, and physical rehabilitation services. Its management contracts increasingly cover multiple services. In addition, the Company has capitalized on its expertise in managing the delivery of mental health services by directly offering managed behavioral health care services and employee assistance programs to businesses and managed care organizations. The Company believes it is strategically sized to deliver such services on a national basis, while providing local, individualized service to both employers and health plans and to their respective employees or members.
The Company considers that it has four identifiable business segments generating 99.8% of its revenues as follows: (1) Employee assistance programs and managed care, (2) mental health contract management services, (3) physical rehabilitation contract management services, (4) outcomes measurement and psychiatric database services. Of the total revenues of the Company for the year ended August 31, 2001, such business segments constituted 25.1%, 62.1%, 10.5%, and 2.1% respectively. See Note 13 to the Consolidated Financial Statements of the Company included herein for certain financial information regarding industry segments of the Company.
MENTAL HEALTH SERVICES
The Company believes that there continues to be substantial opportunities to provide mental health contract management services to general acute care hospitals in the United States. General acute care hospitals are increasingly outsourcing key clinical departments to independent contract management companies for several reasons, including: (i) the expertise necessary for the development, management and operation of specialized clinical programs differs from that for traditional medical/surgical services, (ii) hospitals often lack access to skilled professionals and the support staff needed to operate specialized clinical programs, (iii) hospitals often lack expertise in the marketing and development activities required to support specialized clinical programs, and (iv) hospitals often lack expertise necessary to design and operate specialized clinical programs that satisfy regulatory, licensing, accreditation and reimbursement requirements.
A major shift in the delivery of mental health services is occurring as payors are increasingly using managed care methods to review and require pre-approval for mental health treatment and to evaluate alternatives to inpatient hospitalization in order to ensure that each patient's treatment regimen utilizes clinical resources effectively. The Company believes that general acute care hospitals need to be able to offer a broad array of mental health care services in order to develop or participate in integrated delivery systems responsive to the demands of managed care companies and other third-party payors. The Company also believes that it costs general acute care hospitals less to provide inpatient and partial hospitalization mental health services than it costs freestanding psychiatric hospitals in part due to the ability of acute care hospitals to utilize excess capacity. General acute care hospitals are also able to provide their mental health patients with needed medical care on-site and in a more cost-effective manner than freestanding psychiatric hospitals. Furthermore, general acute care hospitals are eligible to receive reimbursement under the Medicaid program for mental health care provided to Medicaid-eligible adults, unlike freestanding psychiatric hospitals, which are not presently eligible.
The Company believes that, due to the increasing emphasis on cost-effective treatment, significant demand exists for a complete continuum of mental health services. In response to this demand, it has expanded the mental health programs it manages to include partial hospitalization (or day treatment), outpatient treatment, and short-term crisis intervention as alternatives and compliments to inpatient care. The Company believes it is uniquely positioned to capitalize on the increased demand for mental health contract management services as a result of its ability to provide a full continuum of mental health services, its proprietary quality and outcomes measurement system and its demonstrated industry expertise. In addition, the Company believes its position as the leading contract manager of mental health programs provides the Company with a significant advantage in attracting and retaining employees and yields several economies of scale such as the ability to consolidate accounting and administrative functions.
The Company intends to continue to emphasize the area of mental health programs for the elderly ("geropsychiatric programs"). At August 31, 2001, 69% of the mental health treatment programs managed by the Company were geropsychiatric programs. Many elderly patients with short-term mental illness also have physical problems that make the general acute care hospital environment the most appropriate site for their care. Subject to certain recently enacted caps on reimbursement amounts, the Medicare program reimburses general acute care hospitals for their cost of providing these services, which includes the Company's management fee as well as allocated overhead costs to the facility, and allows reimbursement for partial hospitalization that permit the patient to be treated in the most cost-effective environment. The Company has developed particular expertise in developing specialized psychiatric programs for the elderly, in operating such programs, and in assisting hospitals to receive approval for inpatient programs as distinct part units ("DPUs") under Medicare. Approval of an inpatient program as a DPU is significant to client hospitals because services provided in DPUs are exempt from predetermined reimbursement rates and are reimbursed by Medicare on an actual cost basis, subject to certain significant limitations described below.
The fees received by the Company for its services under management contracts are paid directly by its client hospitals. The client hospitals receive reimbursement under either the Medicare or Medicaid programs or payments from insurers, self-funded benefit plans or other third-party payors for the mental health and physical rehabilitation services provided to patients of the programs managed by the Company. As a result, the availability and amount of such reimbursement, which are subject to change, impacts the decisions of general acute care hospitals regarding
whether to offer mental health and physical rehabilitation services pursuant to management contracts with the Company, as well as the decisions whether to renew such contracts and the amount of fees to be paid thereunder.
The Balanced Budget Act of 1997 mandated the elimination of cost-based reimbursement of mental health partial hospitalization services. Implementation began August 1, 2000. The resulting reimbursement for partial hospitalization services based on the Medicare outpatient prospective payment system utilizes a fixed reimbursement amount per patient day. The base reimbursement rate is a wage-adjusted rate of $206.82 per day, which lowered Medicare reimbursement levels to many hospitals for partial hospitalization services. This change adversely affected the ability of the Company to maintain and obtain management contracts for partial hospitalization services and the amount of fees paid to the Company under such contracts.
Revenues from partial hospitalization services were $7.4 million, or 7.9% of total contract management revenues for the year ended August 31, 2001, down approximately $7.8 million, or 51.3% from the prior fiscal year. Of the 54 contracts including partial hospitalization services in effect on August 31, 2001, 40 program locations had partial hospitalization services in operation, 12 program locations were in operation but the partial hospitalization services were not in operation, and 2 program locations were not yet in operation for any of the services. The termination of all partial hospitalization contracts, while unlikely and not expected, could reduce operating income by $2.5 million or more annually.
In April 2000, HCFA (renamed in June 2001 to the Centers for Medicare and Medicaid Services, or "CMS") adopted new rules requiring a CMS determination that a facility has provider-based status before a provider can bill for the services rendered at the facility. The new rules have been construed by CMS to apply to inpatient mental health and rehabilitation units. The rules contain numerous requirements, some specifically applicable to facilities operated under management contracts, which must be satisfied in order to receive a CMS determination of provider-based status. The rules are applicable to a provider for new programs at the beginning of its first Medicare cost reporting year that commences after January 10, 2001. Existing programs at October 1, 2000 are "grand-fathered", unless they elect early adoption, until October 1, 2002. The particular application of the rules to inpatient units managed by the Company is currently unclear in several respects. CMS has indicated that it intends to issue guidelines under the new rules, which may provide clarification. At the current time, there is uncertainty with respect to both precisely how the new rules are to be applied to inpatient units managed by the Company and uncertainty as to whether the current structure of the management contracts of the Company will satisfy the requirements under the new rules. The Company is unable at this time to definitively determine the effect of the new provider-based rules on its business operations, but it is possible that the new provider-based rules could result in modifications to the contracts which may be unfavorable to the Company or cause termination or non-renewal of management contracts if, under the new rules, it is not possible for the hospital provider to obtain a determination of provider-based status of an inpatient unit operated under a management contract.
In addition, recent amendments to the Medicare statutes provide for a phase-out of cost-based reimbursement of physical rehabilitation services over a two-year period beginning no earlier than January 1, 2002. The phase in of a prospective payment system with reimbursement based on a functional patient classification may raise in some cases and lower in others the Medicare reimbursement levels to hospitals for physical rehabilitation services. To the extent that client reimbursement decreases, this could adversely affect the ability of the Company to maintain and obtain management contracts for physical rehabilitation services and the amount of fees paid to the Company under such contracts.
CQI+ OUTCOMES MEASUREMENT SYSTEM
The Company has developed and markets a proprietary mental health outcome measurement system. The CQI+ Outcomes Measurement System, (the "CQI+ System") provides outcome information regarding the effectiveness of a hospital's mental health programs. The availability of such information enables a hospital to demonstrate to third-party payors whether patients are improving as a result of the treatment provided, to refine its clinical treatment programs to improve the effectiveness of care provided, and to demonstrate the benefits of its programs to patients and providers. The CQI+ system provides the Company with a valuable tool for demonstrating clinical results of the mental health programs managed by the Company and in marketing such management services to other hospitals. The Company provides outcome measurement services to acute care hospital-based programs,
freestanding psychiatric hospitals, community mental health centers, residential treatment centers and outpatient clinics. The Joint Commission on Accreditation of Healthcare Organizations ("JCAHO"), as part of its ORYX Initiative, requires each hospital to select at least one acceptable measurement system and multiple clinical performance (outcome) measures. The Company's CQI+ System has met the criteria for inclusion in the ORYX Initiative and is included on JCAHO's list of acceptable systems. The Company is committed to meeting the requirements as established by JCAHO. Since developing the CQI+ System over seven years ago, the Company has compiled a database containing outcome measurement data on approximately 75,000 patients. With the growth of managed care and the JCAHO accreditation requirement, the Company believes that its CQI+ System is becoming an important component of the mental health services it provides.
PSYCHSCOPE DATABASE SERVICES
The Company developed and began to market in fiscal 1999 PsychScope Database Services, which are based on outcomes measurement data collected from approximately 75,000 patients that have participated in the CQI+ Outcomes Measurement System since 1994. The PsychScope Services allow pharmaceutical product marketers and researchers to access information on the clinical treatment of patients in behavioral health programs across the U.S. PsychScope Services can be accessed by customers as either standard quarterly reports which track and trend key drug usage variables and associated patient health status, severity of illness, patient functioning, and symptoms, or as custom research studies which are completely customer specified. PsychScope Services support pharmaceutical company drug marketing strategies, the creation of diagnosis based patient and treatment profiles, the development of drug research protocols, and assessment of competitive drug positioning and usage. The healthcare market for database services is an established and growing market that is fueled by the highly competitive pharmaceutical market.
PHYSICAL REHABILITATION SERVICES
The Company has successfully expanded the types of programs that it manages for its client hospitals to include physical rehabilitation services. The Company's acquisition of Specialty Healthcare Management, Inc. ("Specialty"), in August 1997, expanded the Company's operations to include the contract management of physical rehabilitation programs. The Company believes that many of the same factors driving demand for contract management of mental health programs are also driving significant demand for contract management of physical rehabilitation programs. The Company provides contract management for a full range of physical rehabilitation services. In addition to acute physical therapy and rehabilitation services, the Company also provides contract management for outpatient rehabilitation programs. Outpatient rehabilitation services are dominated by the treatment of sports and work related injuries, but also provide the continuum of rehabilitative care necessary to meet the medical needs of a post-acute care patient following a disabling illness or traumatic injury. Pressure from payors to move inpatients to the lowest-cost appropriate treatment setting has helped fuel growth in these outpatient services.
Recent amendments to the Medicare statutes provide for a linear phase-out of cost-based reimbursement of physical rehabilitation, which is currently expected to begin on January 1, 2002. Reimbursement for physical rehabilitation services on a prospective payment system basis will be phased-in over two years. Under the prospective payment rates recently announced, it appears that the majority of the Company's clients will experience increased reimbursement, although several clients expect reduced reimbursement including one that could suffer losses on the services being provided without additional volume.
MANAGED BEHAVIORAL HEALTH CARE SERVICES AND EMPLOYEE ASSISTANCE PROGRAMS
The Company is a provider of managed behavioral health care, utilization management and employee assistance programs (EAP). The Company provides its clients with quality, cost-effective programs for administration and management of behavioral health, substance abuse and psychiatric disability management services. The Company also maintains extensive involvement on a national level in the at-risk management of mental health services under employer plans and commercial programs. Beginning with the acquisition of Florida Professional Psychological Services, Inc. ("Florida PPS"), in August 1996, and continuing with the acquisitions of Acorn Behavioral Health Care Management Corporation ("Acorn"), Inc. in October 1997, and FPM Behavioral
Health, Inc. ("FPM") in June 1998, the Company expanded its services to include the provision of full risk, capitated managed behavioral health care services for health maintenance organizations ("HMOs") and self-insured employers, as well as the provision of employee assistance programs for employers. The Company further expanded its services in this area with the acquisitions of ChoiceHealth, Inc., Resources in Employee Assistance and Corporate Health, Inc., and Occupational Health Consultants of America (OHCA), effective October 5, 1998, April 1, 1999 and August 1, 2001, respectively.
The behavioral health care services are provided by mental health care professionals that are employed by the Company or are under contract with the Company as independent providers. The clinical staff represents a broad range of treatment and case management specialties and is qualified to respond to the complete continuum of behavioral health concerns, pediatric to geriatric. The staff includes psychiatrists, nurses, psychologists, social workers, and other related mental health personnel. The Company believes that its existing relationships with health care providers and its expertise in the provision of mental health care services provide it with the capability to establish, operate and manage the network of health care professionals necessary to economically furnish such services.
Corporate development initiatives undertaken by the Company to expand its behavioral service businesses include the pursuit of a Knox-Keene license to conduct "at-risk" business in the state of California. In January 2001, the Company redirected the development of a corporate integrated EAP and managed care computer software system in favor of locally developed, subsidiary level, individual EAP and managed care solutions. Accordingly, separate initiatives for EAP and managed care have been undertaken by the EAP and managed care divisions of Horizon Behavioral Services, Inc., which involve enhancements to current software applications and/or purchasing commercially available software. The expenses associated with these two initiatives are reflected in the "other" (i.e., corporate) category in the Company's segment information included elsewhere herein.
In October 2000, Horizon Behavioral Services, Inc. was awarded a three year, Full Accreditation from the National Committee for Quality Assurance (NCQA) under its 2000 standards for managed behavioral health care organizations (MBHOs). NCQA is an independent, not-for-profit organization dedicated to assessing and reporting on the quality of managed behavioral health care organizations, physician organizations, managed care organizations and credentials verification organizations. The NCQA accreditation process is a voluntary review that evaluates how well a managed behavioral health care organization manages all parts of its delivery system in order to continuously improve health care for its members. The NCQA standards for the accreditation of a MBHOs are intended to help organizations achieve the highest level of performance possible, reduce patient risk for untoward outcomes, and create an environment of continuous improvement. Accreditation decisions include Full Accreditation (the highest level), One-year Accreditation, Provisional Accreditation and Denial.
Employee assistance programs, which are usually provided by employers as a benefit at no cost to employees, give employees the opportunity to have consultations with a health care provider to identify and discuss problems that may be affecting the work performance of the employee and a course of action or treatment to address such problems. The EAP also provides consultative services for the supervisors, managers and human resource departments of companies purchasing services. Critical Incident Debriefing programs and specialized training are elements of the program. The Company also offers a comprehensive array of work life information and referral sources as well as HorizOnline, an internet based EAP program, which is available exclusively to its clients. As with its other products, the Company intends to market such programs as an additional service it can offer new and existing client hospitals. In March 2000, the Company's EAP/Employer division received its third successive full, two-year accreditation for utilization management from the American Accreditation HealthCare/Commission (URAC), a non-profit charitable organization founded in 1990 to establish standards for the health care industry.
SERVICES
MENTAL HEALTH SERVICES
The Company has the expertise to manage a broad range of clinical mental health programs, including geropsychiatric, general adult, substance abuse and adolescent programs. The programs use a treatment team concept, with the admitting physician, team psychologist, social workers, nurses, therapists and counselors coordinating each phase of therapy. The programs include crisis intervention, individual therapy, group and family therapy, recreational therapy, occupational therapy, lifestyle education, social services and substance abuse counseling. Family involvement is encouraged. Each treatment program is individually tailored as much as practicable to meet the needs of the patients, the client hospital, physicians and payor groups. Mental health services represented 112 of the Company's 138 management contracts at August 31, 2001.
Elements of the Continuum of Care
The mental health treatment programs managed by the Company are designed to provide a continuum of mental health services, consisting of inpatient, partial hospitalization (or day treatment), outpatient and home health services.
Inpatient Services. Inpatient services are generally provided to patients needing the most intensive mental health treatment and who frequently have accompanying medical care needs. The patient is admitted to the client hospital and remains there on a 24-hour per day basis throughout the course of the inpatient treatment, which is continued until the patient can be stabilized and moved to another level in the continuum of mental health services. Please refer to the Medicare and Medicaid; Reimbursement for Services section below for a discussion of recent CMS rules requiring a CMS determination that a facility has provider-based status.
Partial Hospitalization. Partial hospitalization services are provided for limited periods per day at established intervals with the patient returning home at the conclusion of each day's treatment. Partial hospitalization services are designed to be both an alternative to inpatient hospitalization services and a key component of care following inpatient hospitalization.
Outpatient Services. Outpatient services consist generally of consultative sessions that can be rendered in a variety of individual or group settings at various locations, including hospitals, clinics or the offices of the service provider. Outpatient service providers can also serve as gatekeepers for persons being evaluated for treatment. Once an individual is assessed for treatment in an outpatient environment, the individual is provided the appropriate level of service in relation to the diagnosis.
Home Health Services. Home health services are provided in the patient's home. Typically, these services are provided on a periodic basis by an experienced psychiatric nurse working under the direct supervision of a psychiatrist. The nurse may provide medication management, vital sign monitoring, individual and family therapy, and other related clinical services. Patients utilizing home health services include individuals whose clinical conditions make it difficult or impossible to leave their homes due to psychiatric illness or a combination of psychiatric and medical illness. Home health service patients also include patients without access to transportation. Patients over the age of 65 often use psychiatric home health services.
