PRELIMINARY COPY
HEALTHSOUTH CORPORATION
NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
April ____, 1998
The Annual Meeting of Stockholders of HEALTHSOUTH Corporation (the
"Company") will be held at One HealthSouth Parkway, Birmingham, Alabama, on
Thursday, May 21, 1998, at 2:00 p.m., C.D.T., for the following purposes:
1. To elect twelve Directors to serve until the next Annual Meeting of
Stockholders and until their successors are duly elected and qualified.
2. To vote upon an Amendment to the Restated Certificate of Incorporation
of the Company to increase the authorized Common Stock of the Company to
600,000,000 shares of Common Stock, par value $.01 per share.
3. To approve the 1998 Restricted Stock Plan of the Company.
4. To vote upon a proposal submitted by Iron Workers' Local No. 25 Fringe
Benefit Funds urging the Board of Directors to establish certain additional
requirements for service on the Compensation Committee.
5. To transact such other business as may properly come before the Annual
Meeting or any adjournment thereof.
Stockholders of record at the close of business on March 31, 1998, are
entitled to notice of, and to vote at, the Annual Meeting or any adjournment
thereof.
IF YOU CANNOT ATTEND THE ANNUAL MEETING IN PERSON, PLEASE DATE AND EXECUTE
THE ACCOMPANYING PROXY AND RETURN IT PROMPTLY TO THE COMPANY. IF YOU ATTEND THE
ANNUAL MEETING, YOU MAY REVOKE YOUR PROXY AND VOTE IN PERSON IF YOU DESIRE TO DO
SO, BUT ATTENDANCE AT THE ANNUAL MEETING DOES NOT OF ITSELF SERVE TO REVOKE YOUR
PROXY.
ANTHONY J. TANNER
Secretary
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PRELIMINARY COPY
HEALTHSOUTH CORPORATION
PROXY STATEMENT
INTRODUCTION
This Proxy Statement is furnished to the holders of Common Stock, par value
$.01 per share, of HEALTHSOUTH Corporation (the "Company") in connection with
the solicitation of Proxies by and on behalf of the Board of Directors of the
Company for use at the Annual Meeting of Stockholders to be held on May 21, 1998
or any adjournment thereof. A form of Proxy for use at the Annual Meeting is
also enclosed. Any such Proxy may be revoked by a stockholder at any time before
it is exercised by either giving written notice of such revocation to the
Secretary of the Company or submitting a later-dated Proxy to the Company prior
to the Annual Meeting. A stockholder attending the Annual Meeting may revoke his
Proxy and vote in person if he desires to do so, but attendance at the Annual
Meeting will not of itself revoke the Proxy.
The Company's principal executive offices are located at One HealthSouth
Parkway, Birmingham, Alabama 35243. The Company's telephone number is (205)
967-7116.
Proxy materials will be mailed to stockholders by the Management of the
Company on or about April 21, 1998. The Company has retained ChaseMellon
Shareholder Services, L.L.C. to solicit proxies on its behalf and will pay
ChaseMellon Shareholder Services, L.L.C. a fee of 9,500 for those services. The
Company will reimburse ChaseMellon Shareholder Services, L.L.C. for
out-of-pocket expenses incurred in connection with such solicitation. Additional
solicitation may be made by mail, telephone or telegram by the officers or
regular employees of the Company, who will receive no additional compensation
therefor. Arrangements will also be made with brokerage houses, custodians,
nominees and fiduciaries for the forwarding of proxy materials to the beneficial
owners of Common Stock held of record by such persons, and the Company will
reimburse such brokerage houses, custodians, nominees and fiduciaries for
reasonable out-of-pocket expenses incurred by them in connection therewith. The
entire expense of solicitation, including the cost of preparing, assembling and
mailing the proxy materials, will be borne by the Company.
The purposes of the Annual Meeting of Stockholders are to (a) elect a Board
of Directors to serve until the next Annual Meeting of Stockholders, (b) vote
upon an Amendment to the Restated Certificate of Incorporation of the Company to
increase the authorized Common Stock of the Company to 600,000,000 shares, (c)
approve the 1998 Restricted Stock Plan of the Company and (d) vote upon a
proposal submitted by Iron Workers' Local No. 25 Fringe Benefit Funds urging the
Board of Directors to establish certain additional requirements for service on
the Compensation Committee (the "Iron Workers' Proposal"). The Company is not
aware at this time of any other matters that will come before the Annual
Meeting. If any other matters properly come before the Annual Meeting, it is the
intention of the persons designated as proxies to vote in accordance with their
judgment on such matters. Shares represented by executed and unrevoked Proxies
will be voted in accordance with instructions contained therein or, in the
absence of such instructions, in accordance with the recommendations of the
Board of Directors. Abstentions and broker non-votes will not be counted for
purposes of determining whether any given proposal has been approved by the
stockholders of the Company. Accordingly, abstentions and broker non-votes will
not affect the votes to be taken on the election of Directors, the approval of
the 1998 Restricted Stock Plan or the Iron Workers' Proposal, which require for
approval the affirmative vote of a majority of the shares of Common Stock
present or represented and entitled to vote at the Annual Meeting. Because the
proposal to amend the Company's Restated Certificate of Incorporation requires
the affirmative vote of a majority of the issued and outstanding shares of
Common Stock of the Company, abstentions and broker non-votes will be the
equivalent of votes against this proposal.
As to all matters that may come before the Annual Meeting, each stockholder
will be entitled to one vote for each share of Common Stock of the Company held
by him at the close of business on March 31, 1998. The holders of a majority of
the shares of Common Stock of the Company present in person or by
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proxy and entitled to vote will constitute a quorum at the Annual Meeting.
Abstentions and broker non-votes will be counted for purposes of determining the
presence of a quorum. At March 31, 1998, the record date for the Annual Meeting,
there were ____________ shares of Common Stock outstanding.
DISSENTERS' RIGHTS OF APPRAISAL
There are no dissenters' rights of appraisal in connection with any vote of
stockholders to be taken at the 1998 Annual Meeting of Stockholders.
PROPOSALS BY STOCKHOLDERS
Any proposals by stockholders of the Company intended to be presented at
the 1999 Annual Meeting of Stockholders must be received by the Company for
inclusion in the Company's Proxy Statement and form of Proxy by December ____,
1998.
ELECTION OF DIRECTORS
NOMINEES FOR DIRECTOR
At the Annual Meeting, twelve Directors are to be elected. The Bylaws of
the Company permit the Board of Directors to determine the number of Directors
of the Company. Unless other instructions are specified, the enclosed Proxy will
be voted in favor of the persons named below to serve until the next Annual
Meeting of Stockholders and until their successors shall have been duly elected
and qualified. The affirmative vote of a majority of the shares of Common Stock
present or represented and entitled to vote at the Annual Meeting is required
for the election of each Director. In the event any of the nominees shall be
unable to serve as a Director, it is the intention of the persons designated as
proxies to vote for substitutes selected by the Board of Directors. The Board of
Directors of the Company has no reason to believe that any of the nominees named
below will be unable to serve if elected.
The following table sets forth certain information concerning the twelve
nominees for Director of the Company:
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION
AND ALL POSITIONS A DIRECTOR
NAME AGE WITH THE COMPANY SINCE
- - ------------------------------ ----- ----------------------------------------------------------- -----------
<S> <C> <C> <C>
Richard M. Scrushy ........... 45 Chairman of the Board and Chief Executive Officer and 1984
Director
Phillip C. Watkins, M.D. ..... 56 Physician, Birmingham, Alabama, and Director 1984
George H. Strong ............. 71 Private Investor, Locust, New Jersey, and Director 1984
C. Sage Givens ............... 41 General Partner, Acacia Venture Partners, and Director 1985
Charles W. Newhall III ....... 53 Partner, New Enterprise Associates Limited Partnerships, 1985
and Director
James P. Bennett ............. 40 President and Chief Operating Officer and Director 1993
Larry R. House ............... 54 Private Investor, Birmingham, Alabama, and Director 1993
Anthony J. Tanner ............ 49 Executive Vice President -- Administration and Secre- 1993
tary and Director
John S. Chamberlin ........... 70 Private Investor, Princeton, New Jersey, and Director 1993
P. Daryl Brown ............... 43 President -- HEALTHSOUTH Outpatient Centers and 1995
Director
Joel C. Gordon ............... 69 Private Investor, Nashville, Tennessee, Consultant to the 1996
Company and Director
Michael D. Martin ............ 37 Executive Vice President, Chief Financial Officer and 1998
Treasurer and Director
</TABLE>
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Richard M. Scrushy, one of the Company's management founders, has served as
Chairman of the Board and Chief Executive Officer of the Company since 1984, and
also served as President of the Company from 1984 until March 1995. From 1979 to
1984, Mr. Scrushy was with Lifemark Corporation, a publicly-owned healthcare
corporation, serving in various operational and management positions. Mr.
Scrushy is also Chairman of the Board of MedPartners, Inc., a publicly-traded
physician practice management company for which he also served as Acting Chief
Executive Officer from January 16 through March 18, 1998, and Chairman of the
Board of Capstone Capital, Inc., a publicly-traded real estate investment trust.
He also serves on the boards of directors of several privately-held healthcare
corporations and is a principal of 21st Century Health Ventures L.L.C., a
private equity investment fund sponsor.
Phillip C. Watkins, M.D., FACC, is and has been for more than five years in
the private practice of medicine in Birmingham, Alabama. A graduate of The
Medical College of Alabama, Dr. Watkins is a Diplomate of the American Board of
Internal Medicine. He is also a Fellow of the American College of Cardiology and
the Subspecialty Board of Cardiovascular Disease.
George H. Strong retired as senior vice president and chief financial
officer of Universal Health Services, Inc. in December 1984, a position he held
for more than six years. Mr. Strong is a private investor and continued to act
as a Director of Universal Health Services, Inc., a publicly-traded hospital
management corporation, until 1993. Mr. Strong is also a director of Core Funds,
a public mutual fund group, Integrated Health Services, Inc., a publicly-traded
healthcare corporation, and AmeriSource, Inc., a large drug wholesaler.
C. Sage Givens is a general partner of Acacia Venture Partners, a private
venture capital fund capitalized at $66,000,000. From 1983 to June 30, 1995, Ms.
Givens was a general partner of First Century Partners, a private venture
capital fund capitalized at $100,000,000. Ms. Givens managed the fund's
healthcare investments. Ms. Givens serves on the boards of directors of PhyCor,
Inc. and UroHealth Systems, Inc., both publicly-traded healthcare corporations,
and several privately-held healthcare companies.
Charles W. Newhall III is a general partner and founder of New Enterprise
Associates Limited Partnerships, Baltimore, Maryland, where he has been engaged
in the venture capital business since 1978. Mr. Newhall is also a director of
Integrated Health Services, Inc., MedPartners, Inc. and Opta Food Ingredients,
Inc., all of which are publicly-traded corporations.
James P. Bennett joined the Company in May 1991 as Director of Inpatient
Operations, was promoted to Group Vice President -- Inpatient Rehabilitation
Operations in September 1991, again to President and Chief Operating Officer --
HEALTHSOUTH Rehabilitation Hospitals in June 1992, to President -- HEALTHSOUTH
Inpatient Operations in February 1993, and to President and Chief Operating
Officer of the Company in March 1995. Mr. Bennett was elected a Director in
February 1993. From August 1987 to May 1991, Mr. Bennett was employed by Russ
Pharmaceuticals, Inc., Birmingham, Alabama, as Vice President -- Operations,
Chief Financial Officer, Secretary and director. Mr. Bennett served as certified
public accountant on the audit staff of the Birmingham, Alabama office of Ernst
& Whinney (now Ernst & Young LLP) from October 1980 to August 1987.
Larry R. House served as Chairman of the Board, President and Chief
Executive Officer of MedPartners, Inc. a publicly-traded physician practice
management firm, from August 1993 until January 16, 1998. Mr. House was elected
a Director of the Company in February 1993. At the same time he became President
- - -- HEALTHSOUTH International, Inc. and New Business Ventures, a position which
he held until August 31, 1994, when he terminated his employment with the
Company to concentrate on his duties at MedPartners. Mr. House joined the
Company in September 1985 as Director of Marketing, subsequently served as
Senior Vice President and Chief Operating Officer of the Company, and in June
1992 became President and Chief Operating Officer -- HEALTHSOUTH Medical
Centers. Prior to joining the Company, Mr. House was president and chief
executive officer of a provider of clinical contract management services for
more than ten years.
Anthony J. Tanner, Sc.D., a management founder, serves as Executive Vice
President -- Administration and Secretary of the Company and was elected a
Director in February 1993. From 1980 to 1984,
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Mr. Tanner was with Lifemark Corporation in the Shared Services Division as
director, clinical and professional programs (1982-1984) and director, quality
assurance and education (1980-1982), where he was responsible for the
development of clinical programs and marketing programs.
P. Daryl Brown joined the Company in April 1986 and served until June 1992
as Group Vice President -- Outpatient Operations. He became President --
HEALTHSOUTH Outpatient Centers in June 1992, and was elected as a Director in
March 1995. From 1977 to 1986, Mr. Brown served with the American Red Cross,
Alabama Region, in several positions, including Chief Operating Officer,
Administrative Director for Financing and Administration and Controller.
John S. Chamberlin retired in 1988 as president and chief operating officer
of Avon Products, Inc., a position he had held since 1985. From 1976 until 1985,
he served as chairman and chief executive officer of Lenox, Incorporated, after
22 years in various assignments for General Electric. From 1990 to 1991, he
served as chairman and chief executive officer of New Jersey Publishing Co. Mr.
Chamberlin is chairman of the board of Life Fitness Company and WNS, Inc., and
is a director of The Scotts Company and UroHealth Systems, Inc. He is a member
of the Board of Trustees of the Medical Center at Princeton and is a trustee of
the Woodrow Wilson National Fellowship Foundation.
Joel C. Gordon served as Chairman of the Board of Directors of SCA from its
founding in 1982 until January 17, 1996, when SCA was acquired by the Company.
Mr. Gordon also served as Chief Executive Officer of SCA from 1987 until January
17, 1996. Mr. Gordon serves on the boards of directors of Genesco, Inc., an
apparel manufacturer, and SunTrust Bank of Nashville, N.A.
Michael D. Martin joined the Company in October 1989 as Vice President and
Treasurer, and was named Senior Vice President -- Finance and Treasurer in
February 1994 and Executive Vice President -- Finance and Treasurer in May 1996.
In October 1997, he was additionally named Chief Financial Officer of the
Company, and in March 1998, he was named a Director of the Company. From 1983
through September 1989, Mr. Martin specialized in healthcare lending with
AmSouth Bank N.A., Birmingham, Alabama, where he was a Vice President
immediately prior to joining the Company. Mr. Martin is a Director of Capstone
Capital, Inc. and MedPartners, Inc. and is a principal of 21st Century Health
Ventures.
Directors hold office until the next Annual Meeting of Stockholders of the
Company and until their successors are elected and qualified. Officers are
elected annually by the Board of Directors and serve at the discretion of the
Board of Directors.
MANAGEMENT MATTERS
There are no arrangements or understandings known to the Company between
any of the Directors, nominees for Director or executive officers of the Company
and any other person pursuant to which any such person was elected as a Director
or an executive officer, except the Employment Agreement between the Company and
Richard M. Scrushy described under "Executive Compensation and Other Information
- - -- Audit and Compensation Committee Report on Executive Compensation -- Chief
Executive Officer Compensation" in this Proxy Statement and except that Mr.
Gordon was initially named to the Board of Directors under the terms of the
merger agreement pursuant to which the Company acquired SCA. There are no family
relationships between any Directors, nominees for Director or executive officers
of the Company. The Board of Directors of the Corporation held a total of eight
meetings during 1997.
There are no employment contracts between the Company and any executive
officer named in the Summary Compensation Table under "Executive Compensation
and Other Information -- Executive Compensation -- General", other than the
Employment Agreement with Richard M. Scrushy described under "Executive
Compensation and Other Information -- Audit and Compensation Committee Report on
Executive Compensation -- Chief Executive Officer Compensation" in this Proxy
Statement. Except for such Employment Agreement and except for the broad-based
retirement plans of the Company described under "Executive Compensation and
Other Information -- Retirement Investment Plan" and "Executive Compensation and
Other Information -- Employee Stock Benefit Plan" and the Executive Deferred
Compensation Plan of the Company described under "Executive Compensation and
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Other Information -- Deferred Compensation Plan", there are no compensatory
plans or arrangements with respect to any such executive officer which result or
will result from the resignation or retirement of such executive officer or any
other termination of such executive officer's employment with the Company and
its subsidiaries or from a change in control of the Company or from a change in
such executive officer's responsibilities following a change in control of the
Company.