Consulting Services
In late 1999 the Company made a commitment to expand its services by offering its considerable expertise in the mental health industry to hospital clients on a consulting basis. Over the past twenty years, the Company has been involved in the management of every facet of the mental health delivery system: inpatient, partial hospitalization, outpatient, home health and practice management. The Company's consulting services allow clients to take advantage of the Company's considerable expertise without a contract management relationship. The Company has developed three standard consulting modules that it refers to as its Avenues(TM) service modules. The Company's Avenues(TM) service modules provide assessment and ongoing support in key areas such as clinical
policies and procedures development, Medicare billing and coding assistance, comprehensive clinical audits, outcomes measurement and reporting, professional marketing and community relations.
CQI+ OUTCOMES MEASUREMENT SYSTEM
The Company began offering its CQI+ Outcomes Measurement System in 1994. The CQI+ System provides a qualitative and quantitative tool for mental health programs to evaluate the clinical effectiveness of treatment and to make adjustments in the programs in order to improve quality and appropriateness of care. In addition, the CQI+ System enables client hospitals to demonstrate to third-party payors the effectiveness of the treatment programs and provides a valuable tool to the hospital in demonstrating the benefits of its programs to patients and providers. The CQI+ System also assists the hospitals in complying with the increasing demands of regulatory and accrediting bodies for quality assessment of their mental health programs. JCAHO, as part of its accreditation process, requires each hospital to select at least one acceptable measurement system and multiple clinical performance (outcome) measures under the ORYX Initiative. The Company's CQI+ System has met the criteria for inclusion in the ORYX Initiative and is included on JCAHO's list of acceptable systems. The Company is committed to meeting future requirements as established by JCAHO. As of August 31, 2001, 56 of the Company's management contracts included the CQI+ System and there were 104 stand-alone CQI+ contracts. The CQI+ System provides the Company with a valuable tool in demonstrating clinical results of the mental health programs managed by the Company and in marketing such management services to other hospitals.
Since offering the CQI+ System, the Company has compiled a database containing outcome measurement data on approximately 75,000 patients. Sample data is collected from randomly selected patients at admission, discharge and 90 to 180 days after discharge. Quarterly outcome reports include a summary of patient characteristics and outcome measures. The Company trains and supervises on-site personnel to ensure the collection of accurate outcome measurement data.
PSYCHSCOPE DATABASE SERVICES
The Company developed and began to market in fiscal 1999 PsychScope Database Services, which are based on outcomes measurement data collected from approximately 75,000 patients that have participated in the CQI+ Outcomes Measurement System since 1994. The PsychScope Services allow pharmaceutical product marketers and researchers to access information on the clinical treatment of patients in behavioral health programs across the U.S. PsychScope services are sold to customers in two different service package offerings. The first offering allows customers to purchase standard quarterly reports which report key variables for drug usage by diagnosis as well as patient health status, severity of illness, patient functioning, and symptoms. This service allows customers the opportunity to track and trend the data over time for use in marketing projects and clinical research. The second PsychScope services allow customers to design customized retrospective and prospective research studies using the PsychScope database. This offering is used to support pharmaceutical company drug marketing strategies, the creation of diagnosis based patient and treatment profiles, the development of drug research protocols, and assessment of competitive drug positioning and usage. The healthcare market for database services is an established and growing market that is fueled by the highly competitive and rapidly growing pharmaceutical market. Due to the U.S. launches of several new psychiatric drugs, the psychiatric database services market is expected to grow significantly. As of August 31, 2001 the Company had 8 contracts to provide outcomes database services.
PHYSICAL REHABILITATION SERVICES
The Company provides contract management for a broad range of physical rehabilitation programs including (i) acute physical medicine and rehabilitation, (ii) subacute physical therapy and rehabilitation, and (iii) outpatient rehabilitation. Physical rehabilitation services represented 26 of the Company's 138 management contracts at August 31, 2001.
Acute Physical Therapy and Rehabilitation. The physical therapy and rehabilitation program incorporates a variety of treatments and services aimed at maximizing an individual's capabilities following a disabling illness or traumatic injury. The treatment program is provided by an interdisciplinary team of health care professionals including physicians, physical, speech, occupational and recreational therapists, rehabilitation nurses and social
workers. The Company attempts to tailor an acute physical therapy and rehabilitation program for a health care facility to satisfy unmet community and medical staff needs, while maximizing utilization of the facility.
Sub-acute Physical Therapy and Rehabilitation. Rapidly changing reimbursement issues have challenged health care providers to seek alternative services to meet the needs of their patient population requiring lower cost and intensity physical medicine and rehabilitation services. Comprehensive physical medicine and rehabilitation services at the subacute level offer an attractive alternative for acute care hospitals to meet these needs. The Company evaluates the feasibility of a health care facility providing rehabilitation services at the sub-acute level by analyzing a facility's discharge data, conducting a market analysis of services offered in a facility's community, assessing medical staff needs and evaluating financial viability.
Outpatient Rehabilitation. Outpatient rehabilitation serves as an adjunct to inpatient physical therapy and rehabilitation programs at the acute and/or sub-acute levels. The program provides the continuum of rehabilitative care necessary to meet the medical needs of a post-acute care patient following a disabling illness or traumatic injury.
Please refer to the Medicare and Medicaid; Reimbursement for Services section below for a discussion of new CMS rules requiring a CMS determination that a facility has provider-based status.
MANAGED BEHAVIORAL HEALTH CARE SERVICES AND EMPLOYEE ASSISTANCE PROGRAMS
The Company began offering behavioral health care services to HMOs and self-insured employers, and employee assistance programs to employers, with the acquisition of Florida PPS in 1996, and continuing with the acquisitions of Acorn in October 1997, FPM in June 1998, ChoiceHealth in October 1998, REACH in April 1999, and Occupational Health Consultants of America (OHCA) in August 2001. As of August 31, 2001, the Company had 646 contracts to provided EAP and managed behavioral health care services for nearly 2.3 million lives covered by various health plans and companies with which it had contracted. The Company contracts with HMOs to provide the mental health care component of the general health plans offered by such entities. The contracts are primarily on a full risk, capitated basis under which the Company is paid a set fee per month for each member of the respective health plan. The behavioral health care services are provided by mental health care professionals that are employed by the Company or are under contract with the Company as independent providers. In addition, the Company operates four clinics within the state of Florida, which perform related services. The Company reimburses the independent professionals and institutions on a discounted fee-for-service basis.
The Company utilizes a specialized network of contract providers, as well as staff clinicians and CEAP professionals, to operate employee assistance programs for employers. Many of the providers in the managed care network also participate in the EAP network. Employee assistance programs, which are usually provided by employers as a benefit at no cost to employees, generally give employees and their dependents the opportunity to have three to six consultations annually with a health care provider to discuss problems that may be affecting their ability to work. Such problems frequently relate to matters unrelated to mental health care. The purpose of the consultation is to help the employee identify the problem and to recommend a course of action or treatment to address the problem. The Company frequently provides training to employer personnel for identifying troubled employees. Often an employer will refer an employee for consultation after observing a change in work performance. The Company believes that such early identification, consultation and treatment can frequently minimize the likelihood that the problem will develop into a serious debilitating event requiring extensive treatment. Critical Incident Stress Debriefing for employers and their employees has been increasingly utilized in the past year. The Company also offers a comprehensive array of work life information and referral sources as well as HorizOnline, an internet based EAP program, which is available exclusively to its clients. The Company is paid a specified fee per month per employee for its services, which amount varies depending on the range of services provided.
OPERATIONS
GENERAL
The Company operates its mental health management contract business through a regional structure with offices in the Chicago, Dallas and Tampa metropolitan areas and a national support center ("NSC") in the Dallas suburb of Lewisville, Texas. The structure is designed to keep key operating employees of the Company in direct contact with clients. Each of the three regional offices is staffed to have the capacity to supervise up to 40 mental health management contract locations. Each regional office is under the supervision of a vice president who in turn supervises regional directors, each of whom has direct responsibility over eight to ten mental health management contract locations. Other regional office personnel include clinical and other specialists, who are available to provide assistance to the local programs and client hospital personnel. Presently, the Company's physical rehabilitation management contracts are operated in the same manner out of its NSC with plans to develop a comparable regional structure as it expands that area of its operations.
At August 31, 2001, the Company had 905 program employees at its contract locations and 171 employees at its regional and NSC offices.
The Company develops and operates its outcomes measurement system primarily out of its NSC. Program personnel are responsible for the completion of the data input forms concerning the various treatment programs. The data is input into the national database using automated technologies from which reports are developed, reviewed and analyzed by the staff of 34 employees, which are also located at the NSC.
During fiscal year 1998, the Company combined its three managed care subsidiaries (Florida PPS, Acorn, and FPM Behavioral Health) into Horizon Behavioral Services to promote a national integrated organization, a stronger market identification and achieve operating efficiencies. Under the new operating structure, the Company's managed care business is located in suburban Orlando, Florida, its EAP/Employer business is located in suburban Philadelphia, PA and the newly acquired OHCA EAP subsidiary is headquartered in Nashville, Tennessee, with regional and satellite offices in various cities.
The Company's managed care operations have 28 licensed clinicians providing services in the four clinic locations in Florida, an additional 127 employees working in clinical management and administrative positions, and has provider network contracts with approximately 5,400 providers and facilities.
The Company's EAP/Employer operation has 49 employees and has contracts with approximately 12,000 individual providers located in all 50 states.
The Company's OHCA EAP subsidiary has 55 employees and has contracts with approximately 2,873 individual providers located in all 50 states.
MANAGEMENT CONTRACTS
The Company provides its management services under contracts with its client hospitals. Each contract is tailored to address the differing needs of the client hospital and its community. The Company and the client hospital determine the programs and services to be offered by the hospital and managed by the Company, which may consist of one or more treatment programs offering inpatient, partial hospitalization, or outpatient services. Under the contracts, the hospital is the actual provider of the mental health or physical rehabilitation services and utilizes its own facilities (including beds for inpatient programs), support services (such as billing, dietary and housekeeping), and generally its own nursing staff in connection with the operation of its programs.
While each of the Company's management contracts is tailored to the specific needs of the client hospital, substantially all of the Company's contracts contain non-compete and confidentiality provisions. In addition, the Company's management contracts typically prohibit the client hospital from soliciting the employment of the Company employees during the contract term and for a specified period thereafter.
Contracts are frequently renewed or amended prior to or at their stated expiration dates. Some contracts are terminated prior to their stated expiration dates pursuant to agreement of the parties or early termination provisions included in the contracts. As of August 31, 2001, 2000 and 1999, the Company had successfully retained 86%, 79%, and 78%, respectively, of the management contracts in existence at the beginning of such fiscal years. The Company believes that among the most frequent reasons why the client hospitals do not renew a contract is that they desire to manage such programs themselves, the economic viability of the programs have changed resulting in their closing the programs, or a change in hospital administration results in a change in philosophy regarding the use of contract managers.
Under each contract, the Company receives a fee for its management services from the client hospital. Management fees may be either a variable fee related in part to patient census at the program or a fixed fee with reimbursement for specified direct program costs. The management fee is frequently subject to periodic adjustments as a result of changes in the consumer price index or other economic factors. A significant number of the Company's management contracts require the Company to refund some or all of its fee if either Medicare reimbursement for services provided to patients of the programs is denied or the fee paid to the Company is denied as a reimbursable cost. During the fiscal year ended August 31, 2001, the Company refunded $5,811 of its fees in relation to these denials.
Program Development
The Company assists in the development of each clinical program as requested by the client hospital, including such matters as licensing, accreditation, certificate of need approvals and Medicare certification. The Company also develops and implements a marketing plan for the clinical programs to be offered by the hospital. Each program is marketed locally with an emphasis on the hospital addressing the needs of the local community. The Company markets the clinical programs in the community in the name of the client hospital. The Company's name is not used and its role is not publicly emphasized in the operation of the clinical programs offered by its client hospitals. Each patient is admitted by the medical staff of the client hospital, and all charges for clinical services provided to the patient accrue directly to the client hospital or treating physician.
The Company also develops and maintains standardized policy and procedure manuals, initial and ongoing staff training and education, and comprehensive quality assurance and ethical and regulatory compliance procedures. Each local program director receives ongoing support from the Company's National Support Center and regional support staff in all areas including recruiting, finance, reimbursement, development, marketing, quality assurance and compliance.
Each operating region is responsible for training new employees, including formalized instruction and on-the-job training. Continuing education programs are also provided to employees. In addition, the Company has a centralized orientation program for new program directors, an annual conference for all program directors, and an on-going ethics compliance plan.
Program Staffing
Mental health programs typically have an independent psychiatric medical director, a program director who is usually a psychologist or a social worker, a clinical assessment coordinator and additional social workers or therapists as needed. Some programs also include a nurse manager or a community education coordinator. Physical rehabilitation programs generally have an independent medical director, a program director, and additional clinical staff tailored to meet the needs of the program and the client hospital, which may include physical and occupational therapists, a speech pathologist, a social worker and other appropriate supporting personnel. Medical directors generally have a contract with the Company under which on-site administrative services needed to administer the program are provided. These contracts generally include nondisclosure, nonsolicitation and noncompetition covenants pursuant to which the medical director agrees not to solicit the Company employees for specified periods, disclose confidential information of the Company or render certain administrative or management services within specified time periods and geographic areas to any enterprise in competition with the Company or the programs it manages. Except for the nursing staff, which is typically provided by the hospital, the other program personnel are
usually employees of the Company. At August 31, 2001, the Company had an average of 7 employees per contract location.
Program Education
Because the treatment programs managed by the Company are offered by general acute care hospitals, most patients are referred by the client hospital's medical staff or result from relationships that the client hospital has in the community. Many contract locations have a community education coordinator (CEC) who works with a development committee consisting of Company and hospital personnel to educate physicians, other health professionals and nursing homes in the community of the treatment programs that are available at the client hospital. The CEC also designs and offers community educational programs regarding various health issues.
Internal Clinical Audits
The Company has established a comprehensive internal clinical audit process for its mental health programs. The Company's regional mental health clinical specialists review the services and clinical documentation of the treatment programs to ensure compliance with client hospital, federal and state standards. The Company also has an internal clinical auditor who makes unannounced visits to contract locations on a periodic basis. The auditor reviews medical records and marketing programs, and conducts interviews with physicians, referral sources and client hospital staff members. Results of the audits are independently reported directly to the senior management of the Company, rather than through the operating organization.
Contract Locations
At August 31, 2001, the Company had a total of 138 management contracts with general acute care hospitals located in 36 states and the District of Columbia, as shown below:
Client Hospitals
The Company's clients are primarily small to medium sized hospitals often located in rural areas, but do include some large tertiary care hospitals. At August 31, 2001, 22.5% of the Company's management contracts were with proprietary hospitals. The remaining contracts are primarily with community not-for-profit hospitals.
MANAGED CARE AND EMPLOYEE ASSISTANCE CONTRACTS
The Company delivers its EAP and managed care services through provider networks and through employees in the Philadelphia, Orlando and Nashville metropolitan areas, as well as ten regional offices located in the Southeastern United States. Additionally, the Company operates four clinics in the Orlando area. During the fiscal year ended August 31, 2000, the company closed five clinic locations in the Tampa and Jacksonville, Florida areas. These closures were due to declining membership in these areas. Claims processing is currently done at the Philadelphia and Orlando locations.
SALES AND MARKETING
At August 31, 2001, the Company employed in direct sales activities for its mental health and physical rehabilitation management business seven full-time Vice Presidents of Development, two Senior Vice Presidents of Development and a Senior Vice President of Business and Contract Development. In addition, the company has one Vice President of Development for consulting services. The Company compiles information from numerous databases, as well as other sources and referrals, to identify prospective clients. The Company has developed profiles of over 5,000 hospitals in the United States, with numerous financial and operating characteristics for each hospital. Potential clients include hospitals without existing mental health, physical rehabilitation, employee assistance or other programs as well as hospitals with existing programs of which the Company could assume management. A select list of candidates is systematically and regularly updated based on criteria indicating which hospitals are the most likely potential clients. A Vice President of Development, who typically acts as the point person on the sales team directly contacts the prospective clients and, where appropriate, presents a detailed proposal to key decision-makers. The proposal often contains detailed financial projections of the proposed programs. The Company works with the potential client to develop contract terms responsive to the client's specific needs. The typical sales cycle for a management contract is approximately nine months, during which time a Senior Vice President of Development will assist the Vice President of Development and will generally become involved at the later stages of the sales process and negotiate the final terms of the management contract. The Company believes it can increase sales of rehabilitation management contracts by applying its expertise in winning mental health management contracts to the solicitation of rehabilitation management contracts. In addition, the Company believes it has substantial opportunity to cross-sell a broad range of services to client hospitals and is pursuing the development of such opportunities as a primary part of its business strategy.
The subsidiary Mental Health Outcomes ("MHO") markets the CQI+ Outcomes Measurement System to 1,200 medical/surgical hospitals with psychiatric inpatient units and 300 free-standing psychiatric hospitals nationwide and PsychScope Database Services to 18 pharmaceutical companies. MHO employs a full-time Director of Market Development who markets the CQI+ System to hospitals based on an understanding of psychiatric program outcomes measurement needs and determining the most compatible CQI+ System Module. MHO also employs a full time Coordinator of Market Development for telemarketing to support initial "cold" calling to prospective customers. In addition, CQI+ is marketed as an "add-on" service to the contract managed psychiatric programs provided by Horizon Mental Health Management through efforts of the Vice Presidents of Development. MHO also employs a full-time Director of Market Development and a clinical liaison who market PsychScope services by providing market insight and secondary data services to researchers and pharmaceutical marketers.