The Audit and Compensation Committee of the Board is responsible for
reviewing all reports from the Company's auditors, monitoring internal controls
and reviewing the Company's compensation program, as well as administering the
Company's stock option plans. On May 1, 1997, C. Sage Givens, George H. Strong
and Phillip C. Watkins, all of whom are outside Directors, were appointed to
serve on this committee for a period of one year or until their successors are
appointed. They continue to serve in such capacity. This committee held two
meetings and acted twice by unanimous written consent during 1997.
On August 14, 1997, the Board of Directors established a Corporate
Compliance Committee of the Board of Directors, which is responsible for
establishing and reviewing the Company's Corporate Compliance Program and
otherwise ensuring that the Corporation operates in compliance with federal,
state and local laws and regulations. At that time, Richard M. Scrushy, Chairman
of the Board and Chief Executive Officer of the Company, James P. Bennett,
President and Chief Operating Officer of the Company, and Anthony J. Tanner,
Executive Vice President -- Administration and Secretary of the Company, and
John S. Chamberlin, Joel C. Gordon, and Charles W. Newhall III, all of whom are
outside directors, were appointed to serve on this committee, with Mr. Tanner
appointed as Chairman and Compliance Officer. Members of the committee serve for
a period of one year or until their successors are appointed. This committee
held one meeting in 1997.
The Company has no other standing audit, nominating or compensation
committees of the Board of Directors.
SECTION 16(A) BENEFICIAL OWNERSHIP COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
officers and Directors, and persons who beneficially own more than 10% of a
registered class of the Company's equity securities, to file reports of
ownership and changes in ownership with the Securities and Exchange Commission
and the New York Stock Exchange. Officers, Directors and beneficial owners of
more than 10% of the Company's Common Stock are required by SEC regulations to
furnish the Company with copies of all Section 16(a) forms that they file. Based
solely on review of the copies of such forms furnished to the Company, or
written representations that no reports on Form 5 were required, the Company
believes that for the period from January 1, 1997 through December 31, 1997, all
of its officers, Directors and greater-than-10% beneficial owners complied with
Section 16(a) filing requirements applicable to them, except as set forth below.
Joel C. Gordon, a Director of the Company, failed to timely report three
open market sales aggregating 15,000 shares of the Company's Common Stock in
December 1995, which sales were reported on Form 5 in February 1998. The sales
were made by a trust of which Mr. Gordon is a trustee. George H. Strong, a
Director of the Company, failed to timely report a sale of 40,000 shares of
Common Stock by a trust of which he is a trustee in September 1997, which sale
was reported on Form 5 in February 1998. Charles W. Newhall III, a Director of
the Company, failed to timely report a sale of 61 shares of Common Stock in
February 1996, a sale of 30,133 shares of Common Stock in March 1996, and a sale
of 30,440 shares of Common Stock in January 1997, each of which sales was
reported on Form 4 in November 1997. The Company has consulted with the
foregoing persons concerning their obligations to comply with Section 16(a).
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AMENDMENT TO RESTATED CERTIFICATE OF INCORPORATION
TO INCREASE AUTHORIZED COMMON STOCK
At a meeting of the Board of Directors of the Company on, March 6, 1998,
the Board of Directors approved an Amendment (the "Amendment") to Article FOURTH
of the Company's Restated Certificate of Incorporation to increase the number of
authorized shares of Common Stock of the Company from 500,000,000 to 600,000,000
shares of Common Stock, par value $.01 per share. Such approval was subject to
the approval of the Amendment by the holders of a majority of the outstanding
shares of Common Stock.
In connection with such proposal, the following resolution will be
introduced at the Annual Meeting:
RESOLVED, that the first paragraph of Article FOURTH of the Restated
Certificate of Incorporation of this Corporation be amended to read as
follows:
"FOURTH. The total number of shares of stock which the Corporation shall
have authority to issue is Six Hundred One Million Five Hundred Thousand
(601,500,000) shares, consisting of Six Hundred Million (600,000,000)
shares of Common Stock, par value One Cent ($.01) per share, and One
Million Five Hundred Thousand (1,500,000) shares of Preferred Stock, par
value Ten Cents ($.10) per share."
INCREASE IN AUTHORIZED COMMON STOCK
The Board of Directors recommends that the Company's stockholders approve
the proposed Amendment to the Restated Certificate of Incorporation to increase
the authorized Common Stock of the Company to 600,000,000 shares of Common
Stock, par value $.01 per share, because it considers such proposal to be in the
best long-term and short-term interests of the Company, its stockholders and its
other constituencies. The proposed increase in the number of shares of
authorized Common Stock will ensure that a sufficient number of shares will be
available, if needed, for issuance in connection with any possible future
transactions approved by the Board of Directors, including, among others, stock
splits, stock dividends, acquisitions, financings and other corporate purposes.
The Board of Directors believes that the availability of the additional shares
of Common Stock for such purposes without delay or the necessity for a special
stockholders' meeting (except as may be required by applicable law or regulatory
authorities or by the rules of any stock exchange on which the Company's
securities may then be listed) will be beneficial to the Company by providing it
with the flexibility required to consider and respond to future business
opportunities and needs as they arise. The availability of additional authorized
shares of Common Stock will also enable the Company to act promptly when the
Board of Directors determines that the issuance of additional shares of Common
Stock is advisable. It is possible that shares of Common Stock may be issued at
a time and under circumstances that may increase or decrease earnings per share
and increase or decrease the book value per share of shares presently held.
Except for issuance in connection with the various convertible debentures,
stock options and stock purchase warrants referred to in this Proxy Statement,
the Company does not have any immediate plans, agreements, arrangements,
commitments or understandings with respect to the issuance of any of the
remaining additional shares of Common Stock which would be authorized by the
proposed Amendment to the Restated Certificate of Incorporation.
Under the Restated Certificate of Incorporation, the Corporation presently
has authority to issue 500,000,000 shares of Common Stock, par value $.01 per
share, of which _____________ shares were issued and outstanding on March 31,
1998. In addition, as of March 31, 1998, approximately (a) 13,651,877 shares of
Common Stock were reserved for issuance upon conversion of the Company's 3.25%
Convertible Subordinated Debentures due 2003, (b) ____________ shares of Common
Stock were reserved for issuance under the Company's Stock Option Plans, under
which options to purchase a total of _____________ shares of Common Stock were
outstanding, and (c) 980,542 shares were reserved for issuance pursuant to the
exercise of outstanding stock purchase warrants. Approximately _________ shares
were available for issuance on March 31, 1998.
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RECOMMENDATION OF THE BOARD OF DIRECTORS
The Board of Directors recommends that stockholders vote FOR the adoption
of the Amendment to the Restated Certificate of Incorporation to increase the
authorized shares of Common Stock to 600,000,000 shares of Common Stock, par
value $.01 per share. The affirmative vote of the holders of a majority of the
outstanding shares of Common Stock entitled to vote at the Annual Meeting will
be necessary for the approval of the Amendment to the Restated Certificate of
Incorporation.
1998 RESTRICTED STOCK PLAN
GENERAL
The Company's Board of Directors has adopted the 1998 Restricted Stock Plan
for the Company's executives and other key employees of the Company and its
subsidiaries. The 1998 Restricted Stock Plan is intended to advance the
Company's interests by providing such persons with additional incentives to
promote the success of the Company's business, to increase their proprietary
interest in the success of the Company and to encourage them to remain in the
Company's employ. Management believes that the 1998 Restricted Stock Plan is a
necessary tool to help the Company compete effectively with other enterprises
for the services of new employees and to retain key employees, all as may be
required for the future development of the Company's business. Management
intends for the 1998 Restricted Stock Plan to complement the stock option plans
of the Company described herein. See "Executive Compensation -- Stock Option
Plans".
It should be noted that each officer and employee of the Company has, by
reason of being eligible to receive awards under the 1998 Restricted Stock Plan,
an interest in seeing that the 1998 Restricted Stock Plan is adopted by the
stockholders.
Set forth below is a summary of the major features of the 1998 Restricted
Stock Plan. This summary does not purport to be a complete statement of all the
provisions of the 1998 Restricted Stock Plan, and is qualified in its entirety
by the text of the composite copy of the 1998 Restricted Stock Plan attached to
this Proxy Statement as Appendix A.
COMMON STOCK SUBJECT TO THE 1998 RESTRICTED STOCK PLAN
The aggregate number of shares of Common Stock covered by the 1998
Restricted Stock Plan is 3,000,000 shares. Shares issued pursuant to awards
under the 1998 Restricted Stock Plan may be either authorized but unissued
shares or shares re-acquired by the Company. If, on or prior to the termination
of the 1998 Restricted Stock Plan, an award granted thereunder expires or is
terminated for any reason without having vested in full, the unvested shares
covered thereby will again become available for the grant of awards under the
1998 Restricted Stock Plan. The maximum number of shares of Common Stock for
which any individual may be granted awards under the 1998 Restricted Stock Plan
during any calendar year is 100,000.
ADMINISTRATION OF THE 1998 RESTRICTED STOCK PLAN
The 1998 Restricted Stock Plan is administered by the Audit and
Compensation Committee of the Board of Directors (the "Committee"), each member
of which is an outside director. The Committee has full and exclusive authority
to determine the grant of awards under the 1998 Restricted Stock Plan.
Currently, Phillip C. Watkins, M.D., C. Sage Givens and George H. Strong serve
as the Committee.
AWARDS OF RESTRICTED STOCK UNDER THE 1998 RESTRICTED STOCK PLAN
Each award granted under the 1995 Plan shall be granted pursuant to and
subject to the terms and conditions of a restricted stock agreement (a
"Restricted Stock Agreement") to be entered into between the Company and the
optionholder at the time of such award. Any such Restricted Stock Agreement
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shall incorporate by reference all of the terms and provisions of the 1998
Restricted Stock Plan as in effect at the time of grant and may contain such
other terms and provisions as shall be approved and adopted by the Committee.
During a period set by the Committee of not less than one year nor more
than ten years commencing with the date of an award under the Restricted Stock
Plan (the "Restriction Period"), a participant will not be permitted to sell,
transfer, pledge, assign or otherwise dispose of the shares of Common Stock
subject to such award. Within these limits, the Committee may provide for the
vesting of awards and the lapse of such restrictions in installments based upon
the passage of time, the achievement by the Company of certain identified
performance goals, or the occurrence of other events, or any combination
thereof, all as the Committee deems appropriate. Except as otherwise provided in
the 1998 Restricted Stock Plan or a particular Restricted Stock Agreement, upon
termination of a participant's employment for any reason during the Restriction
Period, all shares awarded to such participant and still subject to restrictions
shall be forfeited by the participant and be reacquired by the Company, without
consideration or payment therefor.
In the event of a "Change in Control" (as defined), of the Company, awards
under the 1998 Restricted Stock Plan will become immediately vested in full. A
"Change in Control" is defined to include the acquisition of more than 25% of
the outstanding voting securities of the Company by a single person or group,
the election to the Board of Directors of persons constituting a majority of the
Board of Directors who are not "Incumbent Directors" (as defined), or the
approval by the stockholders of the Company of (i) a merger, reorganization or
similar transaction which results in the then-current stockholders of the
Company owning less than 75% of the combined voting power of the reorganized or
merged entity, (ii) the liquidation or dissolution of the Company, or (iii) the
sale of all or substantially all of the assets of the Company. These provisions
of the 1998 Restricted Stock Plan may have some deterrent effect on certain
mergers, tender offers or other takeover attempts, thereby having some potential
adverse effect on the market price of the Company's Common Stock. In addition,
in the event of a participant's retirement, disability or death, all
restrictions with respect to such participant's awards shall lapse; provided,
however, in the case of retirement, the Committee may determine that such
restriction shall not lapse as to all or a portion of an award or that all or
any of the shares subject to restriction shall be forfeited.
Awards granted under the 1998 Restricted Stock Plan shall be assignable or
transferable prior to vesting only by will or pursuant to the laws of descent
and distribution, except that a participant may transfer shares granted under
the Restricted Stock Plan to one or more members of such participant's immediate
family, to a partnership consisting only of such members of such participant's
immediate family, or to a trust all of the beneficiaries of which are members of
the participant's immediate family. Except as otherwise provided in the 1998
Restricted Stock Plan or a particular Restricted Stock Agreement, a participant
shall have with respect to the shares of Common Stock covered by an award all of
the rights of a stockholder of the Company, including the right to vote such
shares and receive dividends and other distributions thereon.
EXPIRATION, TERMINATION AND AMENDMENT OF THE 1998 RESTRICTED STOCK PLAN
The 1998 Restricted Stock Plan will terminate on the earliest of (a) May
20, 2008, (b) the date on which all shares of Common Stock reserved for issuance
under the 1998 Restricted Stock Plan shall have been issued and are fully vested
thereunder, or (c) such earlier time as the Board of Directors may determine.
Any award outstanding under the 1998 Restricted Stock Plan at the time of its
termination shall remain in effect in accordance with its terms and conditions
and those of the 1998 Restricted Stock Plan.
The 1998 Restricted Stock Plan may, at any time or from time to time, be
terminated, modified or amended by the stockholders of the Company by the
affirmative vote of the holders of a majority of the outstanding shares of
Common Stock entitled to vote. The Board of Directors may, insofar as permitted
by law, from time to time with respect to any shares of Common Stock at the time
not subject toawards, suspend or discontinue the 1998 Restricted Stock Plan or
revise or amend it in any respect whatsoever, except that, without approval of
the stockholders of the Company, no such revision or amendment shall
8
<PAGE>
increase the number of shares subject to the 1998 Restricted Stock Plan, extend
the period during which awards may be vested, or change the provisions relating
to adjustment to be made upon changes in capitalization. Subject to the
provisions described above, the Board of Directors has the power to amend the
1998 Restricted Stock Plan and any outstanding awards granted thereunder in such
respects as the Board of Directors shall, in its sole discretion, deem advisable
in order to incorporate in the 1998 Restricted Stock Plan or any such award any
new provision or change designed to comply with or take advantage of
requirements or provisions of the Internal Revenue Code of 1986, as amended (the
"Code"), or other statute, or rules or regulations of the Internal Revenue
Service or other federal or state governmental agency enacted or promulgated
after the adoption of the 1998 Restricted Stock Plan.
FEDERAL TAX CONSEQUENCES
Pursuant to the Code, a participant under the 1998 Restricted Stock Plan
must pay personal income taxes on an amount equal to the fair market value of
the shares subject to an award determined at the first time that such shares are
not subject to a substantial risk of forfeiture. Thus, with respect to an award
which vests in installments, a participant will normally incur taxable income
with respect to the vested portion of an award at the time when such portion
becomes vested, based upon the fair market value of such vested portion at such
time. Alternatively, such participant may, within 30 days of the date of such
award, make an election to include in his taxable income the fair market value
of the shares underlying such award at the date of grant, without taking into
account the restrictions on the award. The Company will generally be entitled to
a tax deduction in a like amount during the Company's tax year in which the
participant recognizes taxable income as a result of the award. The basis of the
participant in the shares underlying the award will be equal to the fair market
value of such shares on the date on which such participant recognizes taxable
income. A subsequent sale of such shares by the participant will result in a
long- or short-term capital gain or loss depending upon the total period of time
that such shares are held by such participant.
NEW PLAN BENEFITS
No awards have been made under the 1998 Restricted Stock Plan. The number
of shares covered by particular awards to be made under the 1998 Restricted
Stock Plan is not determinable at this time.
VOTE REQUIRED; RECOMMENDATION OF THE BOARD OF DIRECTORS
Management recommends a vote FOR the adoption of the 1998 Restricted Stock
Plan. The affirmative vote of the holders of a majority of the outstanding
shares of the Common Stock present or represented and entitled to vote at the
Annual Meeting will be necessary for stockholder approval of the 1998 Restricted
Stock Plan.
9
<PAGE>
STOCKHOLDER PROPOSAL
THE IRON WORKERS' PROPOSAL
Iron Workers' Local No. 25 Fringe Benefit Funds, 25130 Trans X Drive, Novi,
Michigan 48375-2438, claiming beneficial ownership of "over 20,000 shares" of
the Company's Common Stock through Iron Workers' Local No. 25 Pension Fund, has
submitted the proposal set forth below (the "Iron Workers' Proposal", as defined
above).
"SHAREHOLDER PROPOSAL
"The shareholders urge that the Board of Directors adopt a policy that no
board member shall serve on the Compensation Committee if he or she is not an
independent director. For these purposes, the Board shall adopt the following
definition of independence -- based on a definition adopted by the Council of
Institutional Investors -- to mean a director who:
1. has not been employed by the Company or an affiliate in an executive
capacity;
2. has not been a member of a corporation or firm that is one of the
Company's paid advisors or consultants;
3. has not been employed by a significant customer or supplier to the
Company;
4. has not had personal services contract with the Company or its
affiliates;
5. has not been employed by a foundation or university that receives
grants or endowments from the Company;
6. is not a relative of an executive of the corporation or its
affiliates;
7. has not been part of an interlocking directorate in which the CEO or
other executive officer of the Company serves on the board of another
corporation that employs the director;
8. and has not had any personal, financial and/or professional
relationships with the CEO, other executive officers, or the Company
that would interfere with the exercise of independent judgment by such
director.
"SUPPORTING STATEMENT
"The purpose of this proposal is to incorporate within the Audit and
Compensation Committee a standard of independence that will permit objective
decision making on compensation issues at HEALTHSOUTH. While HEALTHSOUTH does
require that directors meet a minimal standard of independence to serve on the
committee, this standard is not sufficient to ensure that a director is free of
relationships that could diminish his or her independent judgment. Currently,
there are two directors on the Committee with conflict of interest issues.
"According to real estate assessment records in Monroe County, Florida, Dr.
Phillip Watkins and CEO Richard Scrushy jointly own property in Key Colony
Beach, a resort area in the Florida Keys. The property was purchased in June
1994 by Dr. Watkins and Mr. Scrushy for approximately $400,000. Dr. Watkins also
owns a yacht registered in Key Colony Beach.
"HEALTHSOUTH has arranged a credit agreement with Nationsbank allowing the
company to invest up to $5 Million in Acacia Venture Partners, a private venture
capital fund. C. Sage Givens is a founder and the managing general partner of
Acacia Venture Partners.
"Additionally, Givens' firm recently invested $4 Million in Managed Care
USA, a company specializing in managing worker's compensation claims. As
reported in the Charlotte Business Journal, Ms. Givens helped to secure a
national contract between Managed Care USA and HEALTHSOUTH through her position
on the Board.
10
<PAGE>
"Shareholders are best served if Committee members are truly independent.
This is especially important considering the large compensation packages awarded
to executive officers of HEALTHSOUTH. Richard Scrushy, earning over $22 Million
in 1996, is among the top overpaid CEO's in the nation according to Graef
Crystal, a leading executive compensation expert."
RESPONSE OF THE BOARD OF DIRECTORS
The Board of Directors recommends a vote AGAINST the Iron Worker's
Proposal, for the reasons set forth below.
The Company's Board of Directors agrees that decisions concerning the
compensation of executive officers should be made by a committee of independent
directors. The Board believes that each of the members of the Audit and
Compensation Committee is, in fact, independent, and a valuable member of the
Committee. The Board further believes that the arbitrary standard suggested by
the proposal is unworkable when applied to a large, national business such as
that of the Company and would in fact deprive the Committee of expert
independent judgment and substantial institutional knowledge of the Company and
its business.
The current members of the Committee have all been directors of the Company
since prior to its initial public offering in 1986, and (with the exception of
Ms. Givens, who was named to the Committee in 1989) have served on the Committee
for more than 10 years. Each member of the Committee meets the definition of
independence adopted by the New York Stock Exchange, which excludes any director
who has "any relationship that, in the opinion of the Board of Directors, would
interfere with the exercise of independent judgment. Further, each member meets
the more stringent test of being an "outside director" under the regulations
promulgated under Section 162(m) of the Internal Revenue Code of 1986, as
amended (which regulations provide, among other things, that an outside director
cannot be a current employee, a former employee receiving compensation for prior
services (subject to certain exceptions), a current or former officer of the
corporation, or a person who receives (or is entitled to receive) remuneration
from the corporation in any capacity other than as a director).
The Board of Directors believes that the arbitrary requirements proposed
under the Iron Workers' Proposal are unnecessary and inappropriate in that,
unlike the standards imposed by the New York Stock Exchange and the Internal
Revenue Code, such requirements would, for example, presume that a director was
not independent because that director was an employee of a company that engaged
in arm's-length commercial transactions with the Company in the ordinary course
of business, or of a foundation or university that received grants or endowments
from the Company. The Company operates in all 50 states, the United Kingdom and
Australia, and as a consequence has customer or supplier relationships with a
wide range of other companies around the world which may or may not meet the
undefined and subjective standard of being "significant." Likewise, as part of
its policy of corporate stewardship, the Company provides support to a number of
charitable foundations and educational institutions around the country. The
arbitrary requirements contained in the Iron Workers' Proposal would, without
further inquiry into the substantive independence of the directors,
automatically bar any employees of such companies, foundations and institutions
from serving on the Committee, potentially depriving the Committee of
knowledgeable and experienced insight into the matters facing it.
With respect to the current members of the Committee, the Board of
Directors takes strong issue with the suggestion that any of them lack
independence. The Board certainly does not believe that the former joint
ownership of vacation property by Dr. Watkins and Mr. Scrushy (which joint
ownership was terminated in 1997) has in any way influenced Dr. Watkins's
judgment, nor does the Board understand the significance of the statement
concerning Dr. Watkins's yacht. The Company, along with numerous pension funds,
university endowments and other institutional investors, has made an investment
in Acacia Venture Partners, and such investment is one of many permitted under
the Company's principal credit agreement. Such investment is not material to the
Company. In addition, the Board does not understand why the proponents
apparently find it troublesome that Ms. Givens has utilized her role to assist
the Company in obtaining a potentially valuable managed care contract for the
Company.
The Board of Directors believes that the existing standards for
independence of the Audit and Compensation Committee are consistent with
industry standards and with the best interests of the Company's stockholders,
and that the requirements set forth in the Iron Workers' Proposal would
11
<PAGE>
impose arbitrary and unnecessary limitations that could deprive the Company and
its stockholders of valuable present and future members of the Committee. The
Board further notes that the existing members of the Committee bring a wealth of
knowledge about the Company and the healthcare industry to bear on the
Committee's decisions, and that the compensation plans developed and implemented
by the Committee have enabled the Company to attract and retain a management
team that has led the Company to become the only healthcare services provider to
operate facilities in all 50 states, to a record of 46 consecutive quarters of
meeting or exceeding analysts' expectations, to become part of the S&P 500 only
13 years from inception, and to become the nation's largest provider of
outpatient surgery and rehabilitative healthcare services. The Board believes
that its existing policies with respect to the Audit and Compensation Committee
have served the Company and its stockholders well, and that the Iron Workers'
Proposal is unnecessary and inadvisable.
VOTE REQUIRED; RECOMMENDATION OF THE BOARD OF DIRECTORS
The Board of Directors recommends a vote AGAINST the Iron Workers'
Proposal. The affirmative vote of the holders of a majority of the outstanding
shares of the Common Stock present or represented and entitled to vote at the
Annual Meeting will be necessary for stockholder approval of the Iron Workers'
Proposal.
12
<PAGE>
EXECUTIVE COMPENSATION AND OTHER INFORMATION
EXECUTIVE COMPENSATION -- GENERAL
The following table sets forth compensation paid or awarded to the Chief
Executive Officer and each of the other four most highly compensated executive
officers of the Company (the "Named Executive Officers") for all services
rendered to the Company and its subsidiaries in 1995, 1996 and 1997.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION LONG-TERM COMPENSATION
-------------------------------------- -------------------------
BONUS/ANNUAL STOCK LONG-TERM ALL
INCENTIVE OPTION INCENTIVE OTHER COM-
NAME AND PRINCIPAL POSITION YEAR SALARY AWARD AWARDS PAYOUTS PENSATION(1)
- - -------------------------------- ------ ------------- ------------- ----------- ----------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Richard M. Scrushy 1995 $1,748,646 $ 5,000,000 2,000,000 -- $ 650,108
Chairman of the Board 1996 3,391,775 8,000,000 1,500,000 -- 34,286(2)
and Chief Executive Officer(3) 1997 3,398,999 10,000,000 1,300,000 -- 21,430
James P. Bennett 1995 382,528 600,000 300,000 -- 7,985
President and Chief 1996 496,590 800,000 200,000 -- 32,106(2)
Operating Officer 1997 639,161 1,500,000 700,000 -- 10,158
Michael D. Martin 1995 176,746 500,000 170,000 -- 7,919
Executive Vice President, 1996 281,644 750,000 120,000 -- 31,586(2)
Chief Financial Officer 1997 359,672 2,000,000 450,000 -- 9,700
and Treasurer
P. Daryl Brown 1995 274,582 310,000 260,000 -- 8,580
President -- HEALTHSOUTH 1996 335,825 400,000 100,000 -- 11,181
Outpatient Centers 1997 370,673 450,000 250,000 -- 10,737
Anthony J. Tanner 1995 249,438 300,000 200,000 -- 8,728
Executive Vice President -- 1996 298,078 350,000 100,000 -- 7,763
Administration and Secretary 1997 371,114 450,000 450,000 -- 9,817
</TABLE>
- - ----------
(1) Includes car allowances of $500 per month for Mr. Scrushy and $350 per month
for the other Named Executive Officers. Also includes (a) matching
contributions under the Company's Retirement Investment Plan for 1995, 1996
and 1997, respectively, of: $292, $708 and $791 to Mr. Scrushy; $900, $1,425
and $1,425 to Mr. Bennett; $900, $1,371 and $1,324 to Mr. Martin; $900,
$1,897 and $1,319 to Mr. Brown; and $2,044, $1,290 and $1,215 to Mr. Tanner;
(b) awards under the Company's Employee Stock Benefit Plan for 1995, 1996
and 1997, respectively, of $1,626, $3,389 and $2,889 to Mr. Scrushy; $1,626,
$3,387 and $2,889 to Mr. Bennett; $1,626, $3,386 and $2,889 to Mr. Martin;
$1,626, $3,389 and $2,889 to Mr. Brown; and $509, $1,276 and $2,889 to Mr.
Tanner; and (c) split-dollar life insurance premiums paid in 1995, 1995 and
1997 of $2,190, $2,312 and $11,750 with respect to Mr. Scrushy; $1,109,
$1,217 and $1,644 with respect to Mr. Bennett; $1,193, $752 and $1,287 with
respect to Mr. Martin; $1,854, $1,695 and $2,329 with respect to Mr. Brown;
and $1,975, $997 and $1,513 to Mr. Tanner. See "Executive Compensation and
Other Information -- Retirement Investment Plan" and "Executive Compensation
and Other Information -- Employee Stock Benefit Plan".
(2) In addition to the amounts described in the preceding footnote, includes the
conveyance of real property valued at $640,000 to Mr. Scrushy in 1995, and
the forgiveness of loans in the amount of $21,877 each owed by Messrs.
Scrushy, Bennett and Martin in 1996.
(3) Salary amounts for Mr. Scrushy include monthly incentive compensation
amounts payable upon achievement of certain budget targets. See "Executive
Compensation and Other Information -- Audit and Compensation Committee
Report on Executive Compensation -- Chief Executive Officer Compensation".
13
<PAGE>
STOCK OPTION GRANTS IN 1997
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
---------------------------------------------------------
% OF TOTAL
OPTIONS
NUMBER OF GRANTED TO EXERCISE
OPTIONS EMPLOYEES IN PRICE EXPIRATION GRANT DATE
NAME GRANTED FISCAL YEAR PER SHARE DATE PRESENT VALUE (1)
- - ---------------------------- ----------- -------------- ----------- ------------ ------------------
<S> <C> <C> <C> <C> <C>
Richard M. Scrushy ......... 600,000 8.9% $ 20.125 2/29/07 $ 6,690,000
700,000 10.47% 23.625 8/14/07 9,163,000
James P. Bennett ........... 350,000 5.2% 20.125 2/28/07 3,902,500
350,000 5.2% 23.625 8/14/07 4,581,500
Michael D. Martin .......... 150,000 2.2% 20.125 2/28/07 1,672,500
300,000 4.5% 23.625 8/14/07 3,927,000
P. Daryl Brown ............. 100,000 1.5% 20.125 2/28/07 1,115,000
150,000 2.2% 23.625 8/14/07 1,963,500
Anthony J. Tanner .......... 150,000 2.2% 20.125 2/28/07 1,672,500
300,000 4.5% 23.625 8/14/07 3,927,000
</TABLE>
- - ----------
(1) Based on the Black-Scholes option pricing model adapted for use in valuing
executive stock options. The actual value, if any, an executive may realize
will depend upon the excess of the stock price over the exercise price on
the date the option is exercised, so that there is no assurance that the
value realized by an executive will be at or near the value estimated by the
Black-Scholes model. The estimated values under that model are based on
arbitrary assumptions as to certain variables, including the following: (i)
stock price volatility is assumed to be 38%; (ii) the risk-free rate of
return is assumed to be 5.69%; (iii) dividend yield is assumed to be 0; and
(iv) the time of exercise is assumed to be 8.4 years from the date of grant.
STOCK OPTION EXERCISES IN 1997 AND OPTION VALUES AT DECEMBER 31, 1997
<TABLE>
<CAPTION>
NUMBER VALUE OF UNEXERCISED
OF SHARES NUMBER OF UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS
ACQUIRED AT DECEMBER 31, 1997 (1) AT DECEMBER 31, 1997 (2)
ON VALUE ------------------------------- --------------------------------
NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- - ---------------------------- ----------- -------------- ------------- --------------- --------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Richard M. Scrushy ......... 4,000,000 $93,384,947 11,172,524 -- $216,170,768 --
James P. Bennett ........... 250,000 5,369,011 1,310,000 -- 14,730,175 --
Michael D. Martin. ......... 123,000 2,050,069 570,000 60,000 3,757,500 $1,162,500
P. Daryl Brown ............. 147,000 2,882,846 1,038,000 -- 18,262,098 --
Anthony J. Tanner .......... 270,000 6,198,039 940,000 -- 11,960,075 --
</TABLE>
- - ----------
(1) Does not reflect any options granted and/or exercised after December 31,
1997. The net effect of any such grants and exercises is reflected in the
table appearing under "Principal Stockholders".
(2) Represents the difference between market price of the Company's Common Stock
and the respective exercise prices of the options at December 31, 1997. Such
amounts may not necessarily be realized. Actual values which may be
realized, if any, upon any exercise of such options will be based on the
market price of the Common Stock at the time of any such exercise and thus
are dependent upon future performance of the Common Stock.
14
<PAGE>
STOCKHOLDER RETURN COMPARISON (1)
Set forth below is a line graph comparing the total returns of the
Company's Common Stock, the Standard & Poor's 500 (S&P 500) Index and a peer
group index ("Rehab Index") compiled by the Company, consisting of Tenet
Healthcare Corporation and NovaCare, Inc., publicly-traded healthcare companies
whose businesses are similar in some respects to that of the Company. The graph
assumes $100 invested on December 31, 1992, in HEALTHSOUTH Common Stock and each
of the indices. The Rehab Index has been weighted for market capitalization, and
the Company assumes reinvestment of dividends for purposes of the graph.
[INSERT GRAPH]
<TABLE>
<CAPTION>
DECEMBER 31 HEALTHSOUTH S&P 500 REHAB INDEX
- - ------------- ------------- --------- ------------
<S> <C> <C> <C>
1992 100 100 100
1993 96 110 98
1994 138 111 92
1995 221 153 147
1996 293 188 172
1997 421 252 254
</TABLE>
- - ----------
(1) In previous proxy statements of the Company, the Rehab Index included
Continental Medical Systems, Inc. ("CMS"). In May 1995, CMS was acquired by
Horizon Healthcare Corporation, which was the surviving corporation in the
merger. Because CMS was not publicly traded during all of 1995 or
thereafter, data relating to CMS has been deleted from the Rehab Index for
all periods.