The subsidiary Horizon Behavioral Services ("HBS") markets employee assistance programs and managed behavioral health programs to employers and HMO's nationwide. HBS employs a full-time Vice President of EAP Sales, and five Regional Vice Presidents of Sales to market its traditional EAP products, two Regional Sales Representatives to market its emerging business EAP products, and three Regional Marketing Directors for the newly acquired OHCA EAP product, and a Vice President to market its behavioral health managed care services. The HBS sales staff markets the EAP to employers by assessing the individualized behavioral health benefit needs of their employees and providing the appropriate EAP model. In addition, EAP services may be marketed by the Horizon Mental Health Management Vice Presidents of Development to hospitals as a benefit for their employees. The HBS sales Vice President markets the behavioral health managed care services to HMOs and self-insured employers who wish to outsource management of the behavioral health benefit to an experienced provider.
COMPETITION
The health care industry is highly competitive and subject to continual changes in the method in which services are provided and the types of companies providing such services. The Company competes with several national competitors and many regional and local competitors, some of which have greater resources than the Company. In addition, hospitals could elect to manage their own mental health and physical rehabilitation programs.
Competition among contract managers for hospital-based mental health and physical rehabilitation programs is generally based upon reputation for quality, price, the ability to provide financial and other benefits for the hospital, and the management expertise necessary to enable the hospital to offer mental health and physical rehabilitation programs that provide the full continuum of mental health and physical rehabilitation services in a quality and cost-effective manner. The pressure to reduce health care expenditures has emphasized the need to manage the appropriateness of mental health and physical rehabilitation services provided to patients. As a result, competitors without management experience covering the various levels of the continuum of mental health and physical rehabilitation services may not be able to compete successfully. The Company believes that its reputation and management expertise will enable it to compete successfully in this rapidly changing market.
In addition, general acute care hospitals offering mental health and physical rehabilitation programs managed by the Company compete for patients with other providers of mental health care services, including other general acute care hospitals, freestanding psychiatric hospitals, independent psychiatrists and psychologists, and with other providers of physical rehabilitation services, including other general acute care hospitals, freestanding rehabilitation facilities and outpatient facilities.
The Company also competes with hospitals, nursing homes, clinics, physicians' offices and contract nursing companies for the services of registered nurses. Registered nurses are in limited supply and there can be no assurance that the Company will be able to attract a sufficient number of registered nurses for its growing needs.
The behavioral health care marketplace includes three large national providers who control over half of the market. The rest of the market is highly fragmented and consists of other organizations from medium size regional operations to very small local providers in the EAP business. The primary factor affecting competition in the EAP business is the range of services provided. In addition, quality of service and price are also of importance to EAP customers. Price is the primary factor in obtaining additional managed care customers. All companies involved in behavioral health care must plan to overcome obstacles related to increased customer and government scrutiny, particularly the HIPPA regulations. Customers require sophisticated data that provides information regarding clinical outcomes, patient and provider satisfaction, and administrative performance information.
On October 20, 2000, Horizon Behavioral Services, Inc., managed care operations in Orlando, Florida received a three-year, Full Accreditation from the National Committee for Quality Assurance ("NCQA"). NCQA is an independent, not-for-profit organization dedicated to assessing and reporting on the quality of managed behavioral healthcare organizations, physician organizations, managed care organizations and credentials verification organizations. A Full Accreditation is granted for a period of three years to those plans that have excellent programs for continuous quality improvement and meet NCQA's rigorous standards.
GOVERNMENT REGULATION
The Company's business is affected by federal, state and local laws and regulations concerning, among other matters, mental health and physical rehabilitation facilities and reimbursement for mental health and physical rehabilitation services. These regulations impact the development and operation of mental health and physical rehabilitation programs managed by the Company for its client hospitals. Licensing, certification, reimbursement and other applicable government regulations vary by jurisdiction and are subject to periodic revision. The Company is not able to predict the content or impact of future changes in laws or regulations affecting the mental health or physical rehabilitation sectors.
FACILITY USE AND CERTIFICATION
Hospital facilities are subject to various federal, state and local regulations, including facilities use, licensure and inspection requirements, and licensing or certification requirements of federal, state and local health agencies. Many states also have certificate of need laws intended to avoid the proliferation of unnecessary or under-utilized health care services and facilities. The mental health and physical rehabilitation programs which the Company manages are also subject to licensure and certification requirements. The Company assists its client hospitals in obtaining required approvals for new programs. Some approval processes may lengthen the time required for programs to commence operations. In granting and renewing a facility's licenses, governmental agencies generally consider, among other factors, the physical condition of the facility, the qualifications of administrative and professional staff, the quality of professional and other services, and the continuing compliance of such facility with the laws and regulations applicable to its operations. The Company believes that the mental health and physical rehabilitation programs it manages and the facilities of the client hospitals used in the operation of such programs comply in all material respects with applicable licensing and certification requirements.
MEDICARE AND MEDICAID; REIMBURSEMENT FOR SERVICES
Most of the Company's client hospitals receive reimbursement under one or more of the Medicare or Medicaid programs for mental health and physical rehabilitation services provided in programs managed by the Company. The Company is paid directly by its client hospitals for the management services it provides. While fees paid to the Company by its client hospitals are not subject to or based upon reimbursement under the Medicare or Medicaid programs or from any other third-party payor, under many of its management contracts the Company is obligated to refund a portion of its fee if Medicare denies reimbursement for an individual patient treatment, or its fee if the fee paid to the Company is denied by Medicare as a reimbursable cost. Since a substantial portion of the patients of the programs managed by the Company are covered by Medicare, any changes which limit or reduce Medicare reimbursement levels could have a material adverse effect on the Company's client hospitals and, in turn, on the Company.
The Company is not a provider reimbursed by Medicare or Medicaid but provides contract management services to such providers. As such, the Company could be considered subject to such federal and state laws. While the Company believes that its relationships with its client hospitals, medical directors and other providers and the fee arrangements with its client hospitals are consistent with Medicare and Medicaid criteria, those criteria are often vague and subject to interpretation. The federal government has been actively investigating health care providers for potential abuses. There can be no assurance that aggressive anti-fraud enforcement actions will not adversely affect the business of the Company.
The Medicare program was enacted in 1965 to provide a nationwide, federally funded health insurance program for the elderly. The program is divided in Part A and Part B, each of which has separate rules and requirements and separate funding sources. Medicare Part A, the Hospital Insurance Program (42 U.S.C. Section 1395c et seq.) is financed primarily through mandatory taxes on workers' wages. Part A pays for hospital, skilled nursing, home health agency, hospice, and dialysis services determined to be medically necessary for the individual patient. Medicare Part B, the Supplementary Medical Insurance program (42 U.S.C. Section 1395j et seq.), is a voluntary medical benefits plan in which eligible individuals can enroll to receive benefits in addition to those available under Part A. Under Part B, each beneficiary must pay a monthly premium, meet a deductible towards the cost of covered items and services determined to be medically necessary, and generally pay 20 percent of the Medicare allowable charge as coinsurance on most covered items. Non-institutional services, including physician services, outpatient hospital services, durable medical equipment, and laboratory services, among others, are paid under Medicare Part B. In addition, the 1997 Balanced Budget Act added a new Medicare Part C, which provides Medicare beneficiaries with additional health plan choices, such as managed care plans and medical savings accounts.
The Medicare program is administered by the Centers for Medicare and Medicaid Services, or "CMS" (formerly the Health Care Financing Administration or "HCFA") of the U.S. Department of Health and Human Services ("HHS"). CMS adopts regulations and issues interpretive memoranda and program manuals providing detailed explanation of the Medicare program. The payment operations of the Medicare program are handled by intermediaries (under Part A) and carriers (under Part B) who are insurance companies and Blue Cross/ Blue Shield
plans which contract with the Secretary of HHS (the "Secretary") to make Medicare payments to providers in a particular geographic region. Individual intermediaries and carriers issue transmittals, bulletins, notices, and general instructions to providers and suppliers in their respective areas to facilitate the administration of the Medicare program, but are required to follow the Medicare statute, CMS regulations, CMS transmittals, and the program manuals. Within these requirements, intermediaries and carriers are granted broad discretion to establish particular guidelines and procedures for making Medicare coverage determinations and payments, including prior approval, utilization limits, and specific documentation.
The Medicaid program is a joint federal-state cooperative arrangement established for the purpose of enabling states to furnish medical assistance on behalf of aged, blind, or disabled individuals, or members of families with dependent children, whose income and resources are insufficient to meet the costs of necessary medical services. The federal and state governments share the costs of such aid pursuant to statutory formulae. The Secretary has primary federal responsibility for administering the Medicaid program. The responsibility has been delegated to CMS, whose Medicaid Bureau carries out this delegation. States are not required to participate in the Medicaid program. States which choose to participate, however, must administer their Medicaid programs in accordance with federal law, the implementing regulations and policies of the Secretary and their approved state plans. A state becomes eligible to receive federal funds by submitting to the Secretary a state plan for medical assistance. The federal Medicaid statute establishes minimum standards for state plans in such area as administration, eligibility, coverage of services, quality and provision of services, and payment for services. States have significant latitude, within these standards, to determine the mix of services and structure of their state Medicaid programs. The state plan must be amended by appropriate submission to the Secretary whenever necessary to reflect changes in federal statutes, regulations, policies, court decisions, or material changes in any phase of state law, policy, or operations.
In order to receive reimbursement under the Medicare or Medicaid programs, each client hospital or facility must meet applicable requirements promulgated by HHS relating to the type of facility, personnel, standards of patient care and compliance with all state and local laws, rules and regulations. The Company has a comprehensive ethics and regulatory compliance program and believes that the programs it manages comply in all material respects with applicable Medicare and Medicaid requirements.
In the mid-1980's, changes in reimbursement rates and procedures included the creation of the Prospective Payment System ("PPS") using predetermined reimbursement rates for diagnosis related groups ("DRGs"). The DRG system established fixed payment amounts per discharge for diagnoses generally provided by acute care hospitals. Mental health and physical rehabilitation services provided by acute care hospitals which qualify for an exemption are deemed to be Distinct Part Units ("DPUs") and are not included in the DRG system. Services provided by DPUs are reimbursed on an actual cost basis, subject to certain limitations. The mental health and physical rehabilitation programs managed by the Company which are eligible for reimbursement by the Medicare program currently meet the applicable requirements for designation as DPUs and are exempt from the DRG system. In the future, however, it is possible that Medicare reimbursement for mental health services, including those provided by programs managed by the Company, could be under the DRG system or otherwise altered as has recently occurred for physical rehabilitation services as discussed below. At August 31, 2001, of the 159 mental health treatment programs managed by the Company at its 112 management contract locations, 109 were geropsychiatric programs for which a substantial majority of the patients are covered by Medicare.
Amendments to the Medicare regulations established maximum reimbursement amounts on a per case basis for both inpatient mental health and physical rehabilitation services. Effective as of October 1, 1997, regulations promulgated pursuant to these amendments establish a ceiling on the rate of increase in operating costs per case for mental health and physical rehabilitation services furnished to Medicare beneficiaries. Prior to these amendments, the reimbursement amounts were tied to each hospital's mental health or physical rehabilitation unit cost during such unit's first year of operations, subject to adjustment. The regulations established a nationwide cap limiting the reimbursement target amount on a per case basis for mental health and physical rehabilitation service, for Medicare fiscal years beginning October 1, 1997, and later, to $10,534 and $19,104, respectively, subject to variable adjustments up to the market indices. Various factors have changed since October 1, 1997. Currently the range of target amounts on a per case basis for mental health and physical rehabilitation services, for Medicare fiscal years beginning October, 2001, and later, are $6,658.08 to $16,015.09 and $13,037.61 to $29,849.96 respectively. The variability within a range, is the difference in wages across the country. The limitations have resulted, in some cases,
in decreased amounts reimbursed to the Company's client hospitals. This decrease in reimbursement has, in some cases, led to the renegotiation of a lower contract management fee structure for the Company and in other cases has resulted in termination or nonrenewal of the management contract, or closure of the program.
The Balanced Budget Act of 1997 mandated the elimination of cost-based reimbursement of mental health partial hospitalization services. Implementation began August 1, 2000. The resulting reimbursement for partial hospitalization services based on the Medicare outpatient prospective payment system utilizes a fixed reimbursement amount per patient day. The base reimbursement rate is a wage-adjusted rate of $206.82 per day, which may lower Medicare reimbursement levels to many hospitals for partial hospitalization services. This change has adversely affected the ability of the Company to maintain and/or obtain management contracts for partial hospitalization services and the amount of fees paid to the Company under such contracts.
Acute rehabilitation units within acute-care hospitals which were previously eligible, are currently eligible on a transitional basis (see PPS discussion below), to obtain an exemption from the Prospective Payment System, generally after the first year of operation, upon satisfaction of specified federal criteria. Such criteria include the operation for a full 12 months under the Prospective Payment System and the completion of an initial exemption survey. The exemption survey measures compliance with certain criteria applicable to exempt units generally, including approval to participate as a Medicare provider, admission standards, record keeping, compliance with state licensure laws, segregation of beds, accounting standards and certain specific standards applicable to rehabilitation units, including staffing, medical care and patient mix. Upon successful completion of the survey, Medicare payments for rehabilitation services provided in inpatient units are made under a cost-based reimbursement system. As of August 31, 2001, all of the Company's managed physical rehabilitation programs in operation were exempt from the Prospective Payment System.
Recent amendments to the Medicare statutes provide for a transitional phase-out of cost-based reimbursement of physical rehabilitation services over a two-year period beginning no earlier than January 1, 2002. Depending on a hospital's Medicare fiscal year, the phase in period could be from 12 to 24 months. The phase in of a prospective payment system with reimbursement based on a functional patient classification may raise in some cases and lower in others the Medicare reimbursement levels to hospitals for physical rehabilitation services. To the extent that client reimbursement decreases, this could adversely affect the ability of the Company to maintain and/or obtain management contracts for physical rehabilitation services and the amount of fees paid to the Company under such contracts.
The Medicare and Medicaid programs are subject to statutory and regulatory changes, retroactive and prospective rate adjustments, administrative rulings and funding restrictions, any of which could have the effect of limiting or reducing reimbursement levels to general acute care hospitals for mental health and physical rehabilitation services provided by programs managed by the Company. The Company cannot predict whether any changes to such government programs will be adopted or, if adopted, the effect, if any, such changes will have on the Company. In addition, a significant number of the Company's management contracts require the Company to refund a portion of its fee if Medicare reimbursement to the client hospital is disallowed for a patient treated in a program managed by the Company or its fee if the fee paid to the Company is disallowed as a reimbursable cost. During the fiscal year ended August 31, 2001, the Company refunded $5,811 of its fees in relation to these denials. Also, Medicare retrospectively audits cost reports of client hospitals upon which Medicare reimbursement for services rendered in the programs managed by the Company is based. Accordingly, at any time, the Company could be subject to refund obligations to client hospitals for prior year cost reports that have not been audited and settled at the date hereof. The cost reports are prepared by the client hospitals independent of the Company which does not participate in, nor offer advice on, their preparation. Any significant decrease in Medicare reimbursement levels, the imposition of significant restrictions on participation in the Medicare program, or the disallowance by Medicare of any significant portion of the client hospital's costs, including the fee to the Company, where the Company has a reimbursement denial repayment obligation, could adversely affect the Company. In addition, there can be no assurance that hospitals which offer mental health or physical rehabilitation programs now or hereafter managed by the Company will satisfy the requirements for participation in the Medicare or Medicaid programs.
Payors, including Medicare and Medicaid, are attempting to manage costs, resulting in declining amounts paid or reimbursed to hospitals for the services provided for inpatient services. As a result, the number of patients
served by general acute care hospitals on a per diem, episodic or capitated basis may increase in the future. There can be no assurance that if amounts paid or reimbursed to hospitals decline, it will not adversely affect the Company.
Medicare regulations limit reimbursement for mental health, physical rehabilitation and other health care charges paid to related parties. A party is considered "related" to a provider if it is deemed to be controlled by the provider. One test for determining control for this purpose is whether the percentage of the total revenues of the party received from services rendered to the provider is so high that it effectively constitutes control. Although the Company believes that it does not receive sufficient revenues from any customer that would make it a related party, it is possible that such regulations could limit the number of management contracts that the Company could have with a particular client.
In April 2000, CMS adopted new rules requiring a CMS determination that a facility has provider-based status before a provider can bill Medicare for the services rendered at the facility. The new rules have been construed by CMS to apply to inpatient mental health and rehabilitation units. The rules contain numerous requirements, some specifically applicable to facilities operated under management contracts that must be satisfied in order to receive a CMS determination of provider-based status. The rules are applicable to a provider for new programs at the beginning of its first Medicare cost reporting year that commences after January 10, 2001. Existing programs at October 1, 2000 are "grand-fathered", unless they elect early adoption, until October 1, 2002. The particular application of the rules to inpatient units managed by the Company is currently unclear in several respects. CMS has indicated that it intends to issue guidelines under the new rules, which may provide clarification. At the current time, there is uncertainty with respect to both precisely how the new rules are to be applied to inpatient units managed by the Company and uncertainty as to whether the current structure of the management contracts of the Company will satisfy the requirements under the new rules. The Company is unable at this time to definitively determine the effect of the new provider-based rules on its business operations, but it is possible that the new provider-based rules could result in termination or non-renewal of management contracts if, under the new rules, it is not possible for a provider to obtain a determination of provider-based status of an inpatient unit operated under a management contract.
Federal law contains certain provisions designed to ensure that services rendered by hospitals to Medicare and Medicaid patients are medically necessary and meet professionally recognized standards. These provisions include a requirement that admissions of Medicare and Medicaid patients to hospitals must be reviewed in a timely manner to determine the medical necessity of the admissions. In addition, these provisions state that a hospital may be required by the federal government to reimburse the government for the cost of Medicare-reimbursed services that are determined by a peer review organization to have been medically unnecessary. As part of its on-going regulatory and regulatory compliance program initiatives, the Company and its client hospitals have developed and implemented quality assurance programs and procedures for utilization review and retrospective patient care evaluation intended to meet these requirements.