STOCK OPTION PLANS
Set forth below is information concerning the various stock option plans of
the Company at December 31, 1997. All share numbers and exercise prices have
been adjusted to reflect the Company's March 1997 two-for-one stock split.
1984 Incentive Stock Option Plan
The Company had a 1984 Incentive Stock Option Plan (the "ISO Plan"),
intended to qualify under Section 422(b) of the Internal Revenue Code of 1986,
as amended (the "Code"), covering an aggregate of 4,800,000 shares of Common
Stock. The ISO Plan expired on February 28, 1994, in accordance with its terms.
As of December 31, 1997, there were outstanding under the ISO Plan options to
purchase 19,702 shares of the Company's Common Stock at prices ranging from
$2.52 to $3.7825 per share. All such options remain in full force and effect in
accordance with their terms and the ISO Plan. Under the ISO Plan, which was
administered by the Board of Directors, key employees could be granted options
to purchase shares of Common Stock at 100% of fair market value on the date of
grant (or 110% of fair market value in the case of a 10% stockholder/ grantee).
The outstanding options granted under the ISO Plan must be exercised within ten
years from the date of grant, are cumulatively exercisable with respect to 25%
of the shares covered thereby after the expiration of each of the first through
the fourth years following the date of grant, are nontransferable except by will
or pursuant to the laws of descent and distribution, are protected against
dilution and expire within three months after termination of employment, unless
such termination is by reason of death.
15
<PAGE>
1988 Non-Qualified Stock Option Plan
The Company also has a 1988 Non-Qualified Stock Option Plan (the "NQSO
Plan") covering a maximum of 4,800,000 shares of Common Stock. As of December
31, 1997, there were outstanding under the NQSO Plan options to purchase 57,300
shares of the Company's Common Stock at prices ranging from $8.375 to $16.25 per
share. The NQSO Plan, which is administered by the Audit and Compensation
Committee of the Board of Directors, provides that Directors, executive officers
and other key employees may be granted options to purchase shares of Common
Stock at 100% of fair market value on the date of grant. The NQSO Plan expires
on February 28, 1998. Options granted pursuant to the NQSO Plan have a ten-year
term are exercisable at any time during such period, are nontransferable except
by will or pursuant to the laws of descent and distribution, are protected
against dilution and expire within three months of termination of association
with the Company as a Director or termination of employment, unless such
termination is by reason of death.
1989, 1990, 1991, 1992, 1993, 1995 and 1997 Stock Option Plans
The Company also has a 1989 Stock Option Plan (the "1989 Plan"), a 1990
Stock Option Plan (the "1990 Plan"), a 1991 Stock Option Plan (the "1991 Plan"),
a 1992 Stock Option Plan (the "1992 Plan"), a 1993 Stock Option Plan (the "1993
Plan"), a 1995 Stock Option Plan (the "1995 Plan") and a 1997 Stock Option Plan
(the "1997 Plan"), under each of which incentive stock options ("ISOs") and
non-qualified stock options ("NQSOs") may be granted. The 1989, 1990, 1991,
1992, 1993 and 1995 Plans cover a maximum of 2,400,000 shares, 3,600,000 shares,
11,200,000 shares, 5,600,000 shares, 5,600,000 shares, 15,134,463 (to be
increased by 0.9% of the outstanding Common Stock of the Company on each January
1, beginning January 1, 1996) shares and 5,000,000 shares, respectively, of the
Company's Common Stock. As of December 31, 1997, there were outstanding options
to purchase an aggregate of 27,213,453 shares of the Company's Common Stock
under such Plans at exercise prices ranging from $2.52 to $23.625 per share. An
additional 4,783,021 shares were reserved for future grants under such Plans.
Each of the 1989, 1990, 1991, 1992, 1993, 1995 and 1997 Plans is administered in
the same manner as the NQSO Plan and provides that Directors, executive officers
and other key employees may be granted options to purchase shares of Common
Stock at 100% of fair market value on the date of grant. The 1989, 1990, 1991,
1992, 1993, 1995 and 1997 Plans terminate on the earliest of (a) October 25,
1999, October 15, 2000, June 19, 2001, June 16, 2002, April 19, 2003, June 5,
2005 and April 30, 2007, respectively, (b) such time as all shares of Common
Stock reserved for issuance under the respective Plan have been acquired through
the exercise of options granted thereunder, or (c) such earlier times as the
Board of Directors of the Company may determine. Options granted under these
Plans which are designated as ISOs contain vesting provisions similar to those
contained in options granted under the ISO Plan and have a ten-year term. NQSOs
granted under these Plans have a ten-year term. Options granted under these
Plans are nontransferable except by will or pursuant to the laws of descent and
distribution (except for certain permitted transfers to family members or
charities), are protected against dilution and will expire within three months
of termination of association with the Company as a Director or termination of
employment, unless such termination is by reason of death.
1993 Consultants' Stock Option Plan
The Company also has a 1993 Consultants' Stock Option Plan (the "1993
Consultants' Plan"), under which NQSOs may be granted, covering a maximum of
3,500,000 shares of Common Stock. As of December 31, 1997, there were
outstanding under the 1993 Consultants' Plan options to purchase 1,509,750
shares of Common Stock at prices ranging from $3.375 to $23.625 per share. An
additional 440,000 shares were reserved for grants under such Plans. The 1993
Consultants' Plan, which is administered by the Board of Directors, provides
that certain non-employee consultants who provide significant services to the
Company may be granted options to purchase shares of Common Stock at such prices
as are determined by the Board of Directors or the appropriate committee. The
1993 Consultants' Plan terminates on the earliest of (a) February 25, 2003, (b)
such time as all shares of Common Stock reserved for issuance under the 1993
Consultants' Plan have been acquired through the exercise of options granted
thereunder, or (c) such earlier time as the Board of Directors of the Company
may determine. Options granted under the 1993 Consultants' Plan have a ten-year
term. Options granted
16
<PAGE>
under the 1993 Consultants' Plan are nontransferable except by will or pursuant
to the laws of descent and distribution, are protected against dilution and
expire within three months of termination of association with the Company as a
consultant, unless such termination is by reason of death.
Other Stock Option Plans
In connection with various major acquisitions, the Company assumed certain
existing stock option plans of the acquired companies, and outstanding options
to purchase stock of the acquired companies under such plans were converted into
options to acquire Common Stock of the Company in accordance with the exchange
ratios applicable to such mergers. At December 31, 1997, there were outstanding
under these assumed plans options to purchase 3,896,820 shares of the Company's
Common Stock at exercise prices ranging from $1.6363 to $53.8192 per share. No
additional options are being granted under any such assumed plans.
RETIREMENT INVESTMENT PLAN
Effective January 1, 1990, the Company adopted the HEALTHSOUTH Retirement
Investment Plan (the "401(k) Plan"), a retirement plan intended to qualify under
Section 401(k) of the Internal Revenue Code of 1986, as amended. The 401(k) Plan
is open to all full-time and part-time employees of the Company who are over the
age of 21, have one full year of service with the Company and have at least
1,000 hours of service in the year in which they enter the 401(k) Plan. Eligible
employees may elect to participate in the Plan on January 1 and July 1 in each
year.
Under the 401(k) Plan, participants may elect to defer up to 20% of their
annual compensation (subject to nondiscrimination rules under the Internal
Revenue Code). The deferred amounts may be invested among four options, at the
participant's direction: a money market fund, a bond fund, a guaranteed
insurance contract or an equity fund. The Company will match a minimum of 10% of
the amount deferred by each participant, up to 4% of such participant's total
compensation, with the matched amount also directed by the participant.
Michael D. Martin, Executive Vice President, Chief Financial Officer and
Treasurer of the Company, and Anthony J. Tanner, Executive Vice President --
Administration and Secretary of the Company, serve as Trustees of the 401(k)
Plan, which is administered by the Company.
EMPLOYEE STOCK BENEFIT PLAN
Effective January 1, 1991, the Company adopted the HEALTHSOUTH
Rehabilitation Corporation and Subsidiaries Employee Stock Benefit Plan (the
"ESOP"), a retirement plan intended to qualify under sections 401(a) and
4975(e)(7) of the Internal Revenue Code of 1986, as amended. The ESOP is open to
all full-time and part-time employees of the Company who are over the age of 21,
have one full year of service with the Company and have at least 1,000 hours of
service in the year in which they begin participation in the ESOP on the next
January 1 or July 1 after the date on which such employee satisfies the
aforementioned conditions.
The ESOP was established with a $10,000,000 loan from the Company, the
proceeds of which were used to purchase 1,655,172 shares of the Company's Common
Stock. In 1992, an additional $10,000,000 loan was made to the ESOP, which was
used to purchase an additional 1,666,664 shares of Common Stock. Under the ESOP,
a Company Common Stock account (a "company stock account") is established and
maintained for each eligible employee who participates in the ESOP. In each plan
year, such account is credited with such employee's allocable share of the
Common Stock held by the ESOP and allocated with respect to such plan year. Each
employee's allocable share for any given plan year is determined according to
the ratio which such employee's compensation for such plan year bears to the
compensation of all eligible participating employees for the same plan year.
Under the ESOP, eligible employees who participate in the ESOP and who have
attained age 55 and have completed 10 years of participation in the ESOP may
elect to diversify the assets in their company stock account by directing the
plan administrator to transfer to the 401(k) Plan a portion of their company
stock account to be invested, as the eligible employee directs, in one or more
of the investment options available under the 401(k) Plan.
17
<PAGE>
Richard M. Scrushy, Chairman of the Board and Chief Executive Officer of
the Company, Michael D. Martin, Executive Vice President, Chief Financial
Officer and Treasurer of the Company, and Anthony J. Tanner, Executive Vice
President -- Administration and Secretary of the Company, serve as Trustees of
the ESOP, which is administered by the Company.
STOCK PURCHASE PLAN
In order to further encourage employees to obtain equity ownership in the
Company, the Company's Board of Directors adopted an Employee Stock Purchase
Plan (the "Stock Purchase Plan") effective January 1, 1994. Under the Stock
Purchase Plan, participating employees may contribute $10 to $200 per pay period
toward the purchase of the Company's Common Stock in open-market transactions.
The Stock Purchase Plan is open to regular full-time or part-time employees who
have been employed for six months and are at least 21 years old. After six
months of participation in the Stock Purchase Plan, the Company will provide a
10% matching contribution to be applied to purchases under the Stock Purchase
Plan. The Company also pays all fees and brokerage commissions associated with
the purchase of the stock. The Stock Purchase Plan is administered by a
broker-dealer firm not affiliated with the Company.
DEFERRED COMPENSATION PLAN
In 1997, the Board of Directors adopted an Executive Deferred Compensation
Plan (the "Deferred Compensation Plan"), which allows senior management
personnel to elect, on an annual basis, to defer receipt of up to 50% of their
base salary and up to 100% of their annual bonus, if any (but not less than an
aggregate of $2,400 per year) for a minimum of five years from the date such
compensation would otherwise have been received. Amounts deferred are held by
the Company pursuant to a "rabbi trust" arrangement, and amounts deferred are
credited with earnings at an annual rate equal to the Moody's Average Corporate
Bond Yield Index (the "Moody's Rate"), as adjusted from time to time, or the
Moody's Rate plus 2% if a participant's employment is terminated by reason of
retirement, disability or death or within 24 months of a change in control of
the Company. Amounts deferred may be withdrawn upon retirement, termination of
employment or death, upon a showing of financial hardship, or voluntarily with
certain penalties. The Deferred Compensation Plan is administered by an
Administrative Committee, currently consisting of Michael D. Martin, Executive
Vice President, Chief Financial Officer and Treasurer of the Company, and
Anthony J. Tanner, Executive Vice President -- Administration and Secretary of
the Company.
BOARD COMPENSATION
Directors who are not also employed by the Company are paid Directors' fees
of $10,000 per annum, plus $3,000 for each meeting of the Board of Directors and
$1,000 for each Committee meeting attended. In addition, Directors are
reimbursed for all out-of-pocket expenses incurred in connection with their
duties as Directors. The Directors of the Company, including Mr. Scrushy, have
been granted non-qualified stock options to purchase shares of the Company's
Common Stock. Under the Company's existing stock option plans, each non-employee
Director is granted an option covering 25,000 shares of such Common Stock on the
first business day in January of each year. See "Executive Compensation and
Other Information -- Stock Option Plans" above.
AUDIT AND COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
General
The Board of Directors of the Company has an Audit and Compensation
Committee (the "Committee"), consisting of Ms. Givens, Mr. Strong and Dr.
Watkins. The Committee is charged by the Board of Directors with establishing a
compensation plan which will enable the Company to compete effectively for the
services of qualified officers and key employees, to give such employees
appropriate incentive to pursue the maximization of long-term stockholder value,
and to recognize such employees' success in achieving both qualitative and
quantitative goals for the benefit of the Company. The Committee makes
recommendations to the full Board of Directors as to appropriate levels of
compensation for specific individuals, as well as compensation and benefit
programs for the Company as a whole.
18
<PAGE>
Compensation Philosophy and Policies for Executive Officers
As its first principle, the Committee believes that executives of the
Company should be rewarded based upon their success in meeting the Company's
operational goals, improving its earnings, maintaining its leadership role in
the outpatient surgery and rehabilitative healthcare services fields, and
generating returns for its stockholders, and the Committee strives to establish
levels of compensation that take such factors into account and provide
appropriate recognition for past achievement and incentive for future success.
The Committee recognizes that the demand for executives with expertise and
experience in the outpatient surgery and rehabilitative healthcare services
fields is intense. In order to attract and retain qualified persons, the
Committee believes that the Company must offer current compensation at levels
consistent with those of other publicly-traded healthcare companies. In
addition, the Committee believes that it is in the best interests of the
Company's stockholders to offer its executives meaningful equity participation
in the Company, in order that those executives' interests will be aligned with
those of the Company's stockholders. The Committee feels that the historic mix
of cash compensation and equity participation has proven to be effective in
stimulating the Company's executives to meet both long-term and short-term goals
and has been a major factor in limiting turnover among senior executives.
The Company's compensation program has three distinct elements: base
salary; incentive compensation, including both cash incentive compensation and
equity-based compensation; and retirement compensation. These elements are
discussed below.
Base Salary: While the demand for experienced managers in the healthcare
industry continues to grow, the Company has been very successful in attracting
and retaining key executives, many of whom have been with the Company since its
early days. The Company believes that its compensation package is instrumental
in such success. The Committee endeavors to establish base salary levels for
those key executives which are consistent with those provided for similarly
situated executives of other publicly-traded healthcare companies, taking into
account each executive's areas and level of responsibility, historical
performance and tenure with the Company. In establishing such levels, the
Company considers compensation for executives of other publicly-traded providers
of healthcare services, such as Columbia/ HCA Healthcare Corporation and Tenet
Healthcare Corporation, as well as other publicly-traded companies of similar
size and with a similar growth rate. Compensation decisions are not targeted to
specific levels in the range of compensation paid by such companies, nor does
the Company maintain a record of where its compensation stands with respect to
such other companies. However, the Committee and the Board of Directors take
such levels of compensation into account in determining appropriate levels of
compensation for the Company's executives.
Incentive Compensation: In addition to base salary, the Committee
recommends to the Board of Directors cash incentive compensation for executives
of the Company, based upon each such executive's success in meeting qualitative
and quantitative performance goals on an annual basis. The total incentive bonus
pool available for the Company's executives and management personnel is capped
at the lesser of (a) the amount by which the Company's annual net income exceeds
the budgeted annual net income established by the Board of Directors and (b) 10%
of the Company's annual net income. No bonuses are payable unless annual net
income exceeds budgeted net income. Individual incentive bonuses within such
bonus pool are not determined in a formulary manner, but are determined on a
basis that takes into account each executive's success in achieving standards of
performance, which may or may not be quantitative, established by the Board of
Directors and such executive's superiors. Bonus determinations are made on a
case-by-case basis, taking into account appropriate quantitative and qualitative
factors, and there is no fixed relationship between any particular performance
factor and the amount of a given executive's bonus. Historically, incentive
compensation has been a major component of the Company's executive compensation,
and the Committee believes that placing executives at risk for such a component
has been effective in motivating such executives to achieve such goals.
In 1994, the Committee initially engaged William M. Mercer, Inc. ("Mercer")
as a consultant to perform a study of the Company's executive compensation
programs. The 1994 Mercer report concluded that the Company's compensation mix
was significantly more highly-leveraged, at risk and performance--
19
<PAGE>
focused than other companies selected by Mercer for comparison, with 41% of the
Company's cash compensation for executive officers being at-risk,
performance-based compensation, compared to 29% for the other companies reviewed
by Mercer.
In addition to cash incentive compensation, as a growth company, the
Company has always utilized equity-based compensation, in the form of stock
options, as a tool to encourage its executives to work to meet its operational
goals and maximize long-term stockholder value. Because the value of stock
options granted to an executive is directly related to the Company's success in
enhancing its market value over time, the Committee feels that its stock option
programs have been very effective in aligning the interests of management and
stockholders.
The Committee determines stock option grants under the Company's various
stock option plans, all of which are described above under "Executive
Compensation and Other Information -- Stock Option Plans". Specific grants are
determined taking into account an executive's current responsibilities and
historical performance, as well as the executive's perceived contribution to the
Company's results of operations. Options are also used to give incentive to
newly-promoted officers at the time that they are asked to assume greater
responsibilities, and, in some cases, to executives who have joined the Company
through acquisitions and have assumed significant leadership roles within the
Company. In evaluating option grants, the Board of Directors considers prior
grants and shares currently held, as well as the recipient's success in meeting
operational goals and the recipient's level of responsibility. However, no fixed
formula is utilized to determine particular grants. The Committee believes that
the opportunity to acquire a significant equity interest in the Company has been
a strong motivation for the Company's executives to pursue the long-term
interests of the Company and its stockholders, and has promoted longevity and
retention of key executives. Information relating to stock options granted to
the five most highly-compensated executive officers of the Company is set forth
elsewhere in this Proxy Statement.
In connection with the Company's use of stock options as a significant
component of compensation, the 1994 Mercer study referred to above indicated
that most companies in Mercer's long-term incentive survey utilized two
long-term incentive plans, while the Company used stock options as its only
long-term incentive plan. The 1994 Mercer study noted that the Company's use of
stock options was very consistent with the practices of high-growth companies
that wished to increase the ownership stake of executives in the company and to
conserve cash by using stock rather than cash in long-term plans.
Retirement Compensation: As described under "Executive Compensation and
Other Information -- Retirement Investment Plan", in 1991 the Company adopted a
401(k) retirement plan in order to give all full-time employees an opportunity
to provide for their retirement on a tax-advantaged basis. In order to further
tie employees' interests to the long-term market value of the Company, the
Company adopted an Employee Stock Benefit Plan (the "ESOP") in 1991, which gives
all full-time employees an opportunity to invest a portion of their retirement
funds in Common Stock of the Company on a tax-advantaged basis. The Committee
believes that the ESOP provides additional incentive to executives to maximize
stockholder value over the long term. See "Executive Compensation and Other
Information -- Employee Stock Benefit Plan". Additionally, in 1997, the Company
adopted a Deferred Compensation Plan, which gives senior management employees
the opportunity to elect to defer receipt of a portion of their salary and bonus
in exchange for a variable rate of interest on the amounts so deferred. See
"Executive Compensation and Other Information -- Deferred Compensation Plan".
Chief Executive Officer Compensation
The Company is a party to an Employment Agreement with Richard M. Scrushy,
pursuant to which Mr. Scrushy, a management founder of the Company, is employed
as Chairman of the Board and Chief Executive Officer of the Company for a
five-year term which currently ends December 31, 2002. Such term is
automatically extended for an additional year on December 31 of each year. In
addition, the Company has agreed to use its best efforts to cause Mr. Scrushy to
be elected as a Director of the Company during the term of the Agreement. Under
the Agreement, Mr. Scrushy received a base salary of $999,000, excluding
incentive compensation of up to $2,400,000, in 1997 and is to receive the same
base salary in 1998 and each year thereafter, with incentive compensation of up
to $2,400,000, subject to annual review by the Board of Directors, and is
entitled to participate in any bonus plan approved by the Board of Directors for
the
20
<PAGE>
Company's management. The incentive compensation was earned at $200,000 per
month in 1997 and is to be earned at $200,000 per month in 1998 and thereafter,
contingent upon the Company's success in meeting certain monthly budgeted
earnings per share targets. Mr. Scrushy earned the entire $2,400,000 incentive
component of his compensation in 1997, as all such targets were met. In
addition, Mr. Scrushy was awarded $10,000,000 under the management bonus plan.
Such additional bonus was based on the Committee's assessment of Mr. Scrushy's
contribution to the establishment of the Company as the industry leader in
outpatient surgery and rehabilitative healthcare services, including his role in
the negotiation and consummation of the acquisitions of Health Images, Inc.,
Horizon/CMS Healthcare Corporation and ASC Network Corporation, as well as his
role in completing the divestiture of the Horizon/CMS non-strategic assets
within two months of consummation of the Horizon/CMS acquisition, as well as the
Company's success in achieving annual budgeted net income targets and other
factors described below. Mr. Scrushy is also provided with a car allowance in
the amount of $500 per month and with disability insurance. Under the Agreement,
Mr. Scrushy's employment may be terminated for cause or if he should become
disabled. Termination of Mr. Scrushy's employment under the Agreement will
result in certain severance pay arrangements. In the event that the Company were
to be acquired, merged or reorganized in such a manner as to result in a change
of control of the Company, Mr. Scrushy has the right to terminate his employment
under the Agreement, in which case he will receive a lump sum payment equal to
three years' annual base salary (including the gross incentive portion thereof)
under the Agreement. Mr. Scrushy has agreed not to compete with the Company
during any period to which any such severance pay relates. Mr. Scrushy may
terminate the Agreement at any time upon 180 days' notice, in which case he will
receive one year's base salary as severance pay.
The Committee reports to the Board of Directors on compensation
arrangements with Mr. Scrushy, and recommends to the Board of Directors the
level of incentive compensation, both cash and equity-based, which is
appropriate for Mr. Scrushy with respect to each fiscal year of the Company. In
making such recommendation, the Committee takes into account the Company's
performance in the marketplace, its success in meeting strategic goals and its
success in meeting monthly and annual budgets established by the Board of
Directors. Again, ultimate compensation decisions are not made in a formulary
manner, but in a manner which takes into account the Company's competitive
position, its position in the financial markets, and the significant
contributions made by Mr. Scrushy to the success of the Company. In making its
decisions with respect to Mr. Scrushy's compensation, the Committee believes
that it is appropriate to recognize that, as a management founder of the
Company, Mr. Scrushy has played an instrumental role in establishing the Company
as the industry leader in outpatient surgery and rehabilitative healthcare
services and that, under his leadership, the Company has significantly enhanced
stockholder value over a period of years and continues to grow in assets, net
revenues, net income and market value.
In 1997, the Committee asked Mercer to review certain information in
connection with the Committee's evaluation of Mr. Scrushy's performance and the
Company's compensation arrangements with Mr. Scrushy. In that connection, Mercer
reviewed the Company's rankings on 14 performance measures for the fiscal year
1996 and the twelve-month period ending September 30, 1997 against three
comparison groups: (a) 1,160 companies with 1996 revenues between $1,000,000,000
and $10,000,000,000, (b) 33 publicly-held healthcare companies with 1996
revenues over $1,000,000,000, and (c) 62 companies from The Wall Street Journal
350 Study of CEO Compensation with 1996 revenues between $2,000,000,000 and
$8,000,000,000 and 1996 market capitalizations between $4,000,000,000 and
$8,000,000,000. Mercer determined that the Company performed above the 90th
percentile on more than two-thirds of the performance measurements and had an
average rank in the 99th percentile on the combined measures of (i) sales and
net income growth and total shareholder return and (ii) sales and earnings per
share growth and total shareholder return.
Mr. Scrushy's stewardship of the Company has led it to 46 consecutive
profitable quarters since the second quarter of 1986, with steadily increasing
earnings per share. In 1997, his leadership led the Company to $5,000,000,000 in
growth in stockholder value, 34% growth in net income and 27% growth in earnings
per share (with approximately 68,740,000 new shares issued during the year). The
Company's stock price rose 44% during the year, outperforming the S&P 500 by
42%. Further, in the period since December 31, 1993, the Company, under Mr.
Scrushy's leadership, has grown from the fourth-largest provider of
rehabilitative healthcare services to the largest provider, and since 1995 has
established itself
21
<PAGE>
as the nation's largest provider of outpatient surgery services and one of the
largest providers of outpatient diagnostic services and occupational medicine
services through a series of strategic acquisitions. During that same period,
the Company has become the second-largest publicly-traded healthcare provider
(by market capitalization) in the nation, has expanded its operations to 50
states, the United Kingdom and Australia and has been named to the S&P 500. The
Committee believes that Mr. Scrushy's leadership has been essential to the
Company's success and growth. In view of these accomplishments, the Committee
believes that it is important to ensure that, if Mr. Scrushy is successful in
leading the Company to achieve the goals set by the Board of Directors, his
compensation will be at a level commensurate with that of chief executive
officers of similarly-performing public companies and that he will continue to
have the opportunity to obtain a significant equity interest in the Company.
Section 162(m) of the Internal Revenue Code
The Omnibus Budget Reconciliation Act of 1993 contains a provision under
which a publicly-traded corporation is sometimes precluded from taking a federal
income tax deduction for compensation in excess of $1,000,000 that is paid to
the chief executive officer and the four other most highly-compensated
executives of the corporation during a corporation's tax year. Compensation in
excess of $1,000,000 continues to be deductible if that compensation is
"performance based" within the meaning of that term under Section 162(m) of the
Internal Revenue Code. Certain transition rules apply with respect to stock
option plans which were approved prior to December 20, 1993, pursuant to Rule
16b-3(b) under the Exchange Act.
The Company believes that its employee stock option plans meet the
requirements of Section 162(m) as performance-based plans. The Committee and the
Board of Directors have currently made a decision not to amend the Company's
cash compensation programs to meet all requirements of Section 162(m) because
such a decision would not be in the best interests of the Company's
stockholders. The Committee believes that, in establishing bonus and incentive
awards, certain subjective factors must be taken into account in particular
cases, based upon the experienced judgment of the Committee members as well as
on factors which may be objectively quantified. The preservation of tax
deductibility of all compensation is an important consideration. However, the
Committee believes that it is important that the Company retain the flexibility
to reward superior effort and accomplishment even where all cash compensation
may not be fully deductible. The Committee will continue to review the
requirements for deductibility under Section 162(m) and will take such
requirements into account in the future as it deems appropriate and in the best
interests of the Company's stockholders. Approximately $10,405,000 of Mr.
Scrushy's compensation paid with respect to 1997, as well as approximately
$450,000 and $112,000 paid to James P. Bennett, President and Chief Operating
Officer of the Company, and Michael D. Martin, Executive Vice President, Chief
Financial Officer and Treasurer of the Company, respectively, will not be
deductible; however, the Company believes that all other compensation paid to
executive officers will be fully deductible.
Conclusion
The Committee believes that the levels and mix of compensation provided to
the Company's executives during 1997 were appropriate and were instrumental in
the achievement of the Company's goals for 1997. It is the intent of the
Committee to ensure that the Company's compensation programs continue to
motivate its executives and reward them for being responsive to the long-term
interests of the Company and its stockholders.
The foregoing report is submitted by the following Directors of the
Company, constituting all of the members of the Audit and Compensation Committee
of the Board of Directors:
C. Sage Givens
George H. Strong
Phillip C. Watkins, Chairman
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<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding beneficial
ownership of the Company's Common Stock as of March 13, 1998, (a) by each person
who is known by the Company to own beneficially more than 5% of the Company's
Common Stock, (b) by each of the Company's Directors and (c) by the Company's
five most highly compensated executive officers and all executive officers and
Directors as a group.
<TABLE>
<CAPTION>
NAME AND NUMBER OF SHARES PERCENTAGE OF
ADDRESS OF OWNER BENEFICIALLY OWNED (1) COMMON STOCK
- - ---------------------------------------------------- ------------------------ --------------
<S> <C> <C>
Richard M. Scrushy ............................ 11,776,658(2) 2.88%
John S. Chamberlin ............................ 247,000(3) *
C. Sage Givens ................................ 387,100(4) *
Charles W. Newhall III ........................ 755,846(5) *
George H. Strong .............................. 514,692(6) *
Phillip C. Watkins, M.D. ...................... 609,254(7) *
James P. Bennett .............................. 1,390,500(8) *
Larry R. House ................................ 84,600(9) *
Anthony J. Tanner ............................. 1,061,358(10) *
P. Daryl Brown ................................ 1,069,736(11) *
Joel C. Gordon ................................ 3,553,268(12) *
Michael D. Martin ............................. 632,008(13) *
FMR Corp. ..................................... 39,920,762(14) 10.02%
82 Devonshire Street
Boston, Massachusetts 02109
Putnam Investments, Inc. ...................... 28,339,151(15) 7.12%
One Post Office Square
Boston, Massachusetts 02109
All Executive Officers and Directors as a Group
(18 persons) ................................ 24,716,836(16) 5.90%
</TABLE>
- - ----------
(1) The persons named in the table have sole voting and investment power with
respect to all shares of Common Stock shown as beneficially owned by them,
except as otherwise indicated.
(2) Includes 11,172,524 shares subject to currently exercisable stock options.
(3) Includes 175,000 shares subject to currently exercisable stock options.
(4) Includes 2,100 shares owned by Ms. Givens's spouse and 385,000 shares
subject to currently exercisable stock options.
(5) Includes 460 shares owned by members of Mr. Newhall's immediate family and
635,000 shares subject to currently exercisable stock options. Mr. Newhall
disclaims beneficial ownership of the shares owned by his family members
except to the extent of his pecuniary interest therein.
(6) Includes 93,373 shares owned by trusts of which Mr. Strong is a trustee and
claims shared voting and investment power and 275,000 shares subject to
currently exercisable stock options.
(7) Includes 465,000 shares subject to currently exercisable stock options.
(8) Includes 1,310,000 shares subject to currently exercisable stock options.
(9) Includes 82,996 shares subject to currently exercisable stock options.
(10) Includes 60,000 shares held in trust by Mr. Tanner for his children and
940,000 shares subject to currently exercisable stock options.
(11) Includes 1,013,000 shares subject to currently exercisable stock options.
(12) Includes 354,340 shares owned by his spouse, 100,988 shares owned by trusts
of which he is a trustee and 409,520 shares subject to currently
exercisable stock options.
(13) Includes 570,000 shares subject to currently exercisable stock options.
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<PAGE>
(14) Shares held by various investment funds for which affiliates of FMR Corp.
act as investment advisor. FMR Corp. or its affiliates claim sole power to
vote 3,327,604 of the shares and sole power to dispose of all of the
shares.
(15) Shares held by various investment funds for which affiliates of Putnam
Investments, Inc. act as investment advisor. Putnam Investments, Inc. or
its affiliates claim shared power to vote 3,338,400 of the shares and
shared power to dispose of all of the shares.
(16) Includes 20,335,344 shares subject to currently exercisable stock options
held by executive officers and Directors.
* Less than 1%
CERTAIN TRANSACTIONS
During 1997, the Company paid $33,909,000 for the purchase of new NCR
computer equipment from GG Enterprises, a value-added reseller of computer
equipment which is owned by Grace Scrushy, the mother of Richard M. Scrushy,
Chairman of the Board and Chief Executive Officer of the Company, and Gerald P.
Scrushy, Senior Vice President -- Physical Resources of the Company. Such
purchases were made in the ordinary course of the Company's business. The price
paid for this equipment was more favorable to the Company than that which could
have been obtained from an independent third party seller.