PATIENT REFERRAL LAWS
Various state and federal laws regulate the relationships between health care providers and referral sources, including federal and state fraud and abuse laws prohibiting individuals and entities from knowingly and willfully offering, paying, soliciting or receiving remuneration in order to induce referrals for the furnishing of health care services or items. These federal laws generally apply only to referrals for items or services reimbursed under the Medicare or Medicaid programs or any state health care program. The objective of these laws is generally to ensure that the purpose of a referral is quality of care and not monetary gain by the referring party. Violations of such laws can result in felony criminal penalties, civil sanctions and exclusion from participation in the Medicare and Medicaid programs.
The Medicare and Medicaid anti-kickback statute, 42 U.S.C. Section 1320a-7b, prohibits the knowing and willful solicitation or receipt of any remuneration "in return for" referring an individual, or for recommending or arranging for the purchase, lease, or ordering, of any item or service for which payment may be made under Medicare or a state health care program. In addition, the statute prohibits the offer or payment of remuneration "to induce" a person to refer an individual, or to recommend or arrange for the purchase, lease, or ordering of any item or service for which
payment may be made under the Medicare or state health care programs. The statute contains exceptions for certain discounts, group purchasing organizations, employment relationships, waivers of coinsurance by community health centers, health plans, and practices defined in regulatory safe harbors.
Under a significant number of its management contracts, the Company receives a variable fee related in part to average daily patient census of the mental health or physical rehabilitation program. In addition, the Company has entered into agreements with physicians to serve as medical directors at the mental health and physical rehabilitation programs and facilities managed by the Company, which generally provide for payments to such persons by the Company as compensation for their administrative services. These medical directors also generally provide professional services at such programs and facilities. In 1991, regulations were issued under federal fraud and abuse laws creating certain "safe harbors" for relationships between health care providers and referral sources. Any relationship that satisfies the terms of the safe harbor is considered permitted. Failure to satisfy a safe harbor, however, does not mean that the relationship is prohibited. Although the contracts and relationships between the Company and its client hospitals and medical directors are not within the safe harbors, the Company believes that such contracts and relationships comply with applicable laws. There can be no assurance, however, that the Company's activities will not be challenged by regulatory authorities.
The Omnibus Budget Reconciliation Act of 1993 contains provisions ("Stark II") prohibiting physicians from referring Medicare and Medicaid patients to an entity with which the physician has a "financial relationship" for the furnishing of a list of "designated health services" including physical therapy, occupational therapy, home health services, and others. If a financial relationship exists, the entity is generally prohibited from claiming payment for such services under the Medicare or Medicaid programs. Compensation arrangements are generally exempted from the Stark provisions if, among other things, the compensation to be paid is set in advance, does not exceed fair market value and is not determined in a manner that takes into account the volume or value of any referrals or other business generated between the parties.
Other provisions in the Social Security Act authorize other penalties, including exclusion from participation in Medicare and Medicaid, for various billing-related offenses. HHS can also initiate permissive exclusion actions for such improper billing practices as submitting claims "substantially in excess" of the provider's usual costs or charges, failure to disclose ownership and officers, or failure to disclose subcontractors and suppliers. Executive Order 12549 prohibits any corporation or facility from participating in federal contracts if it or its principals have been disbarred, suspended or are ineligible, or have been voluntarily excluded, from participating in federal contracts. A principal has been defined as an officer, director, owner, partner, key employee or other person with primary management or supervisory responsibilities.
Additionally, the Health Insurance Portability and Accountability Act of 1996 ("HIPPA") granted expanded enforcement authority to HHS and the U.S. Department of Justice ("DOJ"), and provided enhanced resources to support the activities and responsibilities of the Office of Inspector General ("OIG") of HHS and DOJ by authorizing large increases in funding for investigating fraud and abuse violations relating to health care delivery and payment. On January 24, 1997, the OIG issued guidelines for the Fraud and Abuse Control Program as mandated by the Act, and on February 19, 1997 issued an interim final rule establishing procedures for seeking advisory opinions on the application on the anti-kickback statute and certain other fraud and abuse laws. The 1997 Balanced Budget Act also includes numerous health fraud provisions, including: new exclusion authority for the transfer of ownership or control interest in an entity to an immediate family or household member in anticipation of, or following, a conviction, assessment, or exclusion; increased mandatory exclusion periods for multiple health fraud convictions, including permanent exclusion for those convicted of three health care-related crimes; authority of the Secretary to refuse to enter into Medicare agreements with convicted felons; new civil money penalties for contracting with an excluded provider or violating the Medicare and Medicaid antikickback statute; new surety bond and information disclosure requirements for certain providers and suppliers; and an expansion of the mandatory and permissive exclusions added by the Health Insurance Portability and Accountability Act of 1996 to any federal health care program (other than the Federal Employees Health Benefits Program).
In addition, federal and some state laws impose restrictions on referrals for certain designated health services by physicians and, in a few states, psychologists and other mental health care professionals to entities with which they have financial relationships. The Company believes that its operations comply with these restrictions to
the extent applicable, although no assurance can be given regarding compliance in any particular factual situation. Federal legislation has been considered to expand current law from its application to Medicare and Medicaid business to all payors and to additional health services. Certain states are considering adopting similar restrictions or expanding the scope of existing restrictions. There can be no assurance that the federal government or other states in which the Company operates will not enact similar or more restrictive legislation or restrictions that could under certain circumstances adversely impact the Company's operations.
MENTAL HEALTH CARE PATIENT RIGHTS
Many states have adopted "patient bill of rights" regulations, which set forth standards for least restrictive treatment, patient confidentiality, patient access to mail and telephones, patient access to legal counsel and requirements that patients be treated with dignity. There are also laws and regulations relating to the civil commitment of patients to mental health programs, disclosure of information concerning patient treatments and related matters. The Company believes that its operations comply with the laws and regulations, although no assurance can be given regarding compliance in any particular factual situation.
LICENSING REQUIREMENTS
Certain of the services provided by the Company's managed behavioral services subsidiaries may be subject to certain licensing requirements in some states. The Company currently holds various licenses in 13 states. If the business operations of such entities are determined to require licenses in other states, then obtaining such licenses or the inability to obtain such licenses could adversely affect the business operations of such entities. In addition, several states have laws that prohibit business corporations from providing, or holding themselves out as providers of, medical care. While the Company has no reason to believe that it is in violation or has violated such statutes, these laws vary from state to state and have seldom been interpreted by the courts or regulatory agencies.
EMPLOYEES
At August 31, 2001, the Company employed 1,369 people, of which 1,038 were full-time employees, 287 were part-time employees, and 44 were temporary employees. The Company has no collective bargaining agreements with any unions and believes that its overall relations with its employees are good. In addition, at August 31, 2001, the Company had administrative services contracts with 160 physicians to serve as medical directors for clinical programs managed by the Company.
INSURANCE
The Company carries general liability, malpractice and professional liability, comprehensive property damage, workers' compensation, directors and officers and other insurance coverages that management considers reasonable and adequate for the protection of the Company's assets, operations and employees. There can be no assurance, however, that the coverage limits of such policies will be adequate. A successful claim against the Company in excess of its insurance coverage could have a material adverse effect on the Company.
ITEM 2.
ITEM 2. PROPERTIES
The Company leases a building consisting of approximately 40,000 square feet for its National Support Center in the Dallas suburb of Lewisville, Texas under a lease term expiring on November 15, 2003, subject to certain purchase and renewal options. In addition, for its contract management business the Company leases an aggregate of 4,626 square feet of space for two regional offices in the Chicago and Tampa metropolitan areas, with lease terms expiring from January 2002 to April 2006. Except for one partial hospitalization program operating in approximately 3,150 square feet of space leased by the Company, the space required for the clinical programs managed by the Company is provided by the client hospitals either within their existing facilities or at other locations owned or leased by the hospitals.
For its managed behavioral health care services and employee assistance programs, the Company leases approximately 91,300 square feet of office space primarily in the Orlando, Philadelphia, and Nashville metropolitan areas, with smaller offices in various parts of the country, under lease terms expiring from November 2001 to April 2008. In January 2001, Horizon Behavioral Services, Inc. relocated its managed care operations to a single location in Lake Mary, Florida from three separate locations in metropolitan Orlando, Florida. In addition, the Company leases approximately 21,925 square feet in various locations throughout central Florida with lease terms expiring from December 2001 to April 2006 for its managed behavioral health care clinical operations.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is, and may be in the future, party to litigation arising in the ordinary course of its business. While the Company has no reason to believe that any such pending claims are material, there can be no assurance that the Company's insurance coverages will be adequate to substantially cover liabilities arising out of such claims or that any such claims will be covered by the Company's insurance. Any material claim which is not covered by insurance may have an adverse effect on the Company's business. Claims against the Company, regardless of their merit or outcome, may also have an adverse effect on the Company's reputation and business.
In late 1999, the Company became aware that a civil qui tam lawsuit had been filed under seal naming the Company's psychiatric contract management subsidiary, Horizon Mental Health Management (Horizon), as one of the defendants therein. In March 2001, the relators served the complaint in the lawsuit brought under the Federal False Claims Act. The complaint alleges that certain on-site Company personnel acted in concert with other non-Company personnel to improperly inflate certain Medicare reimbursable costs associated with psychiatric services rendered at a Tennessee hospital prior to August 1997. The lawsuit names the hospital, the parent corporation of the hospital and a home health agency as additional defendants. The U.S. Department of Justice had previously declined to intervene in the lawsuit. The Company has filed a motion to dismiss and discovery proceedings have been deferred until the court rules on the motion. The Company does not believe the claims asserted in the lawsuit, based on present allegations, represent a material liability to the Company.
In early December 2000, the Company was served with a U.S. Department of Justice subpoena issued by the U.S. Attorney's Office for the Northern District of California. The subpoena requested the production of documents related to certain matters such as patient admissions, patient care, patient charting, and marketing materials, pertaining to hospital gero-psychatric programs managed by the Company. The Company believes the subpoena originated as a result of a sealed qui tam suit and has furnished documents in response to the subpoena. No allegations or claims have been made against the Company. At this time, the Company cannot predict the ultimate scope or any particular future outcome of the investigation.
In March 2001, Horizon Behavioral Services, Inc., a subsidiary of Horizon, was served with a lawsuit filed in a New Jersey district court seeking damages for the unauthorized release of treatment records of a member of an employee assistance program operated by a predecessor of Horizon Behavioral Services, Inc. The lawsuit asserts similar, but separate claims against two unaffiliated co-defendants. The damages in the lawsuit are unspecified. Horizon's insurance carrier has provided the Company a preliminary indication that some of the claims asserted in the lawsuit may not be covered by insurance. The lawsuit is in the initial stage of discovery proceedings.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
EXECUTIVE OFFICERS OF THE REGISTRANT
James W. McAtee has been President and Chief Executive Officer of the Company since November 1, 1998. He has been Secretary of the Company since September 1990 and has been a director of the Company since July 1995. He formerly served as Chief Financial Officer and Treasurer from September 1990 to July 1999. He was Executive Vice President - Finance & Administration of the Company from February 1992 to October 1998 and was a Senior Vice President of the Company from September 1990 to February 1992.
Ronald C. Drabik has been Senior Vice President - Finance and Administration and Treasurer since July 12, 1999. He was previously Senior Vice President, Chief Financial Officer, Secretary and Treasurer of Cuno, Inc., a multinational manufacturer of filtration products, from 1996 to 1999. He was previously Vice President - Finance for Acme Cleveland, a multinational manufacturer of telecommunications and electronic products, from 1995 to 1996. He also served as President and CEO of Met-Coil Systems Corp., a machine tool manufacturer, from 1993 to 1995.
Frank J. Baumann has been Senior Vice President - Operations since March 22, 1999. He has been President - Specialty Rehab Management since March 1999. He formerly served as a Regional Vice President from March 1997 to March 1999. He was also a Regional Director of Operations from November 1996 to March 1997. He was Chief Executive Officer of Mountain Crest Behavioral Healthcare Systems, a freestanding psychiatric hospital, from August 1994 to November 1996.
James K. Don has been Senior Vice President - Business and Contract Development since June 2000. He formerly served as Senior Vice President, Acquisitions and Business Development from April 1997 to May 2000. During the period from October 1996 through March 1997, he served as an acquisitions consultant for Horizon. From May 1990 through September 1996 he was President, CEO and Founder of American Day Treatment Centers, a national company specializing in freestanding partial hospitalization facilities that provide behavioral health care services. American Day Treatment Centers filed a voluntary bankruptcy petition under Chapter 11 of the United States Bankruptcy Code in April 1997.
Linda A. Laitner has been Senior Vice President - Operations since November 1, 1998. She has been President - Horizon Behavioral Services since February 1998. She was previously Vice President Operations - Government Programs for CMG Health, a national managed behavioral healthcare organization, from January 1997 to January 1998. She also served as Vice President Operations - - Implementation for CMG Health from January 1994 to January 1997 and as a Regional Vice President from January 1993 to January 1994.
David S. Tingue has been Senior Vice President - Marketing since November 1, 1998. He has been President - Mental Health Outcomes since October 1997. He formerly served as Executive Vice President, Marketing from July 1998 to October 1998. He was previously Vice President Operations for SDMS Inc, a consulting and service company focusing on disease and population management in the managed healthcare marketplace, from January 1997 to September 1997. He also served as Vice President, Strategic Planning for
SDMS from March 1996 to December 1996 and Vice President, Marketing from July 1994 to March 1996. Prior to this, he was a Regional Business Director for Zeneca Pharmaceuticals, a United Kingdom based healthcare company, from September 1992 to June 1994.
David K. White, Ph.D. has been Senior Vice President - Operations since November 1, 1998. He formerly served as Executive Vice President - Operations from February 1998 to October 1998. He was a Regional Vice President from September 1996 to January 1998. He also served as a Regional Director of Operations from April 1995 to August 1996. He was President and Chief Executive Officer of Charles River Health Management, Inc., a contract management company focusing on the public and private sector, from December 1990 to November 1994.
Officers of the Company are elected by the Board of Directors of the Company and serve at the pleasure of the Board of Directors until their respective successors are elected and qualified.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock of the Company is traded on the Nasdaq National Market under the symbol "HORC".
The following table sets forth the high and low sale prices per share for the Common Stock of the Company as reported by the Nasdaq National Market for the periods indicated:
As of October 31, 2001, there were 127 stockholders of record of the Common Stock of the Company. As of September 1, 2001 (the most recent date that data was available to the Company) there were approximately 417 beneficial owners of 100 or more shares of Common Stock of the Company.
The Company has not paid or declared any cash dividends on its capital stock since its inception. The Company currently intends to retain future earnings for use in the expansion and operation of its business. Borrowings may limit the Company's ability to pay dividends. The payment of any future cash dividends will be determined by the Board of Directors in light of conditions then existing, including the Company's earnings, financial condition and capital requirements, restrictions in financing agreements, business opportunities and conditions, and other factors. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources."
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL INFORMATION AND STATISTICAL DATA
The selected historical consolidated financial data presented below for the fiscal years ended August 31, 2001, 2000 and 1999, and at August 31, 2001 and August 31, 2000, are derived from the audited Consolidated Financial Statements of the Company included elsewhere in this Report. The selected historical consolidated financial data presented below for the fiscal years ended August 31, 1998 and 1997, and at August 31, 1999, 1998 and 1997, are derived from the audited consolidated financial statements of the Company not included herein. Effective August 11, 1997, Horizon acquired Specialty Healthcare Management, Inc. ("Specialty") in a share exchange transaction with the stockholders of Specialty which was accounted for as a pooling of interests. The Consolidated Financial Statements of the Company give effect to the Specialty exchange by combining the results of operations of Horizon for the year ended August 31, 1997 with the results of operations of Specialty for the twelve month period ended August 31, 1997, on a pooling of interests basis. The selected financial information presented below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and with the Consolidated Financial Statements of the Company and Notes thereto included elsewhere in this Report.
(1) Other revenues for the fiscal years ended August 31, 1998 and 1997 consist primarily of physician contract management fees and a favorable cost report adjustment. Other revenues for the years ended August 31, 2000 and 1999 consist primarily of physician contract management fees and revenues related to the Company's Mental Health Outcomes business. Other revenues for the year ended August 31, 2001 consist primarily of physician contract management fees, revenues related to the Company's Mental Health Outcomes business, and consulting revenue.
(2) Adjusted for the Specialty transaction based on historical share amounts, converting each outstanding share of Specialty Common Stock into 147.4616 shares of Horizon Common Stock.
(3) Intangible assets consist of goodwill and service contracts related to various acquisitions of the Company.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company is a provider of employee assistance plans ("EAP") and behavioral health services to business and managed care organizations, as well as a leading contract manager of psychiatric and physical rehabilitation clinical programs offered by general acute care hospitals in the United States. The Company has grown both internally and through acquisitions, increasing both the variety of its treatment programs and services and the number of its management contracts, which totaled 952 as of August 31, 2001. At that date the Company had 646 contracts to provide EAP and managed behavioral health services covering approximately 2.3 million lives. Over the last nine years, the Company has increased its management contracts from 43 to a total of 138 as of August 31, 2001 and currently has contract locations in 36 states and the District of Columbia. Of its management contracts, 112 relate to mental health treatment programs and 26 relate to physical rehabilitation programs. The Company has also developed a proprietary mental health outcomes measurement system known as CQI+. At August 31, 2001, the Company had contracts to provide outcome measurement services at 160 contract locations as well as 8 database project contracts.
The Company capitalizes on its expertise in managing the delivery of mental health services by directly offering managed behavioral health care services and employee assistance programs to businesses and managed care organizations. The Company believes it is strategically sized to deliver national programs, while providing local, individualized service to both employers and health plans and to their respective employees or members. The Company's strategic plan contemplates continued growth in this area of its business. In addition, the Company plans to enhance its position as the leader in the contract management of mental health programs and to further expand the range of services which it offers to its client hospitals to include other clinical and related services and programs. A significant challenge in marketing clinical management contracts is overcoming the initial reservations that many hospital administrators have with outsourcing key clinical services. The Company believes its expertise in working with hospital administrators, its reputation in the industry and its existing hospital contractual relationships provide it with a significant advantage in marketing new contracts. The Company also believes it has opportunities to cross-sell management services of mental health and physical rehabilitation programs to client hospitals by marketing its mental health services to client hospitals for which the Company currently manages only physical rehabilitation programs, and by marketing its physical rehabilitation services to client hospitals for which the Company currently manages only mental health programs. The Company has successfully expanded the breadth of services it offers to include the full continuum of mental health services, including outcome measurement services, and physical rehabilitation services. Its management contracts increasingly cover multiple services.
REVENUES
Managed Behavioral Health Care Services and Employee Assistance Programs
Through its subsidiary Horizon Behavioral Services, Inc. ("HBS"), the Company offers an array of managed care products to corporate clients, self-funded employer groups, commercial HMO and PPO plans, government agencies, and third-party payors. Revenues are derived from employee assistance program ("EAP") services, administrative services only contracts, and at risk managed behavioral health services.
Revenues from EAP contracts are typically based on a per employee per month capitated rate multiplied by the number of eligible employees. The rate for EAP plans is dependent upon services provided under the contract terms. Each plan is specifically written to fulfill the clients' needs and can offer different numbers of counseling sessions and other benefits, such as work life services (including child care and elder care consultation), referral resources and critical incident debriefing and intervention.
Revenues for administrative services only contracts relate to the management of behavioral health benefits and are dependent upon the number of contracts and the services provided. Fees are usually a case rate or a per employee per month fee multiplied by the number of eligible members. The client is able to benefit from the mental
health professionals employed or independently contracted by the Company at favorably discounted rates, as well as the Company's expertise in clinical case management.
The primary factors affecting revenues derived from managed care services are the behavioral health benefits provided and the number of members covered. Fees are based on a per employee per month capitated fee. The capitated rate is dependent upon the benefit designs and anticipated utilization of the customer and is set forth in the contract, usually as a per member per month capitated rate, which is multiplied by the number of eligible members to determine a monthly fee.
During the fiscal year ended August 31, 2000, the Company experienced the termination of six significant managed care contracts, one of which occurred in the quarter ended November 30, 1999, three of which terminated during the quarter ending February 29, 2000, and one of which terminated during the quarter ended May 31, 2000 under a multi-year transitional phase out arrangement, with a majority of the impact in the first year. The effects of the sixth termination occurred gradually over the fiscal year ended August 31, 2001. One of the six contract terminations arose from a client insolvency, which resulted in a $288,000 charge to bad debt during the three months ended November 30, 1999. In the prior fiscal year ended August 31, 2000 the six significant contracts provided annual revenues of approximately $6.8 million, or about 5% of the company's total annual revenues. In the fiscal year ended August 31, 2001 the remaining contract provided revenues of $634,000. The full financial impact of the terminations was realized during fiscal year 2001. The Company has initiated a number of expense reduction measures to mitigate the financial impact of these terminations, which included reductions in staffing and the closing five of the Company's nine clinic locations.
The four remaining Company owned clinics operated in the state of Florida derive income from counseling and therapy services rendered, and from providing services to patients who are employees of customers under various EAP or managed care contracts.
Mental Health Services
The primary factors affecting revenues in a period are the number of management contracts with treatment programs in operation in the period and the number of services covered by each such management contract. The Company provides its management services under contracts with terms generally ranging from three to five years. Each contract is tailored to address the differing needs of each client hospital and its community and increasingly cover multiple treatment programs and services. The Company and the client hospital determine the programs and services to be offered by the hospital and managed by the Company, which may consist of one or more mental health or physical rehabilitation treatment programs offering inpatient, partial hospitalization, outpatient or home health services. Under the contracts, the hospital is the actual provider of the mental health or physical rehabilitation services and utilizes its own facilities (including beds for inpatient programs), nursing staff and support services (such as billing, dietary and housekeeping) in connection with the operations of its programs. As the Company has expanded the breadth of treatment programs it offers to hospitals, it began to move from managing one type of treatment program under a single contract with a hospital to managing multiple treatment programs under such contract.
Contracts are frequently renewed or amended prior to or at their stated expiration dates. Some contracts are terminated prior to their stated expiration dates pursuant to agreement of the parties or early termination provisions included in the contracts. As of August 31, 2001, 2000 and 1999, the Company had successfully retained 86%, 79% and 78%, respectively, of the management contracts in existence at the beginning of such fiscal years. The Company believes the most frequent reason its client hospitals do not renew their contracts with the Company is that the hospitals decide to manage such programs themselves. In addition, a number of contracts have not renewed or been closed since passage of the 1997 Balanced Budget Act due to a decline in profitability, resulting from unfavorable changes in Medicare reimbursement.
Under each contract, the Company receives a fee for its management services from the client hospital. Management fees may be either a variable fee related in part to patient volume, a fixed monthly fee or reimbursement for specified direct program costs plus a fixed fee. The management fee is frequently subject to periodic adjustments as a result of changes in the consumer price index or other economic factors. Payors, including
Medicare and Medicaid, are attempting to manage costs, resulting in declining amounts paid or reimbursed to hospitals for the services provided. As a result, the Company anticipates that the number of patients served by general acute care hospitals on an inpatient basis may decrease and, as an alternative, the number of patients served on a per diem, episodic or capitated basis will increase in the future. However, additional changes in Medicare reimbursement may also unfavorably impact these groups and the Company's management contract business as well.
Over the past four years, the Company has increased revenues through acquisitions (discussed below) and through internal growth by adding services, price escalators and volume increases at existing contract locations. The increases have primarily been due to the increased range of services offered per contract and the increased demand for geropsychiatric services as general hospitals have sought to enter this market. An additional factor affecting revenues has been the Company's policy of establishing a minimum direct margin threshold for its management contracts.
The Company's mix of programs has changed over the last six years reflecting the increased interest in geropsychiatric programs by general hospitals. Geropsychiatric programs as a percentage of the Company's total mental health programs have increased from approximately 57% to 69% during that period.
The fees received by the Company for its services under management contracts are paid directly by its client hospitals. The client hospitals receive reimbursement under either the Medicare or Medicaid programs or payments from insurers, self-funded benefit plans or other third-party payors for the mental health and physical rehabilitation services provided to patients of the programs managed by the Company. As a result, the availability and amount of such reimbursement impacts the decisions of general acute care hospitals regarding whether to offer mental health and physical rehabilitation services pursuant to management contracts with the Company.
Amendments to the Medicare regulations in 1997 as part of the Balanced Budget Act, established maximum reimbursement amounts on a per case basis for both inpatient mental health and physical rehabilitation services. In some cases, the reimbursement limitations have resulted in decreased amounts reimbursed to the Company's client hospitals and have led to the renegotiation of a lower contract management fee structure for the Company. In other cases the reimbursement limitations have resulted in the termination or non-renewal of the management contract, or closure of the program.
The Balanced Budget Act of 1997 mandated the elimination of cost-based reimbursement of mental health partial hospitalization services. Implementation began August 1, 2000. The resulting reimbursement for partial hospitalization services based on the Medicare outpatient prospective payment system utilizes a fixed reimbursement amount per patient day. The base reimbursement rate is a wage-adjusted rate of $206.82 per day, which lowered Medicare reimbursement levels to many hospitals for partial hospitalization services. This change adversely affected the ability of the Company to maintain and/or obtain management contracts for partial hospitalization services and the amount of fees paid to the Company under such contracts.
Revenues from partial hospitalization services were $7.4 million or 7.9% of total contract management revenues for the year ended August 31, 2001, down approximately $7.8 million, or 51.3% from the prior fiscal year. Of the Company's 138 management contracts at August 31, 2001, 54 or 39.1% of the contracts include partial hospitalization services. Of the 54 contracts including partial hospitalization services, 40 program locations had partial hospitalization services in operation, 12 program locations were in operation but the partial hospitalization services were not in operation, and 2 program locations were not yet in operation for any of the services. The termination of all partial hospitalization contracts, while unlikely and not expected, could reduce operating income by $2.5 million or more annually.
In April 2000, CMS adopted new rules requiring a CMS determination that a facility has provider-based status before a provider can bill for the services rendered at the facility. The new rules have been construed by CMS to apply to inpatient mental health and rehabilitation units. The rules contain numerous requirements, some specifically applicable to facilities operated under management contracts that must be satisfied in order to receive a CMS determination of provider-based status. The rules are applicable to a provider for new programs at the beginning of its first Medicare cost reporting year that commences after January 10, 2001. Existing programs at October 1, 2000 are "grand-fathered", unless they elect early adoption, until October 1, 2002. The particular application of the rules
to inpatient units managed by the Company is currently unclear in several respects. CMS has indicated that it intends to issue guidelines under the new rules, which may provide clarification. At the current time, there is uncertainty with respect to both precisely how the new rules are to be applied to inpatient units managed by the Company and uncertainty as to whether the current structure of the management contracts of the Company will satisfy the requirements under the new rules. The Company is unable at this time to definitively determine the effect of the new provider-based rules on its business operations, but it is possible that the new provider-based rules could result in termination or non-renewal of management contracts if, under the new rules, it is not possible for a provider to obtain a determination of provider-based status of an inpatient unit operated under a management contract.
Recent amendments to the Medicare statutes also provide for a phase-out of cost-based reimbursement of physical rehabilitation services over a two-year period beginning no earlier than January 1, 2002. Depending on a hospital's Medicare fiscal year, the phase out period could be from 12 to 24 months. The phase in of a prospective payment system with reimbursement based on a functional patient classification may lower Medicare reimbursement levels to hospitals for physical rehabilitation services. This could adversely affect the ability of the Company to maintain and/or obtain management contracts for physical rehabilitation services and the amount of fees paid to the Company under such contracts.
OPERATING EXPENSES
The primary factor affecting operating expenses for the Company's contract management business in any period is the number of programs in operation in the period. Operating expenses consist primarily of salaries and benefits paid to its clinicians, therapists and supporting personnel. Mental health programs managed by the Company generally have a psychiatric medical director, a program director who is usually a psychologist or a social worker, a community education coordinator and additional social workers or therapists as needed. Physical rehabilitation programs managed by the Company generally have an independent medical director, a program director, and additional clinical staff tailored to meet the needs of the program and the client hospital, which may include physical and occupational therapists, a speech pathologist, a social worker and other appropriate supporting personnel. Medical directors have a contract with the Company under which on-site administrative services needed to administer the program are provided. Except for the nursing staff, which is typically provided by the hospital, the other program personnel are generally employees of the Company. At August 31, 2001, the Company had an average of 7 employees per contract location.
Operating expenses for the Company's managed behavioral health care services and employee assistance programs are comprised of approximately 42% salaries and benefits and approximately 38% medical claims from providers. Medical claims includes payments to independent health care professionals providing services under the capitated mental health services contracts and employee assistance programs offered by the Company. Other costs and expenses include items such as marketing costs and expenses, consulting, accounting and legal fees and expenses, employee recruitment and relocation expenses, rent, utilities, telecommunications costs, and property taxes.
ACQUISITIONS
Effective October 1, 2001, the Company acquired all the mental health management contracts of Perspectives Health Management Corporation in an asset purchase transaction for approximately $2.9 million. The contracts cover 12 mental health management contract locations.
Acquisitions during the last three years have affected the Company's results of operation and financial condition. Details of these acquisitions are included in Note 3 to Consolidated Financial Statements included elsewhere herein this Form 10-K.
RESULTS OF OPERATIONS
The following table sets forth for the fiscal years ended August 31, 2001, 2000 and 1999, the percentage relationship to total revenues of certain costs, expenses and income, and the number of management contracts in operation and covered lives at the end of each fiscal year.
FISCAL YEAR ENDED AUGUST 31, 2001 COMPARED TO FISCAL YEAR ENDED AUGUST 31, 2000
Revenue. Revenues for the fiscal year ended August 31, 2001 were $127.7 million representing a decrease of $6.0 million, or 4.5%, as compared to revenues of $133.7 million for the prior fiscal year. Contract management revenue decreased a net $390,000 as a result of a decrease in partial hospitalization program revenue of $7.8 million resulting from the unfavorable decline due to the Medicare reimbursement change in partial hospitalization programs in operation from 61, as of August 31, 2000, to 40, as of August 31, 2001. This decrease was substantially offset by a $6.4 million increase due to both a 6.6% increase in revenue per average psychiatric location in operation and a 18.0% increase in revenue per average rehab location in operation, as well as a $1.0 million contract termination fee. Premiums and fees decreased $6.4 million, or 16.7% primarily due to the continued effect, i.e. the annualization of the termination of managed care contracts whose revenues for fiscal year 2001 were $634,000 versus $6.8 million for the previous year.
Salaries and Benefits. Salaries and benefits for the fiscal year ended August 31, 2001 were $69.9 million representing a decrease of $1.6 million, or 2.2%, as compared to salaries and benefits of $71.5 million for the prior fiscal year. Average full time equivalents for the fiscal year ended August 31, 2001 were 1,093 representing a decrease of 96, or 8.1%, as compared to average full time equivalents of 1,189 for the fiscal year ended August 31, 2000. A decrease of 31 or 2.6% is attributable to the termination of the managed care contracts and the associated closure of five clinic locations during the third quarter of fiscal year 2000. Also contributing to the decrease is the decline in the average number of locations in operation from 138.3 for the fiscal year ended August 31, 2000 to 126.7 for the fiscal year ended August 31, 2001, as well as cost control initiatives taken by the Company in response to the reduction in revenues. Salary and benefit cost per full time equivalent for the fiscal year ended August 31, 2001 was $63,952 representing an increase of $3,817 per full time equivalent or 6.3% as compared to salary and benefit cost of $60,135 per full time equivalent for the fiscal year ended August 31, 2000. Circumstances contributing to the nationwide increases in employee compensation costs were competitive market conditions, rising healthcare costs and, specifically for the Company, the shift in the mix of its employee base.
Depreciation and Amortization. Depreciation and amortization expenses for fiscal year 2001 were $4.5 million representing a decrease of $600,000 or 11.8%, as compared to depreciation and amortization expenses of $5.1 million for the prior fiscal year. A decrease of $355,000 is due to the accelerated depreciation expense of certain capitalized software in fiscal year 2000. The remaining decrease is due to the Company's limited capital expenditure requirements, which resulted in depreciation generated from assets acquired during the period being less than a reduction in depreciation associated with items becoming fully depreciated.
Other Operating Expenses (Including Medical Claims, Purchased Services and Provision for Bad Debts) Other operating expenses for the fiscal year ended August 31, 2001 were $41.5 million representing a decrease of $2.8 million or 6.1%, as compared to other operating expenses of $44.3 million for the prior fiscal year. The following components identify the primary variances between the periods reported.
Medical claims expense for the fiscal year ended August 31, 2001 was $11.5 million, representing a decrease of $2.8 million or 19.6%, as compared to medical claims expense of $14.3 million for the prior fiscal year. This is primarily the result of the termination of the six managed care contracts discussed earlier. Inpatient days per year per one thousand members decreased from an average of 16.8 for fiscal year 2000 to 15.3 for fiscal year 2001, due to continued utilization management as well as to a more favorable mix of contracts.
Purchased services for the fiscal year ended August 31, 2001 were $11.8 million, representing a decrease of $440,000 or 3.6%, as compared to purchased services of $12.3 million for the prior fiscal year. Medical specialist fees decreased $839,000 in fiscal year 2001, compared to fiscal year 2000. This decrease is primarily a result of the decrease in the average number of contract locations in operation, from 138.3 in fiscal 2000 to 126.7 in fiscal 2001. Consulting fees also decreased by $259,000, in fiscal year 2001, as compared to fiscal year 2000. This decrease was primarily due to the reclassifications of development expenses for software and Knox Keene California licensing in 2001 by the Company's HBS subsidiary. These decreases were partially offset by an increase in the recognition of corporate development expenses for physician reference services of $330,000, resulting primarily from the costs related to establishing a provider network in California in conjunction with obtaining the Knox Keene license. Legal fees also increased in fiscal year 2001 by $248,000, compared to fiscal year 2000. This increase was primarily due
to the expenses associated with the Knox-Keene licensing process in California, as well as for the Department of Justice inquiry in California related to the Company's HMHM subsidiary.
Bad debt expense for the fiscal year ended August 31, 2001 was $1.8 million, representing an $887,000 increase as compared to $877,000 for the prior fiscal year. This increase is primarily the result of reserves recorded for the outstanding balances related to several contract management agreements in which the contract has terminated, litigation is being pursued and/or the hospital has failed or is expected to fail soon.
Other operating expenses for fiscal year 2001 were $16.5 million, a decrease of $300,000 or 1.8%, as compared to other operating expense of $16.8 million for the prior fiscal year. Rent expense decreased $890,000 primarily due to one-time charges, in fiscal 2000, related to the closing of five managed care clinic locations in Florida and to rent acceleration caused by the abandonment of lease property to consolidate Florida operations. Legal settlement expense increased $710,000 due to an increase in estimates for actual and projected legal claims and settlements and related expenses that were and/or may be incurred related to the current fiscal year. The remaining decrease of $120,000 is primarily the result of several Company initiated expense reduction measures, which have significantly reduced expenses.