In June 1994, the Company sold selected properties, including six ancillary
hospital facilities, three outpatient rehabilitation facilities, two outpatient
surgery centers, one uncompleted medical office building and one research
facility to Capstone Capital Corporation ("Capstone"), a publicly-traded real
estate investment trust. The net proceeds of the Company as a result of the
transaction were approximately $58,425,000. The net book value of the properties
was approximately $50,735,000. The Company leases back substantially all these
properties from Capstone and guarantees the associated operating leases,
payments under which aggregate approximately $6,900,000 annually. In addition,
in 1995 Capstone acquired ownership of the Company's Erie, Pennsylvania
inpatient rehabilitation facility, which had been leased by the Company from an
unrelated lessor. The Company's annual lease payment under that lease is
$1,700,000. In 1996 Capstone also acquired ownership of the Company's Altoona
and Mechanicsburg, Pennsylvania inpatient rehabilitation facilities, which had
been leased by the Company from unrelated lessors. The Company's annual lease
payments under such leases aggregate $2,818,000. In 1997, Capstone also acquired
ownership of the Company's Greater Pittsburgh, Pennsylvania inpatient
rehabilitation facility, which had been leased by the Company from an unrelated
lessor. The Company's annual lease payment under such lease is $1,500,000.
Richard M. Scrushy, Chairman of the Board and Chief Executive Officer of the
Company, and Michael D. Martin, Executive Vice President, Chief Financial
Officer and Treasurer of the Company, were among the founders of Capstone and
serve on its Board of Directors. At March 1, 1998, Mr. Scrushy owned
approximately 1.62% of the issued and outstanding capital stock of Capstone, and
Mr. Martin owned approximately 0.61% of the issued and outstanding capital stock
of Capstone. In addition, the Company owned approximately 0.32% of the issued
and outstanding capital stock of Capstone at March 1, 1998. The Company believes
that all transactions involving Capstone were effected on terms no less
favorable than those which could have been obtained in transactions with
independent third parties.
The Company's subsidiary Horizon/CMS Healthcare Corporation ("Horizon/CMS")
is party to an agreement with AMI Aviation II, L.L.C. ("AMI") with respect to
the use of an airplane owned by AMI. Neal M. Elliott, who was Chairman,
President and Chief Executive Officer of Horizon/CMS prior to its acquisition by
the Company in October 1997 and who served as a Director of the Company from
October 1997 until his death in February 1998, was Managing Member of AMI, a
position which is now held by a trust of which Mr. Elliott's widow is a trustee.
Mr. Elliott owned, and such trust now owns, a 99% interest in AMI. Under the use
agreement, Horizon/CMS is obligated to pay $43,000 per month through December
1999 and $57,600 per month from January 2000 through December 2004 for up to 30
hours per month of utilization of the airplane, plus certain operating expenses
of the airplane. The Company has caused Horizon/CMS to continue to honor such
use agreement, and is currently exploring available options with respect to
continued use of the airplane.
24
<PAGE>
In November 1997, the Company agreed to lend up to $10,000,000 to 21st
Century Health Ventures L.L.C. ("21st Century"), an entity formed to sponsor a
private equity investment fund investing in the healthcare industry. Richard M.
Scrushy, Chairman of the Board and Chief Executive Officer of the Company, and
Michael D. Martin, Executive Vice President, Chief Financial Officer and a
Director of the Company, along with another individual not employed by the
Company, are the principals of 21st Century. The purpose of the loan was to
facilitate certain investments by 21st Century prior to the establishment of its
proposed private equity fund, in which the Company and third party investors are
expected to invest. When established, investment by the Company in such private
equity fund is expected to allow the Company to benefit from the opportunity to
participate in investments in healthcare businesses that are not part of the
Company's core businesses, but which the Company believes provide opportunities
for growth. Amounts outstanding under the loan bear interest at 1% over the
prime rate announced from time to time by AmSouth Bank of Alabama and are
repayable upon demand by the Company. At December 31, 1997, 21st Century had
drawn an aggregate of $1,708,333 under the $10,000,000 commitment, of which
$1,500,000 was used to purchase 576,924 shares of Series B Preferred Convertible
Preferred Stock in Summerville Healthcare Group, Inc. ("Summerville"), a
developer and operator of assisted living facilities, and the remainder of which
was used to provide a loan to Physician Solutions, Inc., a provider of
management services to pathology groups. The Company owns an aggregate of
3,361,539 shares of Series B Convertible Preferred Stock of Summerville, which
it acquired in two transactions in July and November 1997. In connection with
the July transaction, Mr. Scrushy and Mr. Martin were appointed to the Board of
Directors of Summerville.
At various times, the Company has made loans to executive officers to
assist them in meeting financial obligations at certain times when they were
requested by the Company to refrain from selling Common Stock in the open
market. At January 1, 1997, loans in the following original principal amounts
were outstanding: $460,000 to Larry R. House, a Director and a former executive
officer, $500,000 to Aaron Beam, Jr., then Executive Vice President and Chief
Financial Officer and a Director, and $140,000 and $350,000 to William T. Owens,
Senior Vice President and Controller. Outstanding principal balances at December
31, 1997 were $447,000 for Mr. House, $500,000 for Mr. Beam and an aggregate of
$476,000 for Mr. Owens. In connection with Mr. Beam's retirement, the Company
agreed to forgive his loan over a period of five years in exchange for his
provision of consulting services to the Company over such period. Such loans
bear interest at the rate of 1-1/4% per annum below the prime rate of AmSouth
Bank of Alabama, Birmingham, Alabama, and are payable on demand.
RELATIONSHIP WITH
INDEPENDENT PUBLIC ACCOUNTANTS
Ernst & Young LLP, Birmingham, Alabama, has been engaged by the Board of
Directors of the Company as independent public accountants for the Company and
its subsidiaries for the fiscal year 1997 and it is expected that such firm will
serve in that capacity for the 1998 fiscal year. Management expects that a
representative of Ernst & Young LLP will be present at the Annual Meeting to
make a statement if he or she desires to do so and to be available to answer
appropriate questions posed by stockholders.
FINANCIAL STATEMENTS
The Company's audited financial statements for the fiscal year ended
December 31, 1997, "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and other selected information are included in
Appendix B to this Proxy Statement.
OTHER MATTERS
As of the date of this Proxy Statement, the Board of Directors of the
Company does not know of any business which will be presented for consideration
at the Annual Meeting other than that specified herein and in the Notice of
Annual Meeting of Stockholders, but if other matters are presented, it is the
intention of the persons designated as proxies to vote in accordance with their
judgment on such matters.
25
<PAGE>
A COPY OF THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED
DECEMBER 31, 1997, INCLUDING THE FINANCIAL STATEMENTS AND FINANCIAL STATEMENT
SCHEDULE THERETO, AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION, WILL BE
FURNISHED WITHOUT CHARGE TO ANY STOCKHOLDER OF THE COMPANY WHOSE PROXY IS
SOLICITED BY THE FOREGOING PROXY STATEMENT, UPON THE WRITTEN REQUEST OF ANY SUCH
PERSON ADDRESSED TO ANTHONY J. TANNER, SECRETARY, HEALTHSOUTH CORPORATION, ONE
HEALTHSOUTH PARKWAY, BIRMINGHAM, ALABAMA 35243. SUCH A REQUEST FROM A BENEFICIAL
OWNER OF THE COMPANY'S COMMON STOCK MUST CONTAIN A GOOD-FAITH REPRESENTATION BY
SUCH PERSON THAT, AS OF MARCH 31, 1998, HE WAS A BENEFICIAL OWNER OF THE
COMPANY'S COMMON STOCK.
Please SIGN and RETURN the enclosed Proxy promptly.
By Order of the Board of Directors:
ANTHONY J. TANNER
Secretary
April __, 1998
26
<PAGE>
APPENDIX A
HEALTHSOUTH CORPORATION
1998 RESTRICTED STOCK PLAN
1. PURPOSE OF THE PLAN. The purpose of the 1998 Restricted Stock Plan
(hereinafter called the "Plan") of HEALTHSOUTH Corporation, a Delaware
corporation (hereinafter called the "Corporation"), is to provide incentive for
future endeavor and to advance the interests of the Corporation and its
stockholders by encouraging ownership of the Common Stock, par value $.01 per
share (hereinafter called the "Common Stock"), of the Corporation by its
executives and other key employees, upon whose judgment, interest and continuing
special efforts the Corporation is largely dependent for the successful conduct
of its operations, and to enable the Corporation to compete effectively with
other enterprises for the services of such new executives and employees as may
be needed for the continued improvement of the Corporation's business, through
the grant of restricted stock awards ("Awards") covering shares of the Common
Stock.
2. PARTICIPANTS. Awards may be granted under the Plan to such executives
and key employees of the Corporation and its subsidiaries as shall be determined
by the Committee appointed by the Board of Directors as set forth in Section 5
of the Plan; provided, however, that no Award may be granted to any person if
such grant would cause the Plan to cease to be an "employee benefit plan" as
defined in Rule 405 of Regulation C promulgated under the Securities Act of
1933.
3. TERM OF THE PLAN. The Plan shall become effective as of May 21, 1998,
subject to the approval by the holders of a majority of the shares of issued and
outstanding Common Stock of the Corporation present and voting at the 1998
Annual Meeting of Stockholders of the Corporation. The Plan shall terminate on
the earliest of (a) April 30, 2008, (b) such time as all shares of Common Stock
reserved for issuance under the Plan have been issued and are fully vested, or
(c) such earlier time as the Board of Directors of the Corporation may
determine. Any Award outstanding under the Plan at the time of its termination
shall remain in effect in accordance with its terms and conditions and those of
the Plan. No Award shall be granted under the Plan after April 30, 2008.
4. STOCK SUBJECT TO THE PLAN. Subject to the provisions of Section 11, the
aggregate number of shares of Common Stock for which Awards may be granted under
the Plan shall not exceed 3,000,000 shares, and the maximum number of shares of
Common Stock for which any individual may be granted Awards under the Plan
during any calendar year is 100,000. If, on or prior to the termination of the
Plan as provided in Section 3, an Award granted under the Plan shall have
expired or terminated for any reason without having vested in full, the unvested
shares covered thereby shall again become available for the grant of Awards
under the Plan.
The shares to be delivered upon exercise of Awards under the Plan shall be
made available, at the discretion of the Board of Directors, either from
authorized but previously unissued shares as permitted by the Certificate of
Incorporation of the Corporation or from shares re-acquired by the Corporation,
including shares of Common Stock purchased in the open market, and shares held
in the treasury of the Corporation.
5. ADMINISTRATION OF THE PLAN. The Plan shall be administered by the Audit
and Compensation Committee of the Board of Directors of the Corporation
(hereinafter called the "Committee"). The acts of a majority of the Committee,
at any meeting thereof at which a quorum is present, or acts reduced to or
approved in writing by a majority of the members of the Committee, shall be the
valid acts of the Committee. The Committee shall determine the executives and
key employees of the Corporation and its subsidiaries who shall be granted
Awards and the number of shares of Common Stock to be subject to each Award.
The interpretation and construction of any provision of the Plan or of any
Award granted under it by the Committee shall be final, conclusive and binding
upon all parties, including the Corporation, its stockholders and Directors, and
the executives and employees of the Corporation and its subsidiaries.
A-1
<PAGE>
No member of the Board of Directors or the Committee shall be liable to the
Corporation, any stockholder, any optionholder or any employee of the
Corporation or its subsidiaries for any action or determination made in good
faith with respect to the Plan or any Award granted under it.
The expenses of administering the Plan shall be borne by the Corporation.
6. GRANT OF AWARDS. (a) Awards may be granted under the Plan by the
Committee in accordance with the provisions of Section 5 at any time prior to
the termination of the Plan. In making any determination as to executives and
key employees to whom Awards shall be granted and as to the number of shares to
be covered by such Awards, the Committee shall take into account the duties of
the respective executives and key employees, their present and potential
contribution to the success of the Corporation, and such other factors as the
Committee shall deem relevant in connection with the accomplishment of the
purposes of the Plan.
(b) Each Award granted under the Plan shall be granted pursuant to and
subject to the terms and conditions of a restricted stock agreement to be
entered into between the Corporation and the participant at the time of such
grant. Each such restricted stock agreement shall be in a form from time-to-time
adopted for use under the Plan by the Committee (such form being hereinafter
called a "Restricted Stock Agreement"). Any such Restricted Stock Agreement
shall incorporate by reference all of the terms and provisions of the Plan as in
effect at the time of grant and may contain such other terms and provisions as
shall be approved and adopted by the Committee.
7. CERTAIN CONDITIONS OF AWARDS. Awards granted under this Plan shall be
subject to the following terms and conditions:
(a) The prospective recipient of an Award shall not, with respect to such
Award, be deemed to have become a participant or to have any rights with respect
to such Award unless and until such recipient shall have executed a Restricted
Stock Agreement or other agreement evidencing the Award and its terms and
conditions and delivered a fully-executed copy thereof to the Corporation and
otherwise complied with the then-applicable terms and conditions under the Plan.
(b) Each participant shall be issued a certificate in respect of shares of
Common Stock awarded under the Plan. Such certificate shall be registered in the
name of the participant, and shall bear an appropriate legend referring to the
terms, conditions and restrictions applicable to such Award substantially in the
following form:
"The transferability of this certificate and the shares of stock
represented hereby are subject to the terms and conditions (including
forfeiture) of the 1998 Restricted Stock Plan of HEALTHSOUTH Corporation
and a Restricted Stock Agreement entered into between the registered
owner and HEALTHSOUTH Corporation. Copies of such Plan and Restricted
Stock Agreement are on file in the offices of the Secretary of
HEALTHSOUTH Corporation."
(c) The Committee may adopt rules which provide that the stock certificates
evidencing shares covered by Awards might be held in custody by a bank or other
institution, or that the Corporation may itself hold such shares in custody
until the restrictions thereon shall have lapsed, and may require as a condition
of any Award that the participant shall have delivered a stock power endorsed in
blank relating to the stock covered by such Award.
(d) Recipients of Awards under the Plan are not required to make any
payment or provide consideration therefor other than the rendering of services
to the Corporation.
8. RESTRICTIONS AND FORFEITURES. The shares of Common Stock awarded
pursuant to the Plan shall be subject to the following restrictions and
conditions:
(a) During a period set by the Committee of not less than one year nor more
than 10 years commencing with the date of an Award (the "Restriction Period"), a
participant will not be permitted to sell, transfer, pledge, assign or otherwise
dispose of shares of Common Stock awarded pursuant to said Award. Within these
limits, the Committee may provide for the vesting of Awards and the lapse of
such
A-2
<PAGE>
restrictions in installments based upon the passage of time, the achievement by
the Corporation of certain identified performance goals, or the occurrence of
other events, or any combination thereof, all as the Committee deems
appropriate.
(b) Except as provided in Section 8(a), a participant shall have with
respect to the shares of Common Stock covered by an Award all of the rights of a
stockholder of the Corporation, including the right to vote such shares and
receive dividends and other distributions thereon.
(c) Subject to the provisions of Section 8(d), unless otherwise provided in
the applicable Restricted Stock Agreement, upon termination of a participant's
employment for any reason during the Restriction Period, all shares awarded to
such participant and still subject to restriction shall be forfeited by the
participant and be reacquired by the Corporation, without consideration or
payment therefor.
(d) In the event of a participant's retirement, disability or death, all
restrictions with respect to such participant's Award shall lapse (subject to
Section 8(e)) and such participant or his beneficiary shall be entitled to
receive (if held in custody by the Corporation or a bank or other institution)
and retain all of the stock subject to the Award; provided, however, that in the
case of retirement, the Committee in its sole discretion may determine that such
restrictions shall not lapse as to all or a portion of an Award or that all or
any of the shares subject to restriction shall be forfeited.
(e) The Committee may impose any conditions on an Award it deems advisable
to ensure the participant's payment to the Corporation of any federal, state or
local taxes required to be withheld with respect to such award.