Interest and Other Income (Expense), Net. Interest income, interest expense and other income for fiscal year 2001 was a net expense of $372,000 as compared to $960,000 in net expense for fiscal year 2000. This change is primarily a result of a decrease in interest expense of $621,000 related to a reduction in the outstanding credit facility balances between the periods, as well as to lower interest rates. The weighted average outstanding balance for fiscal year 2001 was $8.2 million with an ending balance of $6.9 million. The weighted average outstanding balance for fiscal year 2000 was $17.3 million with an ending balance of $14.9 million.
Income Tax Expense. Income tax expense for fiscal year 2001 was $4.5 million representing a decrease of $300,000, or 6.3%, as compared to income tax expense of $4.8 million for the prior fiscal year. The decrease in income tax expense was largely due to a corresponding decrease in pre-tax earnings. The effective tax rates for fiscal years 2001 and 2000 were 40.0% and 40.2% respectively.
FISCAL YEAR ENDED AUGUST 31, 2000 COMPARED TO FISCAL YEAR ENDED AUGUST 31, 1999
Revenue. Revenues for the fiscal year ended August 31, 2000 were $133.7 million representing a decrease of $12.3 million, or 8.4%, as compared to revenues of $146.0 million for the prior fiscal year. Contract management revenue decreased $3.9 million, or 4.0%, due to a decline in the average number of contract locations in operation from 155.8 for fiscal year 1999 to 138.3 for fiscal year 2000, a decrease of 11.2%. However, same store sales, defined as contracts in operation for the entire year in both the current and prior fiscal year, increased by $1.7 million, or 2.6% for fiscal year 2000. Premiums and fees decreased $9.2 million primarily as a result of the termination of the six significant managed care contracts previously discussed. The revenues related to the significant terminated contracts for the fiscal year ended August 31, 2000 were $6.8 million representing a decrease of $8.6 million, as compared to revenues of $15.4 million for the fiscal year ended August 31, 1999.
Salaries and Benefits. Salaries and benefits for the fiscal year ended August 31, 2000 were $71.5 million representing a decrease of $4.2 million, or 5.5%, as compared to salaries and benefits of $75.7 million for the prior fiscal year. Average full time equivalents for the fiscal year ended August 31, 2000 were 1,189 representing a decrease of 104, or 8.0%, as compared to average full time equivalents of 1,293 for the fiscal year ended August 31, 1999. This decrease is a result of cost control initiatives taken by the Company in response to the reduction in revenues. Salary and benefits costs per full time equivalent for fiscal year 2000 were $60,180 representing an increase of $1,602 per full time equivalent, or 2.7%, as compared to salary and benefits cost of $58,578 per full time equivalent for the prior fiscal year.
Depreciation and Amortization. Depreciation and amortization expenses for fiscal year 2000 were $5.1 million representing an increase of $600,000 or 13.3%, as compared to depreciation and amortization expenses of $4.5 million for the prior fiscal year. An increase of $355,000 is due to the accelerated depreciation expense of certain capitalized software that will become obsolete in Fiscal 2001. The remaining increase primarily results from
the depreciation expense of additional equipment purchased for the operation of the Company's contract management and managed care businesses.
Other Operating Expenses (Including Medical Claims, Purchased Services and Provision for Bad Debts). Other operating expenses for fiscal year 2000 were $44.3 million representing a decrease of $8.9 million or 16.7%, as compared to other operating expenses of $53.2 million for the prior fiscal year. The following components identify the primary variances between the periods reported.
Medical claims expense for the fiscal year ended August 31, 2000 was $14.3 million, representing a decrease of $6.7 million or 31.9%, as compared to medical claims expense of $21.0 million for the prior fiscal year. This is primarily the result of the termination of the six significant managed care contracts, discussed previously, as well as improved utilization management and review of patients seeking authorization for treatment. The improved utilization management resulted in a decrease in inpatient cost, attained primarily by directing patient care toward lower cost inpatient facilities and the use of outpatient options. Inpatient days per year per one thousand members decreased from an average of 20.2 for the fiscal year ended August 31, 1999 to 16.8 for the fiscal year ended August 31, 2000.
Purchased services for the fiscal year ended August 31, 2000 was $12.3 million, representing a decrease of $1.4 million or 10.2%, as compared to purchased services of $13.7 million for the prior fiscal year. Medical director fees decreased $874,000 for the fiscal year ended August 31, 2000, as compared to the prior fiscal year. This decrease is a result of the decrease in the average number of contract locations in operation as discussed in the revenue section above as well as the expense controls initiated by the Company. Also, fees paid to temporary physicians decreased $320,000 due to the recruitment of permanent physicians at certain contract locations.
Bad debt expense for the fiscal year ended August 31, 2000 was $877,000, representing an increase of $288,000 or 48.9%, as compared to bad debt expense of $589,000 for the prior fiscal year. Bad debt expense, excluding the recovery of $1,750,000 related to one former Specialty Healthcare Management, Inc. contract, was $2.3 million for the prior fiscal year. Excluding the $1,750,000 recovery, bad debt expense decreased $1.4 million for the fiscal year ended August 31, 2000 versus August 31, 1999. This decrease in bad debt expense can be attributed to the decrease in the reserves related to untimely payments by client hospitals, which resulted from more vigorous collection efforts.
Other operating expense for the fiscal year ended August 31, 2000 was $16.8 million, representing a decrease of $1.1 million or 6.1%, as compared to other operating expense of $17.9 million for the prior fiscal year. Rent expense increased $860,000 primarily due to a one-time charge related to the closing of the five clinic locations, previously discussed, and a one-time charge associated with the acceleration of rent expense for office space in Florida that will be vacated when the managed care operations are consolidated into new leased space. Line of credit loan fees decreased $330,000 due to the full amortization of these fees in the prior fiscal year. Legal settlement expense decreased $490,000 due to a significant decrease in actual and projected legal settlements that were and will be incurred related to fiscal year 2000. Capital contribution expense decreased $272,000 due to the decrease in the number of new capital contributions required per contract with client hospitals. The remaining decrease of $950,000 is a result of certain Company initiated expense reduction measures, which significantly decreased various expense categories, including recruiting expenses, express mail cost and telephone expense.
Interest and Other Income (Expense), Net. Interest income, interest expense and other income for fiscal year 2000 was a net expense of $1.0 million as compared to $1.2 million in net expense for fiscal year 1999. This change results from a decrease in interest expense of $169,000 due to lower outstanding debt and more cash on hand.
Income Tax Expense. Income tax expense for fiscal year 2000 was $4.8 million representing an increase of $200,000, or 0.4%, as compared to income tax expense of $4.6 million for the prior fiscal year. The increase in income tax expense was largely due to a corresponding decrease in pre-tax earnings. The effective tax rates for fiscal years 2000 and 1999 were 40.2% and 39.8% respectively.
LIQUIDITY AND CAPITAL RESOURCES
Effective November 15, 2000, the Company entered into an Amended and Restated Credit Agreement (the "Amended Credit Agreement"), with the Chase Manhattan Bank (now known as JP Morgan Chase), as Agent, to refinance the term loans outstanding under the then existing credit agreement. The Amended Credit Agreement consists of a $15.0 million revolving credit facility to fund ongoing working capital requirements, repurchase shares (subject to certain limits), and finance future acquisitions by the Company. As of August 31, 2001, the Company had borrowings of $6.9 million outstanding against the revolving credit facility.
The following summary of certain material provisions of the Amended Credit Agreement does not purport to be complete, and is subject to, and qualified in its entirety by reference to, the Amended Credit Agreement, a copy of which was previously filed as Exhibit 10.1 to a 10-Q report.
The Company is the borrower under the Amended Credit Agreement, which is unconditionally guaranteed by all material subsidiaries of the Company. Principal outstanding under the Amended Credit Agreement bears interest at the "Base Rate" (the greater of the Agent's "prime rate" or the federal funds rate plus .5%) plus .5% or the "Eurodollar Rate" plus 1.75% to 2.25% (depending on the Company's Indebtedness to EBITDA Ratio), as selected by the Company. The Company pays interest quarterly and incurs quarterly commitment fees ranging from .375% to .5% per annum (depending on the Indebtedness to EBITDA Ratio) on the unused portion of the revolving credit facility.
The Company is subject to certain covenants which include prohibitions against (i) incurring additional debt or liens, except specified permitted debt or permitted liens, (ii) certain material acquisitions, other than specified permitted acquisitions (including any single acquisition not greater than $10.0 million or cumulative acquisitions not in excess of $15.0 million) during any twelve consecutive monthly periods without prior bank approval, (iii) certain mergers, consolidations or asset dispositions by the Company or changes of control of the Company, (iv) certain management vacancies at the Company, and (v) material change in the nature of business conducted. The Amended Credit Agreement allows the Company to redeem or repurchase up to $10.0 million of its capital stock (subject to certain limitations) of which $6.1 million was purchased as of August 31, 2001. In addition, the terms of the revolving credit facility require the Company to satisfy certain ongoing financial covenants. The revolving credit facility is secured by a first lien or first priority security interest in and/or pledge of substantially all of the assets of the Company and of all present and future subsidiaries of the Company.
Effective September 1996, the Company entered into a lease agreement with a term of five years, which was subsequently extended to November 2003, for a building, which had been constructed, to the Company's specifications for its National Support Center. In connection with the lease transaction, the Company guaranteed a loan of approximately $900,000. The loan was by a financial institution to the owner. The Company has also agreed to purchase the building for approximately $4.5 million at the end of the extended lease term, if either the building is not sold to a third party or the Company does not further extend its lease.
The Company believes that its future cash flow from operations (which were $12.0 million for the year ended August 31, 2001) and cash of $2.0 million at August 31, 2001 will be sufficient to cover cash requirements over the next twelve months, including estimated capital expenditures of $1.0 million, other than financing that may be required and entered into for acquisitions.
Effective October 1, 2001, the Company acquired all of the mental health management contracts of Perspectives Health Management ("PHM") for approximately $2.9 million in an asset purchase transaction. The acquisition was funded by incurring debt of $2.9 million under the revolving credit facility.
Effective August 1, 2001, the Company acquired all of the outstanding capital stock of Occupational Health Consultants of America, Inc. ("OHCA") for approximately $3.5 million. The acquisition was funded by incurring debt of $3.5 million under the revolving credit facility.
Effective April 1, 1999, the Company acquired all of the outstanding capital stock of REACH for approximately $2.0 million. The acquisition was funded by incurring debt of $2.0 million under the then existing term loan facility.
Effective October 5, 1998, the Company acquired all of the outstanding capital stock of ChoiceHealth for approximately $2.0 million. The acquisition was funded by incurring debt of $2.0 million under the then existing term loan facility.
Effective June 1, 1998, the Company acquired from Ramsay Health Care, Inc. all the outstanding capital stock of FPM for $20.0 million, subject to certain post-closing adjustments. The acquisition was funded by incurring debt of $20.0 million under the then existing term loan facility.
On October 31, 1997, the Company acquired all of the outstanding capital stock of Acorn for approximately $12.7 million. To fund the acquisition, the Company utilized approximately $1.7 million of existing cash and incurred debt of approximately $11.0 million under the then existing revolving credit facility.
Horizon acquired Specialty on August 11, 1997. In the Specialty transaction, 1,400,000 shares of Horizon common stock were issued and exchanged for all outstanding shares of Specialty capital stock. Upon the acquisition, the Specialty outstanding bank indebtedness of approximately $3.2 million was paid in full.
Effective March 15, 1997, the Company purchased all of the outstanding capital stock of Geriatric. The purchase price was approximately $4.6 million, and was paid from existing cash.
Also effective March 15, 1997, the Company purchased all of the outstanding capital stock of Clay Care. The purchase price was $1.0 million, and was paid from existing cash.
CERTAIN EARNINGS DATA
The following table sets forth for the fiscal years ended August 31, 2001 and 2000, diluted earnings per share based on net income plus amortization expense related to goodwill, net of tax.
INFLATION
The Company's management contracts and employee assistance contracts generally provide for annual adjustments in the Company's fees based upon various inflation indexes, thus mitigating the effect of inflation. During the last three years, inflation has had no significant effects on the Company's business.
DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS
Certain written and oral statements made or incorporated by reference from time to time by the Company or its representatives in this report, other reports, filings with the Commission, press releases, conferences, or otherwise, are "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements include, without limitation, any statement that may predict, forecast, indicate, or imply future results, performance or achievements, and may contain the words "believe," "anticipate," "expect," "estimate," "project," "will be," "will continue," "will likely result," or words or phrases of similar meaning. Such statements involve risks, uncertainties or other factors which may cause actual results to differ materially from the future results, performance or achievements expressed or implied by such forward looking statements. Certain risks, uncertainties and other important factors are detailed in this report and will be detailed from time to time in reports filed by the
Company with the Commission, including Forms 8-K, 10-Q, and 10-K, and include, among others, the following: general economic and business conditions which are less favorable than expected; unanticipated changes in industry trends; decreased demand by general hospitals for the Company's services; the Company's inability to retain existing management contracts or to obtain additional contracts; adverse changes in reimbursement to general hospitals by Medicare or other third-party payers for costs of providing mental health or physical rehabilitation services; adverse changes to other regulatory requirements relating to the provision of mental health or physical rehabilitation services; adverse consequences of investigations by governmental regulatory agencies; fluctuations and difficulty in forecasting operating results; the ability of the Company to sustain, manage or forecast its growth; heightened competition, including specifically the intensification of price competition; the entry of new competitors and the development of new products or services by new and existing competitors; changes in business strategy or development plans; inability to carry out marketing and sales plans; business disruptions; liability and other claims asserted against the Company; loss of key executives; the ability to attract and retain qualified personnel; customer services; adverse publicity; demographic changes; and other factors referenced or incorporated by reference in this report and other reports or filings with the Commission. Moreover, the Company operates in a very competitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible for management to predict all such risk factors, nor can it assess the impact of all such risk factors on the Company's business or the extent to which any factor may cause actual results to differ materially from those contained in any forward looking statements. These forward-looking statements represent the estimates and assumptions of management only as of the date of this report. The Company expressly disclaims any obligation or undertaking to disseminate any updates or revisions to any forward looking statement contained herein to reflect any change in its expectations with regard thereto or any change in events, conditions or circumstances on which any statement is based. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In its normal operations, the Company has market risk exposure to interest rates due to its interest bearing debt obligations, which were entered into for purposes other than trading purposes. To manage its exposure to changes in interest rates, the Company uses both variable rate debt and fixed rate debt of short duration with maturities ranging from 30 to 180 days. The Company has estimated its market risk exposure using sensitivity analyses assuming a 10% change in market rates.
At August 31, 2001, the Company had approximately $6.9 million of debt obligations outstanding with a weighted average interest rate of 6.65%. A hypothetical 10% change in the effective interest rate for these borrowings, assuming debt levels as of August 31, 2001, would change interest expense by approximately $46,000 annually. This would be funded out of cash flows from Operations, which were $12.0 million for the twelve months ended August 31, 2001.
At August 31, 2000, the Company had approximately $14.9 million of debt obligations outstanding with a weighted average interest rate of 7.625%. A hypothetical 10% change in the effective interest rate for these borrowings, assuming debt levels as of August 31, 2000, would change interest expense by approximately $114,000 annually.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the Consolidated Financial Statements of the Company and the Notes thereto appearing at page to attached hereto, all of which information is incorporated by reference into this Item 8.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The Company will file with the Commission a definitive proxy statement with respect to the annual meeting of stockholders of the Company to be held on January 16, 2002 (the "Proxy Statement"). The Company hereby incorporates into this Item 10 by reference to the Proxy Statement the information required by this Item 10 that will appear in the Proxy Statement under the caption ELECTION OF DIRECTORS.
The information called for by this Item 10 with respect to executive officers of the Company appears under the caption EXECUTIVE OFFICERS OF THE REGISTRANT following Item 4 of Part I of this Report, and is incorporated by reference into this Item 10.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The Company hereby incorporates into this Item 11 by reference to the Proxy Statement the information required by this Item 11 that will appear in the Proxy Statement under the caption EXECUTIVE COMPENSATION.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The Company hereby incorporates into this Item 12 by reference to the Proxy Statement the information required by this Item 12 that will appear in the Proxy Statement under the caption SECURITY OWNERSHIP BY MANAGEMENT AND PRINCIPAL STOCKHOLDERS.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Financial Statements - Reference is made to the Index to Consolidated Financial Statements appearing at page of this report.
(2) Financial Statement Schedule - Reference is made to the Index to Financial Statement Schedule appearing at page S-1 of this report.
(3) Exhibits.
NUMBER EXHIBIT
3.1 - Certificate of Incorporation of the Company, as amended (incorporated herein by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K dated August 11, 1997).
3.2 - Amended and Restated Bylaws of the Company, as amended (incorporated herein by reference to Exhibit 3.2 to Amendment No. 2 as filed with the Commission on February 16, 1995 ("Amendment No. 2") to the Company's Registration Statement on Form S-1 filed with the Commission on January 6, 1995 Registration No. 33-88314) (the "Form S-1").
4.1 - Specimen certificate for the Common Stock, $.01 par value of the Company (incorporated herein by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K dated August 11, 1997).
4.2 - Rights Agreement, dated February 6, 1997, between the Company and American Stock Transfer & Trust Company, as Rights Agent (incorporated by reference to Exhibit 4.1 to the Company's Registration Statement on Form 8-A, Registration No. 000-22123, as filed with the Commission on February 7, 1997).