(f) Notwithstanding any contrary provision contained herein, unless
otherwise expressly provided in the Restricted Stock Agreement, any Award
granted hereunder shall become immediately vested in full upon the occurrence of
a Change in Control of the Corporation. For purposes of this Section 8(f),
"Change in Control" shall mean
(i) the acquisition (other than from the Corporation) by any person,
entity or "group" (within the meaning of Sections 13(d)(3) or 14(d)(2) of the
Securities Exchange Act of 1934, but excluding, for this purpose, the
Corporation or its subsidiaries, or any employee benefit plan of the
Corporation or its subsidiaries which acquires beneficial ownership of voting
securities of the Corporation) of beneficial ownership (within the meaning of
Rule 13d-3 promulgated under the Securities Exchange Act of 1934) of 25% or
more of either the then-outstanding shares of Common Stock or the combined
voting power of the Corporation's then-outstanding voting securities entitled
to vote generally in the election of Directors; or
(ii) individuals who, as of May 21, 1998, constitute the Board of
Directors of the Corporation (as of such date, the "Incumbent Board") cease
for any reason to constitute at least a majority of the Board of Directors;
provided, however, that any person becoming a Director subsequent to such
date whose election, or nomination for election, was approved by a vote of at
least a majority of the Directors then constituting the Incumbent Board
(other than an election or nomination of an individual whose initial
assumption of office is in connection with an actual or threatened election
contest relating to the election of Directors of the Corporation) shall be,
for purposes of this Section 9(b)(ii), considered as though such person were
a member of the Incumbent Board; or
(iii) approval by the stockholders of the Corporation of a
reorganization, merger, consolidation or share exchange, in each case with
respect to which persons who were the stockholders of the Corporation
immediately prior to such reorganization, merger, consolidation or share
exchange do not, immediately thereafter, own more than 75% of the combined
voting power entitled to vote generally in the election of directors of the
reorganized, merged, consolidated or other surviving entity's
then-outstanding voting securities, or a liquidation or dissolution of the
Corporation or the sale of all or substantially all of the assets of the
Corporation.
9. NONTRANSFERABILITY OF AWARDS. (a) Except to the extent that such Awards
are vested, Awards granted under the Plan shall be assignable or transferable
only by will or pursuant to the laws of descent and distribution, except to the
extent set forth in the following paragraph.
A-3
<PAGE>
(b) Upon written notice to the Secretary of the Corporation, a participant
may, except as otherwise prohibited by applicable law, transfer shares granted
under the Plan to one or more members of such participant's immediate family, to
a partnership consisting only of members of such participant's immediate family,
or to a trust all of whose beneficiaries are members of the participant's
immediate family. For purposes of this section, a participant's "immediate
family" shall be deemed to include such holder's spouse, children and
grandchildren only.
10. NO RIGHT OF CONTINUED EMPLOYMENT. Nothing in the Plan or in the
Restricted Stock Agreement shall confer upon any participant the right to
continue in the employ of the Corporation or any of its subsidiaries or in any
other relationship thereto or interfere in any way with the right of the
Corporation to terminate such employment or other relationship at any time.
11. ADJUSTMENT OF AND CHANGES IN CAPITALIZATION. In the event that the
outstanding shares of Common Stock shall be changed in number or class by reason
of split-ups, combinations, mergers, consolidations or recapitalizations, or by
reason of stock dividends, the number or class of shares which thereafter may be
acquired through Awards granted under the Plan, both in the aggregate and as to
any individual, and the number and class of shares then subject to Awards
theretofore granted shall be adjusted so as to reflect such change, all as
determined by the Board of Directors of the Corporation. In the event there
shall be any other change in the number or kind of the outstanding shares of
Common Stock, or of any stock or other securities into which such Common Stock
shall have been changed, or for which it shall have been exchanged, then if the
Board of Directors shall, in its sole discretion, determine that such change
equitably requires an adjustment in any Award theretofore granted or which may
be granted under the Plan, such adjustment shall be made in accordance with such
determination.
Notice of any adjustment shall be given by the Corporation to each holder
of an Award which shall have been so adjusted and such adjustment (whether or
not such notice is given) shall be effective and binding for all purposes of the
Plan.
Fractional shares resulting from any adjustment in Awards pursuant to this
Section 11 may be settled in cash or otherwise as the Board of Directors may
determine.
12. SECURITIES ACTS REQUIREMENTS. As a condition to the issuance of any
shares pursuant to an Award under the Plan, the Board of Directors or the
Committee, as the case may be, may require a participant to furnish a written
representation that he is acquiring the shares for investment and not with a
view to distribution of the shares to the public and a written agreement
restricting the transferability of the shares solely to the Corporation, and may
affix a restrictive legend or legends on the face of the certificate
representing such shares. Such representation, agreement and/or legend shall be
required only in cases where in the opinion of the Board of Directors or the
Committee, as the case may be, and counsel for the Corporation, it is necessary
to enable the Corporation to comply with the provisions of the Securities Act of
1933 or other Federal or state statutes having similar requirements, and any
stockholder who gives such representation and agreement shall be released from
it and the legend removed at such time as the shares to which they applied are
registered or qualified pursuant to the Securities Act of 1933 or other Federal
or state statutes having similar requirements, or at such other time as, in the
opinion of the Board of Directors or the Committee, as the case may be, and
counsel for the Corporation, the representation and agreement and legend cease
to be necessary to enable the Corporation to comply with the provisions of the
Securities Act of 1933 or other Federal or state statutes having similar
requirements.
13. AMENDMENT OF THE PLAN. The Plan may, at any time or from time to time,
be terminated, modified or amended by the stockholders of the Corporation by the
affirmative vote of the holders of a majority of the outstanding shares of the
Corporation's Common Stock present and entitled to vote at a meeting of the
Corporation's stockholders duly called and held (or, to the extent permitted by
law, by written consent of the holders of a majority of the outstanding shares
of the Corporation's Common Stock entitled to vote). The Board of Directors of
the Corporation may, insofar as permitted by law, from time to time with respect
to any shares of Common Stock at the time not subject to Awards, suspend or
discontinue the Plan or revise or amend it in any respect whatsoever; provided,
however,
A-4
<PAGE>
that, without approval of the stockholders of the Corporation, no such revision
or amendment shall increase the number of shares subject to the Plan, extend the
period during which Awards may be vested, or change the provisions relating to
adjustment to be made upon changes in capitalization.
14. CHANGES IN LAW. Subject to the provisions of Section 13, the Board of
Directors shall have the power to amend the Plan and any outstanding Awards
granted thereunder in such respects as the Board of Directors shall, in its sole
discretion, deem advisable in order to incorporate in the Plan or any such Award
any new provision or change designed to comply with or take advantage of
requirements or provisions of the Internal Revenue Code of 1986, as amended, or
any other statute, or Rules or Regulations of the Internal Revenue Service or
any other Federal or state governmental agency enacted or promulgated after the
adoption of the Plan.
15. LEGAL MATTERS. Every right of action by or on behalf of the Corporation
or by any stockholder against any past, present or future member of the Board of
Directors, officer or employee of the Corporation arising out of or in
connection with this Plan shall, irrespective of the place where such action may
be brought and irrespective of the place of residence of any such Director,
officer or employee, cease and be barred by the expiration of three years from
whichever is the later of (a) the date of the act or omission in respect of
which such right of action arises, or (b) the first date upon which there has
been made generally available to stockholders an annual report of the
Corporation and a proxy statement for the Annual Meeting of Stockholders
following the issuance of such annual report, which annual report and proxy
statement alone or together set forth, for the related period, the aggregate
number of shares for which Awards were granted; and any and all right of action
by any employee or executive of the Corporation (past, present or future)
against the Corporation arising out of or in connection with this Plan shall,
irrespective of the place where such action may be brought, cease and be barred
by the expiration of three years from the date of the act or omission in respect
of which such right of action arises.
This Plan and all determinations made and actions taken pursuant hereto
shall be governed by the law of Delaware, applied without giving effect to any
conflicts-of-law principles, and construed accordingly.
A-5
<PAGE>
APPENDIX B
NOTE: This Appendix B, together with the foregoing Proxy Statement,
contains the information required to be provided in the Company's annual report
to security holders pursuant to the Rules and Regulations of the Securities and
Exchange Commission. The Company's 1997 Annual Report to Stockholders, which
provides additional information concerning the Company and its performance in
1997, is also included in this mailing.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
NUMBER
-------
<S> <C>
Business ........................................................................ B-2
Selected Financial Data ......................................................... B-2
Quarterly Results ............................................................... B-2
Directors and Executive Officers ................................................ B-4
Management's Discussion and Analysis of
Financial Condition and Results of Operations ................................. B-7
Audited Consolidated Financial Statements of
HEALTHSOUTH Corporation and Subsidiaries
Report of Independent Auditors ................................................. B-15
Consolidated Balance Sheets .................................................... B-16
Consolidated Statements of Income .............................................. B-17
Consolidated Statements of Stockholders' Equity ................................ B-18
Consolidated Statements of Cash Flows .......................................... B-19
Notes to Consolidated Financial Statements ..................................... B-20
Market for the Company's Common Equity and Related Stockholder Matters .......... B-40
Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure ........................................... B-40
</TABLE>
B-1
<PAGE>
BUSINESS
HEALTHSOUTH Corporation ("HEALTHSOUTH" or the "Company") is the nation's
largest provider of outpatient surgery and rehabilitative healthcare services.
The Company provides these services through its national network of outpatient
and inpatient rehabilitation facilities, outpatient surgery centers, diagnostic
centers, occupational medicine centers, medical centers and other healthcare
facilities. The Company believes that it provides patients, physicians and
payors with high-quality healthcare services at significantly lower costs than
traditional inpatient hospitals. Additionally, the Company's national network,
reputation for quality and focus on outcomes has enabled it to secure contracts
with national and regional managed care payors. At March 31, 1998, the Company
had nearly 1,800 patient care locations in 50 states, the United Kingdom and
Australia.
SELECTED FINANCIAL DATA
Set forth below is a summary of selected consolidated financial data for
the Company for the years indicated. All amounts have been restated to reflect
the effects of the 1994 acquisition of ReLife, Inc. ("ReLife"), the 1995
acquisitions of Surgical Health Corporation ("SHC") and Sutter Surgery Centers,
Inc. ("SSCI"), the 1996 acquisitions of Surgical Care Affiliates, Inc. ("SCA")
and Advantage Health Corporation ("Advantage Health"), and the 1997 acquisition
of Health Images, Inc. ("Health Images"), each of which was accounted for as a
pooling of interests.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------------
1993 1994 1995 1996 1997
------------- ------------- ------------- ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Revenues ................................ $1,055,295 $1,726,321 $2,118,681 $2,568,155 $3,017,269
Operating unit expenses ................. 715,189 1,207,707 1,441,059 1,667,248 1,888,435
Corporate general and administrative
expenses .............................. 43,378 67,798 65,424 79,354 82,757
Provision for doubtful accounts ......... 22,677 35,740 42,305 58,637 71,468
Depreciation and amortization ........... 75,425 126,148 160,901 207,132 250,010
Merger and acquisition related ex-
penses (1) ............................ 333 6,520 19,553 41,515 15,875
Loss on impairment of assets (2) ........ --- 10,500 53,549 37,390 ---
Loss on abandonment of computer
project ............................... --- 4,500 --- --- ---
Loss on disposal of surgery centers ..... --- 13,197 --- --- ---
NME Selected Hospitals Acquisition
related expense ....................... 49,742 --- --- --- ---
Interest expense ........................ 25,884 74,895 105,517 98,751 111,504
Interest income ......................... (6,179) (6,658) (8,009) (6,034) (4,414)
Gain on sale of partnership interest..... (1,400) --- --- --- ---
Gain on sale of MCA Stock ............... -- (7,727) --- --- ---
---------- ---------- ---------- ---------- ----------
925,049 1,532,620 1,880,299 2,183,993 2,415,635
---------- ---------- ---------- ---------- ----------
Income from continuing operations
before income taxes, minority
interests and extraordinary item ...... 130,246 193,701 238,382 384,162 601,634
Provision for income taxes .............. 40,450 68,560 86,161 143,929 206,153
---------- ---------- ---------- ---------- ----------
89,796 125,141 152,221 240,233 395,481
Minority interests ...................... 29,549 31,665 43,753 50,369 64,873
---------- ---------- ---------- ---------- ----------
Income from continuing operations
before extraordinary item ............. 60,247 93,476 108,468 189,864 330,608
Income from discontinued operations 3,986 (6,528) (1,162) -- --
Extraordinary item (2) .................. -- -- (9,056) -- --
---------- ---------- ---------- ---------- ----------
Net income ............................ $ 64,233 $ 86,948 $ 98,250 $ 189,864 $ 330,608
========== ========== ========== ========== ==========
Weighted average common shares
outstanding (3)(6) .................... 265,502 273,480 289,594 321,367 346,872
========== ========== ========== ========== ==========
</TABLE>
B-2
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------
1993 1994 1995 1996 1997
----------- ----------- ----------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Net income per common share: (3)(6)
Continuing operations ............ $ 0.23 $ 0.34 $ 0.37 $ 0.59 $ 0.95
Discontinued operations .......... 0.01 (0.02) 0.00 -- --
Extraordinary item ............... -- -- (0.03) -- --
-------- -------- -------- -------- --------
$ 0.24 $ 0.32 $ 0.34 $ 0.59 $ 0.95
======== ======== ======== ======== ========
Weighted average common shares out-
standing -- assuming dilution
(3)(4)(6) ........................ 275,316 300,758 320,018 349,033 365,546
======== ======== ======== ======== ========
Net income per common share -- as-
suming dilution: (3)(4)(6)
Continuing operations ............ $ 0.22 $ 0.32 $ 0.35 $ 0.55 $ 0.91
Discontinued operations .......... 0.01 (0.02) 0.00 -- --
Extraordinary item ............... -- -- (0.03) -- --
-------- -------- -------- -------- --------
$ 0.23 $ 0.30 $ 0.32 $ 0.55 $ 0.91
======== ======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------------------------------
1993 1994 1995 1996 1997
------------- ------------ ------------ ------------ ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and marketable securities ......... $ 153,011 $ 134,040 $ 159,793 $ 153,831 $ 152,399
Working capital ........................ 300,876 308,770 406,601 564,529 566,751
Total assets ........................... 2,000,566 2,355,920 3,107,808 3,529,706 5,401,053
Long-term debt (5) ..................... 1,028,610 1,164,135 1,453,018 1,560,143 1,601,824
Stockholders' equity ................... 727,737 837,160 1,269,686 1,569,101 3,157,428
</TABLE>
- - ----------
(1) Expenses related to SHC's Ballas Merger in 1993, the ReLife and Heritage
Acquisitions in 1994, the SHC, SSCI and NovaCare Rehabilitation Hospitals
Acquisitions in 1995, the SCA, Advantage Health, PSCM and ReadiCare
Acquisitions in 1996, and the Health Images Acquisition in 1997. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations".
(2) See "Notes to Consolidated Financial Statements".
(3) Adjusted to reflect a two-for-one stock split effected in the form of a 100%
stock dividend paid on April 17, 1995 and a two-for-one stock split effected
in the form of a 100% stock dividend paid on March 17, 1997.
(4) Diluted earnings per share in 1994, 1995, 1996 and 1997 reflect shares
reserved for issuance upon conversion of the Company's 5% Convertible
Subordinated Debentures due 2001. Substantially all of such Debentures were
converted into shares of the Company's Common Stock in 1997.
(5) Includes current portion of long-term debt.
(6) Earnings per share amounts prior to 1997 have been restated as required to
comply with Statement of Financial Accounting Standards No. 128, "Earnings
Per Share". For further discussion, see Note 1 of "Notes to Consolidated
Financial Statements".
B-3
<PAGE>
QUARTERLY RESULTS (UNAUDITED)
Set forth below is certain summary information with respect to the
Company's operations for the last eight fiscal quarters. All amounts have been
restated to reflect the effects of the 1996 acquisitions of SCA and Advantage
Health and the 1997 acquisition of Health Images, all of which were accounted
for as poolings of interests. All per share amounts have been adjusted to
reflect a two-for-one stock split effected in the form of a 100% stock dividend
paid on March 17, 1997. Earnings per share amounts for 1996 and the first three
quarters of 1997 have been restated to comply with Statement of Financial
Accounting Standards No. 128, "Earnings Per Share".