10.1 - Amended and Restated Credit Agreement dated November 15, 2000, between Horizon Health Corporation and Horizon Mental Health Management, Inc., as Borrowers, and the Chase Manhattan Bank, as Agent and Individually as a Bank (incorporated herein by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended November 30, 2000).
10.2 - Sixth Amendment to Letter Loan Agreement dated November 15, 2000, between North Central Development Corporation, as Borrower, Horizon Health Corporation and subsidiaries as limited guarantors, and the Chase Manhattan Bank, as the Lender (incorporated herein by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended November 30, 2000).
10.3 - Lease Agreement dated as of December 20, 1995 between North Central Development Company and Horizon Mental Health Management, Inc., a Delaware corporation (incorporated herein by reference to Exhibit 10.8 to the Company's Quarterly Report on Form 10-Q for the quarter ended November 30, 1995).
10.4 - Horizon Health Group, Inc. 1989 Stock Option Plan, as amended (incorporated herein by reference to Exhibit 10.52 of Amendment No. 2 to the Company's Form S-1).
10.5 - Horizon Mental Health Management, Inc. 1995 Stock Option Plan (incorporated herein by reference to Exhibit 10.11 to the November 1995 Form 10-Q).
10.6 - Horizon Mental Health Management, Inc. Amended and Restated 1995 Stock Option Plan for Eligible Outside Directors. (Incorporated herein by reference to Exhibit 10.12 to the Nov 1995 Form 10-Q)
10.7 - Amendments to 1989 Stock Option Plan and 1995 Stock Option Plan (incorporated herein by reference to Exhibit 10.5 to the Company's Current Report on Form 8-K dated September 1, 1997).
10.8 - Amendments to 1995 Stock Option Plan and 1995 First Amended and Restated Stock Option Plan for Eligible Outside Directors (incorporated herein by reference to Exhibit 10.6 to the Company's Current Report on Form 8-K dated September 1, 1997).
10.9 - Amendment to 1995 Amended and Restated Stock Option Plan for Eligible Outside Directors (incorporated herein by reference to Exhibit 10.13 to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1999).
10.10 - Horizon Health Corporation 1998 Stock Option Plan (incorporated herein by reference to Exhibit 10.14 to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1999).
10.11 - Horizon Health Corporation Employee Stock Purchase Plan (incorporated herein by reference to Exhibit 4.3 to the Company's Registration Statement on Form S-8 filed with the Commission on November 30, 1999, Registration No. 333-91761).
10.12 - Horizon Health Corporation Bonus Plan Fiscal 2001 (incorporated herein by reference to Exhibit 10.17 to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 2000).
10.13 - Horizon Health Corporation Bonus Plan Fiscal 2002 (filed herewith).
10.14 - Executive Retention Agreement effective September 1, 1997, between the Company and James Ken Newman (incorporated herein by reference to Exhibit 10.4 to the Company's Current Report on Form 8-K dated September 1, 1997).
10.15 - Agreement dated August 31, 1999 between Horizon Health Corporation, Inc. and Ronald C. Drabik regarding severance arrangements (incorporated herein by reference to exhibit 10.1 to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1999).
10.16 - Employment Agreement, dated November 1, 2001 between Horizon Health Corporation and James W. McAtee (filed herewith).
11 - Statement Regarding Computation of Per Share Earnings (filed herewith).
21 - List of Subsidiaries of the Company (filed herewith).
23 - Consent of PricewaterhouseCoopers LLP (filed herewith).
(b) The Company filed the following reports on Form 8-K during the last quarter of the period covered by this report.
Current report on Form 8-K filed with the Commission on October 2, 2001. The item reported was Item 5, Other Events, announcing a publicly available conference call regarding the 4th quarter and year end financial results on October 16, 2001.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
DATE: NOVEMBER 15, 2001 HORIZON HEALTH CORPORATION
BY: /S/ RONALD C. DRABIK ______________________________________________ RONALD C. DRABIK SENIOR VICE PRESIDENT - FINANCE AND ADMINISTRATION AND TREASURER (PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER)
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 Company and in the capacities and on the dates indicated.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of Horizon Health Corporation:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of changes in stockholders' equity and of cash flows present fairly, in all material respects, the financial position of Horizon Health Corporation and its subsidiaries at August 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended August 31, 2001, in conformity with auditing standards generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
/s/ PRICEWATERHOUSE COOPERS LLP
Pricewaterhouse Coopers LLP October 8, 2001 Dallas, Texas
HORIZON HEALTH CORPORATION CONSOLIDATED BALANCE SHEETS
See accompanying notes.
HORIZON HEALTH CORPORATION CONSOLIDATED BALANCE SHEETS
See accompanying notes.
HORIZON HEALTH CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying notes.
HORIZON HEALTH CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
See accompanying notes.
HORIZON HEALTH CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
HORIZON HEALTH CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
(A) Acquisition of Occupational Health Consultants of America, Inc. effective August 1, 2001.
(B) Acquisition of ChoiceHealth, Inc., Resource in Employee Assistance and Corporate Health, Inc., and the purchase price adjustments of FPM Behavioral Health, Inc. during fiscal year 1999.
See accompanying notes.
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AUGUST 31, 2001, 2000 AND 1999
1. ORGANIZATION
Horizon Health Corporation ("the Company") is a provider of employee assistance programs ("EAP") and behavioral health services to businesses and managed care organizations, as well as a contract manager of clinical and related services, primarily of mental health and physical rehabilitation programs, offered by general acute care hospitals in the United States. The management contracts are generally for initial terms ranging from three to five years, the majority of which have automatic renewal provisions. The Company currently has offices in the Dallas, Texas; Chicago, Illinois; Tampa, Florida; Orlando, Florida; Denver, Colorado; Philadelphia, Pennsylvania; and Nashville, Tennessee metropolitan areas. The Company's National Support Center is in the Dallas suburb of Lewisville, Texas.
The Company was formed in July 1989 for the purpose of acquiring all the assets of two companies. One of these companies, known as Horizon Health Management Company, had been formed in 1981 and since that time had been engaged in the mental health contract management business. The other company owned a freestanding psychiatric hospital in California. Effective March 1, 1990, the assets constituting the contract management business and the psychiatric hospital of the two companies were transferred to the Company. On January 3, 1995, the Company acquired the net assets and operations of National Medical Management Services, a division of National Medical Enterprises, Inc.
Effective October 5, 1998, the Company acquired all of the outstanding capital stock of ChoiceHealth, Inc. ("ChoiceHealth") of Westminster, Colorado. ChoiceHealth has been consolidated with the Company as of October 5, 1998 (see Note 3). Effective April 1, 1999, the Company acquired all of the outstanding capital stock of Resources in Employee Assistance and Corporate Health, Inc. ("REACH"). REACH has been consolidated with the Company as of April 1, 1999 (see Note 3). Effective August 1, 2001, the Company acquired all of the outstanding capital stock of Occupational Health Consultants of America, Inc. ("OHCA"). OHCA has been consolidated with the Company as of August 1, 2001 (see Note 3).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION: The consolidated financial statements include those of the Company and it's wholly owned and majority owned subsidiaries. Investments in unconsolidated affiliated companies are accounted for on the equity method. All significant intercompany accounts and transactions are eliminated in consolidation.
CASH AND CASH EQUIVALENTS: Cash and cash equivalents include highly liquid investments with original maturities of three months or less when purchased.
PROPERTY AND EQUIPMENT: Property and equipment are recorded at cost. Depreciation expense is recorded on the straight-line basis over the assets' estimated useful lives. The useful lives of computer hardware and software are estimated to be three years. The useful lives of furniture and fixtures, and transportation equipment are estimated to be five years. The useful life of office equipment is estimated to be three years. Building improvements are recorded at cost and amortized over the estimated useful lives of the improvements or the terms of the underlying lease whichever is shorter. Routine maintenance, repair items, and customer facility and site improvements are charged to current operations.
CONTRACTS: Contracts represent the fair value of management contracts and service contracts purchased and are being amortized using the straight-line method over seven years.
GOODWILL: Goodwill represents the excess of cost over fair value of net assets acquired and is being amortized using the straight-line method over 40 years.
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. ("SFAS") 141, Business Combinations ("SFAS 141") and SFAS 142, Goodwill and Other Intangible Assets ("SFAS 142"). SFAS 141 addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. SFAS 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination, whether acquired individually or with a group of other assets, and the accounting and reporting for goodwill and other intangibles subsequent to their acquisition. These standards require all future business combinations to be accounted for using the purchase method of accounting. Goodwill will no longer be amortized but instead will be subject to impairment tests at least annually. The Company has elected to adopt SFAS 141 and SFAS 142 on a prospective basis as of September 1, 2001; however, certain provisions of these new standards also apply to any acquisitions concluded subsequent to June 30, 2001. As a result of implementing these new standards, the Company will discontinue the amortization of goodwill as of August 31, 2001. In addition, per the certain provisions in SFAS 141 and SFAS 142, goodwill acquired in the acquisition of OHCA effective August 1, 2001 has not been amortized.
Management believes the adoption of this standard will have a material impact on its financial statements in that its income before taxes will be increased by an amount equal to the amortization expenses that would have otherwise been charged to earnings under current accounting standards, approximately $1.4 million annually. Additionally, the Company's future earnings may periodically be affected in a materially adverse manner should particular segments of its goodwill balances become impaired pursuant to the valuation methodology.
LONG-LIVED AND INTANGIBLE ASSETS: The Company has adopted Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-lived Assets and Assets to be Disposed of." Under SFAS 121, the Company recognizes impairment losses on property and equipment and intangible assets whenever events or changes in circumstances indicate that the carrying amount of long-lived assets, on an individual property basis, may not be recoverable through undiscounted future cash flows. Such losses are determined using estimated fair value or by comparing the sum of the expected future net cash flows to the carrying amount of the asset. Impairment losses are recognized in operating income, as they are determined.
COMMON STOCK REPURCHASE PROGRAM: On September 21, 1998, the Board of Directors of the Company authorized the repurchase of up to 1,000,000 shares of its common stock and on November 19, 1999 the Board of Directors authorized the repurchase of an additional 200,000 shares of its common stock. Pursuant to such authorizations, the Company repurchased 1,189,300 shares through November 30, 1999. On October 12, 2000 the Board of Directors authorized the repurchase of up to an additional 1,000,000 shares of its common stock effective upon the closing of the new Amended Credit Agreement. On February 15, 2001 the Board of Directors authorized the repurchase of an additional 325,000 shares of its common stock. As of August 31, 2001, the Company had repurchased an additional 1,103,563 shares of its common stock (2,292,863 total shares repurchased since September 1998). The stock repurchase plan, as approved by the Board of Directors, authorized the Company to make purchases of its outstanding common stock from time to time in the open market or through privately negotiated transactions, depending on market conditions and applicable securities regulations. The repurchased shares are added to the treasury shares of the Company and may be used for employee stock plans and for other corporate purposes. Of the shares repurchased, a total of 347,552 shares have been reissued pursuant to the exercise of certain stock options and in connection with the Employee Stock Purchase Plan as of August 31, 2001. The shares were repurchased utilizing available cash and borrowings under the Company's credit facility. The Company accounts for the treasury stock using the cost method.
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
REVENUE: Contract management revenue is reported at the estimated net realizable amounts from contracted hospitals for contract management services rendered. Adjustments are accrued on an estimated basis in the period the related services are rendered and adjusted in future periods, as final settlement is determined.
Contract management revenue is based on various criteria such as a per diem calculation using patients per day, a fixed fee, numbers of admissions or discharges, direct expenses, or any combination of the preceding depending on the specific contract.
Premium and fees revenue includes capitated patient services revenues, which are defined by contract and are calculated on a per-member/per-month fee, a fixed fee, and/or a fee for service basis. Capitated revenue is accrued in a similar manner as contract management revenue. For certain contracts the Company bears the economic risk if capitated revenue is insufficient to meet the cost of behavioral health care services incurred by covered members. At August 31, 2001, capitated revenue was more than sufficient to meet these costs.
Some management contracts include a clause, which states that the Company will indemnify the hospital for any third-party payor denials, including Medicare. At the time the charges are denied, the Company records an allowance for 100% of the potential amount to be repaid. Management believes it has adequately provided for potential adjustments that may result from final settlement of these denials.
ADVERTISING COSTS: The Company expenses advertising costs as incurred.
MEDICAL CLAIMS: Outstanding claims include medical claims and related expenses reported but not paid and an estimate of costs incurred but not reported (IBNR) to the Company by health care providers. Management of the Company estimates IBNR costs utilizing the Company's historical experience and current factors.
INCOME TAXES: The Company has adopted Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes." SFAS 109 generally requires an asset and liability approach and requires recognition of deferred tax assets and liabilities resulting from differing book and tax bases of assets and liabilities. It requires that deferred tax assets and liabilities be determined using the tax rate expected to apply to taxable income in the periods in which the deferred tax asset or liability is expected to be realized or settled. Under this method, future financial results will be impacted by the effect of changes in income tax rates on cumulative deferred income tax balances.
EARNING PER SHARE: Earnings per share has been computed in accordance with Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share". Basic earnings per share are computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflect the potential dilution that could occur if the Company's stock options and warrants were exercised. Such dilutive potential common shares are calculated using the treasury stock method.
SEGMENT INFORMATION: In fiscal year 1999, the Company adopted Statement of Financial Accounting Standards ("SFAS") 131, Disclosures about Segments of an Enterprise and Related Information. SFAS 131 supersedes SFAS 14, Financial Reporting for Segments of a Business Enterprise, replacing the "industry segment" approach with the "management" approach. The management approach designates the internal structure that is used by management for making operating decisions and assessing performance as the source of the Company's reportable segments. SFAS 131 also requires certain disclosures about products and services, geographic areas, and major customers. The adoption of SFAS 131 did not affect results of
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
operations or financial position of the Company but did result in changes in the disclosure of segment information (see Note 13).
FINANCIAL INSTRUMENTS: Financial instruments consist of cash and cash equivalents, accounts receivable, current liabilities and long-term debt obligations. The carrying amounts reported in the balance sheets for these financial instruments approximate fair value.
USE OF ESTIMATES: The Company has made certain estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period in order to prepare the financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates.
RECLASSIFICATIONS: Certain prior year amounts have been reclassified to conform to the current year presentation.
3. ACQUISITIONS
OHCA, INC.
Effective August 1, 2001, the Company acquired all of the outstanding capital stock of Occupational Health Consultants of America, Inc. ("OHCA") of Nashville, Tennessee, and OHCA has been consolidated with the company as of August 1, 2001. The Company accounted for the acquisition of OHCA by the purchase method. OHCA provides employee assistance programs and other related behavioral health care services to self-insured employers. OHCA had total revenues of approximately $2.4 million (unaudited) for the seven months ended July 31, 2001. As of August 31, 2001, the preliminary allocation of the purchase price exceeded the fair value of OHCA's tangible net assets by $3,452,797, of which $3,109,621 is recorded as goodwill and $343,176 as service contracts. Tangible assets acquired and liabilities assumed totaled $899,173 and $851,970, respectively. Pro forma financial data is not presented because the impact of this acquisition is not material to the Company's results of operations for any period presented.
REACH, INC.
Effective April 1, 1999, the Company acquired all of the outstanding capital stock of Resources in Employee Assistance and Corporate Health, Inc. ("REACH") of Murray Hill, New Jersey, and REACH has been consolidated with the Company as of April 1, 1999. The Company accounted for the acquisition of REACH by the purchase method. REACH provides employee assistance programs and other related behavioral health care services to self-insured employers. REACH had total revenues of approximately $1.4 million (unaudited) for the ten months ending March 31, 1999. As of August 31, 1999, the preliminary allocation of the purchase price exceeded the fair value of REACH's tangible net assets by $2,326,846, of which $2,054,791 is recorded as goodwill and $272,055 as service contracts. Tangible assets acquired and liabilities assumed totaled $150,496 and $477,342, respectively. Pro forma financial data is not presented because the impact of this acquisition is not material to the Company's results of operations for any period presented.
CHOICEHEALTH, INC.
Effective October 5, 1998, the Company acquired all of the outstanding capital stock of ChoiceHealth, Inc. ("ChoiceHealth") of Westminster, Colorado, and ChoiceHealth has been consolidated with the Company as
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
of October 5, 1998. The company accounted for the acquisition of ChoiceHealth by the purchase method. ChoiceHealth provides managed behavioral health care services, employee assistance programs and other related behavioral health care services to health maintenance organizations and self-insured employers.
ChoiceHealth had total revenues of approximately $7.6 million (unaudited) for the eight months ended August 31, 1998. As of August 31, 1999, the preliminary allocation of the purchase price exceeded the fair value of ChoiceHealth's tangible net assets by $3,114,436, of which $2,935,427 is recorded as goodwill and $179,009 as service contracts. Tangible assets acquired and liabilities assumed totaled $834,928 and $1,899,666, respectively. Pro forma financial data is not presented because the impact of this acquisition is not material to the Company's results of operations for any period presented.
4. PROPERTY AND EQUIPMENT
Property and equipment consist of the following at August 31:
Depreciation expense was $1,393,380, $1,988,315 and $1,420,704 for the years ended August 31, 2001, 2000, and 1999, respectively.
5. ACCRUED EXPENSES
Accrued expenses consisted of the following at August 31:
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. LONG-TERM DEBT
Long-term debt consisted of the following at August 31:
The aggregate maturities of long-term debt during the next five fiscal years are $0 in 2002, $6,900,000 in 2003; and $0 in 2004, 2005 and 2006. On December 9, 1997, the Company entered into a Credit Agreement (the "Credit Agreement") with Chase Bank of Texas, National Association, as Agent for itself and other lenders party to the Credit Agreement for a senior secured credit facility in an aggregate amount of up to $50.0 million (the "Credit Facility"). The Credit Facility consisted of a $10.0 million revolving credit facility (terminated June 30, 2000) and an initial $40.0 million term loan facility which expired November 30, 1999.
On November 16, 2000, the Company entered into an Amended and Restated Credit Agreement, effective November 15, 2000 (the "Amended Credit Agreement"), with The Chase Manhattan Bank (now known as JP Morgan Chase), as Agent, to refinance the term loan outstanding under the existing credit agreement. The Amended Credit Agreement consists of a $15.0 million revolving credit facility to fund ongoing working capital requirements, refinance existing debt, pay dividends, repurchase shares (subject to certain limits) and finance future acquisitions by the Company. As of August 31, 2001 the Company had borrowings of $6.9 million outstanding against the revolving credit facility.
The revolving credit facility bears interest at (1) the Base Rate plus the Base Rate Margin, as defined or (2) the Adjusted Eurodollar Rate, plus the Eurodollar Margin, as defined. At August 31, 2001, the weighted average interest rate on outstanding indebtedness under the credit facility was 6.65%. The Eurodollar Margin varies depending on the debt coverage ratio of the Company. The revolving credit facility matures on November 15, 2003.
The Company is subject to certain covenants which include prohibitions against (i) incurring additional debt or liens, except specified permitted debt or permitted liens, (ii) certain material acquisitions, other than specified permitted acquisitions (including any single acquisition not greater than $10.0 million or cumulative acquisitions not in excess of $15.0 million during any twelve consecutive monthly periods), (iii) certain mergers, consolidations or asset dispositions by the Company or changes of control of the Company, (iv) certain management vacancies at the Company, and (v) material change in the nature of business conducted. In addition, the terms of the Amended Credit Facility require the Company to satisfy certain ongoing financial covenants. The Amended Credit Facility is collateralized by a first lien or first priority security interest in and/or pledge of substantially all of the assets of the Company and of all present and future subsidiaries of the Company.
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. STOCK OPTIONS
The 1989, 1995 and 1998 Stock Option Plans and the 1995 Stock Option Plan for Eligible Outside Directors are collectively referred to as the "Plans." In accordance with the Plans, as amended, 2,581,843 shares of common stock have been reserved for grant to key employees, directors and consultants. Management believes the exercise prices of the options granted approximated or exceeded the market value of the common stock at the date of the grant. The options generally vest ratably over five years from the date of grant and terminate 10 years from the date of grant.
On April 28, 1995 the board of directors created the 1995 Stock Option Plan for Eligible Outside Directors for outside directors owning less than 5% of the stock of the Company. 150,000 shares of common stock are reserved for issuance under this plan. This plan provides for option grants to each eligible director each time he is re-elected to the board after having served as a director for at least one year since his initial grant under the plan. Options vest ratably over five years from the date of grant.
On January 23, 1998, the Stockholders of the Company approved the 1998 Stock Option Plan. The purpose of the Plan is to give the Company a competitive advantage in attracting, retaining and motivating directors, officers, key employees and consultants and to provide the Company and its subsidiaries with a stock option plan providing incentives directly linked to the profitability of the Company's businesses and increases in shareholder value. Under this plan, 500,000 shares of common stock are reserved for issuance. On September 1, 1998, the Company canceled 351,250 options with exercise prices ranging from $14.167 to $26.00, and granted 141,040 options with an exercise price of $7.00, the fair market value at the date of grant. The following table summarizes the status of the Plans:
The following table summarizes information about options outstanding under the Plans at August 31, 2001:
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company applies APB 25 in accounting for the Plans and recognizes no compensation cost in net earnings from the grant of options as options are granted at exercise prices equal to the current stock price. Had compensation cost been determined under the terms of SFAS 123, the Company's pro forma 2001, 2000 and 1999 net earnings and earnings per share would have been:
In accordance with SFAS 123, the fair value of options at date of grant was estimated using the Black-Scholes option-pricing model with the following weighted average assumptions:
In accordance with SFAS 123, the weighted average fair value of options granted during 2001, 2000 and 1999 was $2.77, $3.53, and $4.07 respectively.
8. RETIREMENT PLAN
The Company sponsors a 401(k) plan that covers substantially all eligible employees. The Company can elect to make contributions at its discretion. For the years ended August 31, 2001, 2000 and 1999 the Company made contributions of approximately $550,000, $471,000, and $466,000 respectively.
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. INCOME TAXES
Deferred taxes are provided for those items reported in different periods for income tax and financial reporting purposes. Income tax expense for the years ended August 31 is comprised of the following components:
The components of the net deferred tax asset at August 31 were obtained using the liability method in accordance with SFAS No. 109 and are as follows:
At August 31, 2001, the Company had available estimated, unused net operating loss carryforwards for tax purposes of approximately $1,100,000. These carryforwards, subject to annual utilization limits, may be utilized to offset future years' income and will begin to expire during 2011 if unused prior to that date.
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following is a reconciliation of income taxes at the U.S. federal income tax rate to the Company's effective income tax rate:
10. COMMITMENTS AND CONTINGENCIES
The Company leases various office facilities and equipment under operating leases. The following is a schedule of minimum rental payments under these leases, which expire at various dates:
Rent expense for the years ended August 31, 2001, 2000, and 1999 was $2,282,279, $3,174,094 and $2,325,321, respectively.
The Company leases a building it occupies as its executive offices and National Support Center in the Dallas suburb of Lewisville, Texas. The Company has extended the lease through November 15, 2003. In connection with this lease transaction, the Company guaranteed a loan of approximately $900,000 by a financial institution to the building owner. The Company has also agreed to purchase the building for approximately $4.5 million at the end of the extended lease term, if it is not sold to a third party, or the Company does not further extend its lease.
The Company is insured for professional and general liability on a claims-made basis, with additional tail coverage being obtained when necessary. Management is unaware of any claims against the Company that would cause the final expenses for professional and general liability to vary materially from amounts provided.
The Balanced Budget Act of 1997 mandated the elimination of cost-based reimbursement of mental health partial hospitalization services. Implementation began August 1, 2000. The resulting reimbursement for partial hospitalization services based on the Medicare outpatient prospective payment system utilizes a fixed reimbursement amount per patient day. The base reimbursement rate is a wage-adjusted rate of $206.82 per day, which may lower Medicare reimbursement levels to many hospitals for partial hospitalization services. This change may adversely affect the ability of the Company to maintain
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
and/or obtain management contracts for partial hospitalization services and the amount of fees paid to the Company under such contracts.
In addition, recent amendments to the Medicare statutes provide for a phase-out of cost-based reimbursement of physical rehabilitation services over a two-year period beginning no earlier than January 1, 2002. The phase in of a prospective payment system with reimbursement based on a functional patient classification may lower Medicare reimbursement levels to hospitals for physical rehabilitation services. This could adversely affect the ability of the Company to maintain and/or obtain management contracts for physical rehabilitation services and the amount of fees paid to the Company under such contracts.
In late 1999, the Company became aware that a civil qui tam lawsuit had been filed under seal naming the Company's psychiatric contract management subsidiary, Horizon Mental Health Management (Horizon), as one of the defendants therein. In March 2001, the realtors served the complaint in the lawsuit brought under the Federal False Claims Act. The U.S. Department of Justice had previously declined to intervene in the lawsuit. The Company has filed a motion to dismiss and discovery proceedings have been deferred until the court rules on the motion. The Company does not believe the claims asserted in the lawsuit, based on present allegations, represent a material liability to the Company.
In early December 2000, the Company was served with a U.S. Department of Justice subpoena issued by the U.S. Attorney's Office for the Northern District of California. The subpoena requested the production of documents related to certain matters such as patient admissions, patient care, patient charting, and marketing materials, pertaining to hospital gero-psychiatric programs managed by the Company. The Company believes the subpoena originated as a result of a sealed qui tam suit and has furnished documents in response to the subpoena. No allegations or claims have been made against the Company. At this time, the Company cannot predict the ultimate scope or any particular future outcome of the investigation.
In March 2001, Horizon Behavioral Services, Inc., a subsidiary of Horizon, was served with a lawsuit seeking damages for the unauthorized release of treatment records of a member of an employee assistance program operated by a predecessor of Horizon Behavioral Services, Inc. The lawsuit asserts similar but separate claims against two unaffiliated co-defendants. The damages in the lawsuit are unspecified. Horizon's insurance carrier has provided the Company a preliminary indication that some of the claims asserted in the lawsuit may not be covered by insurance. To date, Horizon does not have sufficient information to fully evaluate the claim or any particular future outcome of this lawsuit.
The Company is involved in litigation arising in the ordinary course of business, including matters involving professional liability. It is the opinion of management that the ultimate disposition of such litigation, net of any applicable insurance, would not be significantly in excess of any reserves or have a material adverse effect on the Company's financial position or results of operations.
11. COMMON STOCK
The Board of Directors adopted in October 1999 the Horizon Health Corporation Employee Stock Purchase Plan ("the Plan"). The purpose of the Plan, which became effective January 1, 2000, is to provide employees of the Company and its subsidiaries the opportunity to acquire an ownership interest in the Company through the purchase of Common Stock at a price below current market prices. The Plan offers eligible employees the ability to purchase company stock at a price 15% below the current market price at designated periods. Eligible employees are able to contribute 1 to 10% of their base salary pursuant to two six-month offering periods which are defined as January 1 - June 30 or July 1 - December 31. Related to the Plan the Company issued 23,959 shares of Common Stock from treasury for the fiscal year ended August 31, 2001, and 14,642 shares from treasury for the fiscal year ended August 31, 2000.
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. EARNINGS PER SHARE
The Company has adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share." All prior earnings per share data presented have been restated in accordance with SFAS 128.
The following is a reconciliation of the numerators and the denominators of the basic and diluted earnings per share computations for net income for the years ended August 31:
During 2001, 2000, and 1999 certain options to acquire common stock were not included in certain computations of EPS because the options exercise price was greater than the average market price of the common shares. The options excluded by quarter are as follows:
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. SEGMENT INFORMATION
The Company has determined that its reportable segments are appropriately based on its method of internal reporting, which disaggregates its business by services category in a manner consistent with the Company's Consolidated Statements of Income format. The Company's reportable segments are Horizon Behavioral Services, Horizon Mental Health Management, Specialty Rehab Management, and Mental Health Outcomes. See notes (A) through (E) below for a description of the services provided by each of the identified segments. The Company's business is conducted solely in the United States.
The following schedule represents revenues and operating results for the twelve months ended August 31 by operating division/segment:
* Earnings before interest, taxes, depreciation and amortization (division operating profit). ** Changes in the reporting relationships of subsidiaries cause fluctuations between periods.
(A) Horizon Behavioral provides managed care and employee assistance programs. (B) Horizon Mental Health Management provides mental health contract management services to general acute care hospitals. (C) Specialty Rehab Management provides physical rehabilitation contract management services to general acute care hospitals. (D) Mental Health Outcomes provides outcomes information regarding the effectiveness of mental health programs and psychiatric data- base services. Beginning in Fiscal Year 2001 Mental Health Outcomes began recording revenue directly for the Horizon Mental Health Management contracts that provide CQI+. (E) "Other" represents the Company's corporate offices and National Support Center located in Lewisville, Texas which provides management, financial, human resource, and information system support for the Company and its subsidiaries.
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following is a summary of unaudited quarterly financial data for fiscal 2001 and 2000:
15. SUBSEQUENT EVENT
ACQUISITION OF PERSPECTIVES HEALTH MANAGEMENT: Effective October 1, 2001, the Company purchased all the mental health management contracts of Perspectives Health Management ("PHM"), a wholly owned subsidiary of Legal Access Technologies, Inc. The Company accounted for the acquisition by the purchase method as required by generally accepted accounting principles. PHM had 12 mental health management contract locations. The management contracts cover 12 inpatient mental health programs, one partial hospitalization mental health program and three intensive outpatient mental health programs. Currently, annualized revenues for the contracts approximate $4.7 million (unaudited). The management contracts constituted all of the business operations of PHM. The purchase price of approximately $2.9 million in cash was funded by the Company's revolving credit facility.
INDEX TO FINANCIAL STATEMENT SCHEDULE
S-1
REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE
To the Board of Directors and Stockholders of Horizon Health Corporation
Our audits of the consolidated financial statements referred to in our report dated October 8, 2001 appearing on page F - 2 of this Annual Report on Form 10-K also included an audit of the Financial Statement Schedule as listed in Item 14(a)(2) of this Form 10-K. In our opinion, this Financial Statement Schedule presents fairly, in all material respects, the information set forth herein when read in conjunction with the related consolidated financial statements.
/s/ PRICEWATERHOUSECOOPERS LLP
PricewaterhouseCoopers LLP Dallas, Texas October 8, 2001
S - 2
HORIZON HEALTH CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
(1) Adjustment reflects reserves in which Horizon is aware that specific hospitals have experienced treatment day denials and to which a corresponding accounts receivable balance does not exist. These amounts are accrued as a liability.
(2) Adjustment reflects items reserved as other receivables, therefore their reserve is not included in the allowance for receivables.
(3) Adjustment includes a recovery of $1.75 million related to one former Specialty contract.
S - 3
INDEX TO EXHIBITS
NUMBER EXHIBIT
3.1 - Certificate of Incorporation of the Company, as amended (incorporated herein by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K dated August 11, 1997).
3.2 - Amended and Restated Bylaws of the Company, as amended (incorporated herein by reference to Exhibit 3.2 to Amendment No. 2 as filed with the Commission on February 16, 1995 ("Amendment No. 2") to the Company's Registration Statement on Form S-1 filed with the Commission on January 6, 1995 Registration No. 33-88314) (the "Form S-1").
4.1 - Specimen certificate for the Common Stock, $.01 par value of the Company (incorporated herein by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K dated August 11, 1997).
4.2 - Rights Agreement, dated February 6, 1997, between the Company and American Stock Transfer & Trust Company, as Rights Agent (incorporated by reference to Exhibit 4.1 to the Company's Registration Statement on Form 8-A, Registration No. 000-22123, as filed with the Commission on February 7, 1997).
10.1 - Amended and Restated Credit Agreement dated November 16, 2000, between Horizon health Corporation and Horizon Mental Health Management, Inc., as Borrowers, and the Chase Manhattan Bank, as Agent and Individually as a Bank (incorporated herein by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended November 30, 2000).
10.2 - Sixth Amendment to Letter Loan Agreement dated November 15, 2000, between North Central Development Corporation, as Borrower, Horizon Health Corporation and subsidiaries as limited guarantors, and the Chase Manhattan Bank, as the Lender (incorporated herein by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended November 30, 2000).
10.3 - Lease Agreement dated as of December 20, 1995 between North Central Development Company and Horizon Mental Health Management, Inc., a Delaware corporation (incorporated herein by reference to Exhibit 10.8 to the Company's Quarterly Report on Form 10-Q for the quarter ended November 30, 1995).
10.4 - Horizon Health Group, Inc. 1989 Stock Option Plan, as amended (incorporated herein by reference to Exhibit 10.52 of Amendment No. 2 to the Company's Form S-1).
10.5 - Horizon Mental Health Management, Inc. 1995 Stock Option Plan (incorporated herein by reference to Exhibit 10.11 to the November 1995 Form 10-Q).
10.6 - Horizon Mental Health Management, Inc. Amended and Restated 1995 Stock Option Plan for Eligible Outside Directors. (Incorporated herein by reference to Exhibit 10.12 to the November 1995 Form 10-Q)
10.7 - Amendments to 1989 Stock Option Plan and 1995 Stock Option Plan (incorporated herein by reference to Exhibit 10.5 to the Company's Current Report on Form 8-K dated September 1, 1997).
10.8 - Amendments to 1995 Stock Option Plan and 1995 First Amended and Restated Stock Option Plan for Eligible Outside Directors (incorporated herein by reference to Exhibit 10.6 to the Company's Current Report on Form 8-K dated September 1, 1997).
10.9 - Amendment to 1995 Amended and Restated Stock Option Plan for Eligible Outside Directors (incorporated herein by reference to Exhibit 10.13 to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1999).
10.10 - Horizon Health Corporation 1998 Stock Option Plan (incorporated herein by reference to Exhibit 10.14 to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1999).
10.11 - Horizon Health Corporation Employee Stock Purchase Plan (incorporated herein by reference to Exhibit 4.3 to the Company's Registration Statement on Form S-8 filed with the Commission on November 30, 1999, Registration No. 333-91761).
10.12 - Horizon Health Corporation Bonus Plan Fiscal 2001 (incorporated herein by reference to Exhibit 10.17 to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 2000).
10.13 - Horizon Health Corporation Bonus Plan Fiscal 2002 (filed herewith).
10.14 - Executive Retention Agreement effective September 1, 1997, between the Company and James Ken Newman (incorporated herein by reference to Exhibit 10.4 to the Company's Current Report on Form 8-K dated September 1, 1997).
10.15 - Agreement dated August 31, 1999 between Horizon Health Corporation, Inc. and Ronald C. Drabik regarding severance arrangements (incorporated herein by reference to exhibit 10.1 to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1999).
10.16 - Employment Agreement, dated November 1, 2001 between Horizon Health Corporation and James W. McAtee (filed herewith).
11 - Statement Regarding Computation of Per Share Earnings (filed herewith).
21 - List of Subsidiaries of the Company (filed herewith).
23 - Consent of PricewaterhouseCoopers LLP (filed herewith).
(b) The Company filed the following reports on Form 8-K during the last quarter of the period covered by this report.
Current report on Form 8-K filed with the Commission on October 2, 2001. The item reported was Item 5, Other Events, announcing a publicly available conference call regarding the 4th quarter and year end financial results on October 16, 2001.