<TABLE>
<CAPTION>
1996
-------------------------------------------------------------
1ST 2ND 3RD 4TH
QUARTER QUARTER QUARTER QUARTER
------------- ------------- ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenues ....................... $ 612,149 $ 628,854 $ 651,742 $ 675,410
Net income ..................... 39,681 61,985 63,481 24,717
Net income per common share..... 0.12 0.19 0.20 0.08
Net income per common share
-- assuming dilution .......... 0.12 0.18 0.18 0.07
</TABLE>
<TABLE>
<CAPTION>
1996
-------------------------------------------------------------
1ST 2ND 3RD 4TH
QUARTER QUARTER QUARTER QUARTER
------------- ------------- ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenues ....................... $ 691,631 $ 723,017 $ 748,370 $ 854,251
Net income ..................... 64,580 81,319 85,919 98,790
Net income per common share..... 0.20 0.24 0.25 0.26
Net income per common share
-- assuming dilution .......... 0.19 0.23 0.24 0.25
</TABLE>
B-4
<PAGE>
EXECUTIVE OFFICERS
The following table sets forth certain information with respect to the
Company's executive officers:
<TABLE>
<CAPTION>
ALL POSITIONS AN OFFICER
NAME AGE WITH THE COMPANY SINCE
- - ---------------------------- ----- ------------------------------------------------------- -----------
<S> <C> <C> <C>
Richard M. Scrushy ......... 45 Chairman of the Board and Chief Executive Officer 1984
and Director
James P. Bennett ........... 40 President and Chief Operating Officer and Director 1991
Anthony J. Tanner .......... 49 Executive Vice President -- Administration and Sec- 1984
retary and Director
Michael D. Martin .......... 37 Executive Vice President, Chief Financial Officer and 1989
Treasurer and Director
Thomas W. Carman ........... 46 Executive Vice President -- Corporate Development 1985
P. Daryl Brown ............. 43 President -- HEALTHSOUTH Outpatient Centers 1986
and Director
Robert E. Thomson .......... 50 President -- HEALTHSOUTH Inpatient Operations 1987
Patrick A. Foster .......... 51 President -- HEALTHSOUTH Surgery Centers 1994
Russell H. Maddox .......... 57 President -- HEALTHSOUTH Imaging Centers 1995
William T. Owens ........... 39 Group Senior Vice President -- Finance and Control- 1986
ler
William W. Horton .......... 38 Senior Vice President and Corporate Counsel and As- 1994
sistant Secretary
</TABLE>
Biographical information for Messrs. Scrushy, Bennett, Tanner, Brown and
Martin is set forth in the Proxy Statement to which this Appendix B is attached
under "Election of Directors".
Thomas W. Carman joined the Company in 1985 as Regional Director --
Corporate Development, and now serves as Executive Vice President -- Corporate
Development. From 1983 to 1985, Mr. Carman was director of development for
Medical Care International. From 1981 to 1983, Mr. Carman was assistant
administrator at the Children's Hospital of Birmingham, Alabama.
Robert E. Thomson joined the Company in August 1985 as administrator of its
Florence, South Carolina inpatient rehabilitation facility, and subsequently
served as Regional Vice President -- Inpatient Operations, Vice President --
Inpatient Operations, Group Vice President -- Inpatient Operations, and Senior
Vice President -- Inpatient Operations. Mr. Thomson was named President --
HEALTHSOUTH Inpatient Operations in February 1996.
Patrick A. Foster joined the Company in February 1994 as Director of
Operations and subsequently served as Group Vice President -- Inpatient
Operations and Senior Vice President -- Inpatient Operations. He was named
President -- HEALTHSOUTH Surgery Centers in October 1997. From August 1992 until
February 1994, he served as Senior Vice President of the Rehabilitation/Medical
Division of The Mediplex Group.
Russell H. Maddox became President -- HEALTHSOUTH Imaging Centers in
January 1996. He served as President -- HEALTHSOUTH Surgery & Imaging Centers
from June 1995 through January 1996. From January 1992 until May 1995, Mr.
Maddox served as Chairman of the Board, President and Chief Executive Officer of
Diagnostic Health Corporation, an outpatient diagnostic imaging company which
became a wholly-owned subsidiary of the Company in 1996. Mr. Maddox was founder
and President of Russ Pharmaceuticals, Inc., Birmingham, Alabama, which was
acquired by Ethyl Corporation in March 1989.
William T. Owens, C.P.A., joined the Company in March 1986 as Controller
and was appointed Vice President and Controller in December 1986. He was
appointed Group Vice President -- Finance and Controller in June 1992 and Senior
Vice President -- Finance and Controller in February 1994 and
B-5
<PAGE>
Group Senior Vice President -- Finance and Controller in March 1998. Prior to
joining the Company, Mr. Owens served as a certified public accountant on the
audit staff of the Birmingham, Alabama office of Ernst & Whinney (now Ernst &
Young LLP) from 1981 to 1986.
William W. Horton joined the Company in July 1994 as Group Vice President
- - -- Legal Services and was named Senior Vice President and Corporate Counsel in
May 1996. From August 1986 through June 1994, Mr. Horton practiced corporate,
securities and healthcare law with the Birmingham, Alabama-based firm now known
as Haskell Slaughter & Young, L.L.C., where he served as Chairman of the
Healthcare Practice Group.
See "Election of Directors" in the Proxy Statement to which this Appendix B
is attached for identification of the Directors of the Company.
B-6
<PAGE>
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
The following discussion is intended to facilitate the understanding and
assessment of significant changes and trends related to the consolidated results
of operations and financial condition of the Company, including certain factors
related to recent acquisitions by the Company, the timing and nature of which
have significantly affected the Company's consolidated results of operations.
This discussion and analysis should be read in conjunction with the Company's
consolidated financial statements and notes thereto included elsewhere in this
Appendix B.
The Company completed the following major acquisitions over the last three
years (common share amounts have been adjusted to reflect stock splits effected
in the form of 100% stock dividends paid on April 17, 1995 and March 17, 1997):
o On April 1, 1995, the Company purchased the operations of the
rehabilitation hospital division of NovaCare, Inc. (the "NovaCare
Rehabilitation Hospitals Acquisition"). The purchase price was
approximately $235,000,000. The NovaCare Rehabilitation Hospitals consisted
of 11 rehabilitation hospitals in seven states, 12 other facilities and two
Certificates of Need.
o On June 13, 1995, the Company acquired Surgical Health Corporation (the
"SHC Acquisition"). A total of 17,062,960 shares of the Company's Common
Stock were issued in the transaction, representing a value of $155,000,000
at the time of the acquisition. The Company also purchased SHC's
$75,000,000 aggregate principal amount of 11.5% Senior Subordinated Notes
due 2004 for an aggregate consideration of approximately $86,000,000. At
that time, SHC operated a network of 36 free-standing surgery centers in 11
states, and five mobile lithotripsy units.
o On October 26, 1995, the Company acquired Sutter Surgery Centers, Inc. (the
"SSCI Acquisition"). A total of 3,552,002 shares of the Company's Common
Stock were issued in the transaction, representing a value of $44,444,000
at the time of the acquisition. At that time, SSCI operated a network of 12
freestanding surgery centers in three states.
o On December 1, 1995, the Company acquired Caremark Orthopedic Services Inc.
(the "Caremark Acquisition"). The purchase price was approximately
$127,500,000. At that time, Caremark owned and operated approximately 120
outpatient rehabilitation centers in 13 states.
o On January 17, 1996, the Company acquired Surgical Care Affiliates, Inc.
(the "SCA Acquisition"). A total of 91,856,678 shares of the Company's
Common Stock were issued in the transaction, representing a value of
approximately $1,400,000,000 at the time of the acquisition. At that time,
SCA operated a network of 67 freestanding surgery centers in 24 states.
o On March 14, 1996, the Company acquired Advantage Health Corporation (the
"Advantage Health Acquisition"). A total of 18,203,978 shares of the
Company's Common Stock were issued in the transaction, representing a value
of approximately $315,000,000 at the time of the acquisition. At that time,
Advantage Health operated a network of 136 sites of service, including four
freestanding rehabilitation hospitals, one freestanding multi-use hospital,
one nursing home, 68 outpatient rehabilitation facilities, 14 inpatient
managed rehabilitation units, 24 rehabilitation services management
contracts and six managed subacute rehabilitation units, primarily located
in the northern United States.
o On August 20, 1996, the Company acquired Professional Sports Care
Management, Inc. (the "PSCM Acquisition"). A total of 3,622,888 shares of
the Company's Common Stock were issued in the transaction, representing a
value of approximately $59,000,000 at the time of the acquisition. At that
time, PSCM operated a network of 36 outpatient rehabilitation centers in
three states.
B-7
<PAGE>
o On December 2, 1996, the Company acquired ReadiCare, Inc. (the "ReadiCare
Acquisition"). A total of 4,007,954 shares of the Company's Common Stock
were issued in the transaction, representing a value of approximately
$76,000,000 at the time of the acquisition. At that time, ReadiCare
operated a network of 37 occupational medicine and rehabilitation centers
in two states.
o On March 3, 1997, the Company acquired Health Images, Inc. ("Health
Images"). A total of 10,343,470 shares of the Company's Common Stock were
issued in the transaction, representing a value of approximately
$208,162,000 at the time of the acquisition. At that time, Health Images
operated 49 freestanding diagnostic centers in 13 states and six in the
United Kingdom.
o On September 30, 1997 the Company acquired ASC Network Corporation (the
"ASC Acquisition"). The Company paid approximately $130,827,000 in cash for
all of the issued and outstanding capital stock of ASC and assumed
approximately $61,000,000 in debt. At that time, ASC operated 29 outpatient
surgery centers in eight states.
o On October 23, 1997 the Company acquired National Imaging Affiliates, Inc.
("NIA"). A total of 984,189 shares of the Company's Common Stock were
issued in the transaction, representing a value of approximately
$20,706,000 at the time of the acquisition. At that time, NIA operated
eight diagnostic imaging centers in six states.
o On October 29, 1997, the Company acquired Horizon/CMS Healthcare
Corporation (the "Horizon/CMS Acquisition"). A total of 45,261,000 shares
of the Company's Common Stock were issued in the transaction, representing
a value of approximately $975,824,000 at the time of the acquisition, and
the Company assumed approximately $740,000,000 in debt. At that time,
Horizon/CMS operated 30 inpatient rehabilitation facilities and
approximately 275 outpatient rehabilitation centers, among other strategic
businesses, as well as certain long-term care businesses. On December 31,
1997, the Company sold the long-term care assets of Horizon/CMS, including
139 long-term care facilities, 12 specialty hospitals, 35 institutional
pharmacy locations and over 1,000 rehabilitation therapy contracts with
long-term care facilities, to Integrated Health Services, Inc. ("IHS"). IHS
paid approximately $1,130,000,000 in cash (net of certain adjustments) and
assumed approximately $94,000,000 in debt in the transaction.
Each of the NovaCare Rehabilitation Hospitals Acquisition, the Caremark
Acquisition, the ASC Acquisition, the Horizon/CMS Acquisition and the NIA
Acquisition was accounted for under the purchase method of accounting and,
accordingly, the acquired operations are included in the Company's consolidated
financial information from their respective dates of acquisition. Each of the
SHC Acquisition, the SSCI Acquisition, the SCA Acquisition, the Advantage Health
Acquisition and the Health Images Acquisition was accounted for as a pooling of
interests and, with the exception of data set forth relating to revenues derived
from Medicare and Medicaid, all amounts shown in the following discussion have
been restated to reflect such acquisitions. SHC, SSCI, SCA, Advantage Health and
Health Images did not separately track such revenues. The PSCM Acquisition and
the ReadiCare Acquisition were also accounted for as poolings of interests.
However, due to the immateriality of PSCM and ReadiCare, the Company's
historical financial statements for all periods prior to the quarters in which
the respective mergers took place have not been restated. Instead, stockholders'
equity has been increased during 1996 to reflect the effects of the PSCM
Acquisition and the ReadiCare Acquisition. The results of operations of PSCM and
ReadiCare are included in the accompanying financial statements and the
following discussion from the date of acquisition forward (see Note 2 of "Notes
to Consolidated Financial Statements" for further discussion).
The Company determines the amortization period of the cost in excess of net
asset value of purchased facilities based on an evaluation of the facts and
circumstances of each individual purchase transaction. The evaluation includes
an analysis of historic and projected financial performance, an evaluation of
the estimated useful life of the buildings and fixed assets acquired, the
indefinite useful life of certificates of need and licenses acquired, the
competition within local markets, lease terms where applicable, and the legal
terms of partnerships where applicable. The Company utilizes independent
appraisers and relies on its own management expertise in evaluating each of the
factors noted above.
B-8
<PAGE>
With respect to the carrying value of the excess of cost over net asset value of
purchased facilities and other intangible assets, the Company determines on a
quarterly basis whether an impairment event has occurred by considering factors
such as the market value of the asset, a significant adverse change in legal
factors or in the business climate, adverse action by regulators, a history of
operating losses or cash flow losses, or a projection of continuing losses
associated with an operating entity. The carrying value of excess cost over net
asset value of purchased facilities and other intangible assets will be
evaluated if the facts and circumstances suggest that it has been impaired. If
this evaluation indicates that the value of the asset will not be recoverable,
as determined based on the undiscounted cash flows of the entity acquired over
the remaining amortization period, the Company's carrying value of the asset
will be reduced by the estimated shortfall of cash flows to the estimated fair
market value.
Governmental, commercial and private payors have increasingly recognized
the need to contain their costs for healthcare services. These payors,
accordingly, are turning to closer monitoring of services, prior authorization
requirements, utilization review and increased utilization of outpatient
services. During the periods discussed below, the Company has experienced an
increased effort by these payors to contain costs through negotiated discount
pricing. The Company views these efforts as an opportunity to demonstrate the
effectiveness of its clinical programs and its ability to provide its
rehabilitative healthcare services efficiently. The Company has entered into a
number of contracts with payors to provide services and has realized an
increased volume of patients as a result.
The Company's revenues include net patient service revenues and other
operating revenues. Net patient service revenues are reported at estimated net
realizable amounts from patients, insurance companies, third-party payors
(primarily Medicare and Medicaid) and others for services rendered. Revenues
from third-party payors also include estimated retroactive adjustments under
reimbursement agreements which are subject to final review and settlement by
appropriate authorities. Management determines allowances for doubtful accounts
and contractual adjustments based on historical experience and the terms of
payor contracts. Net accounts receivable include only those amounts estimated by
management to be collectible.
The Company, in many cases, operates more than one site within a market. In
such markets, there is customarily an outpatient center or inpatient facility
with associated satellite outpatient locations. For purposes of the following
discussion and analysis, same store operations are measured on locations within
markets in which similar operations existed at the end of the period and include
the operations of additional locations opened within the same market. New store
operations are measured on locations within new markets.
RESULTS OF OPERATIONS OF THE COMPANY
Twelve-Month Periods Ended December 31, 1995 and 1996
The Company operated 739 outpatient rehabilitation locations at December
31, 1996, compared to 537 outpatient rehabilitation locations at December 31,
1995. In addition, the Company operated 96 inpatient rehabilitation facilities,
135 surgery centers, 72 diagnostic centers and five medical centers at December
31, 1996, compared to 95 inpatient rehabilitation facilities, 122 surgery
centers, 69 diagnostic centers and five medical centers at December 31, 1995.
The Company's operations generated revenues of $2,568,155,000 in 1996, an
increase of $449,474,000, or 21.2%, as compared to 1995 revenues. Same store
revenues for the twelve months ended December 31, 1996 were $2,408,294,000, an
increase of $289,613,000, or 13.7%, as compared to the same period in 1995. New
store revenues for 1996 were $159,861,000. New store revenues reflect the
acquisition of one inpatient rehabilitation hospital, the addition of eight new
outpatient surgery centers, and the acquisition of outpatient rehabilitation
operations in 57 new markets (see Note 9 of "Notes to Consolidated Financial
Statements"). The increase in revenues is primarily attributable to the addition
of these operations and increases in patient volume. Revenues generated from
patients under the Medicare and Medicaid programs respectively accounted for
37.8% and 2.9% of total revenues for 1996, compared to 40.0% and 2.5% of total
revenues for 1995. Revenues from any other single third-party payor were not
significant in relation to the Company's total
B-9
<PAGE>
revenues. During 1996, same store outpatient visits, inpatient days and surgical
cases increased 19.9%, 10.8% and 7.3%, respectively. Revenue per outpatient
visit, inpatient day and surgical case for same store operations increased
(decreased) by (0.8)%, 3.8% and 1.1%, respectively.
Operating expenses, at the operating unit level, were $1,667,248,000, or
64.9% of revenues, for 1996, compared to 68.0% of revenues for 1995. The
decrease in operating expenses as a percentage of revenues is primarily
attributable to the 13.7% increase in same store revenues noted above. Same
store operating expenses for 1996 were $1,567,820,000, or 65.1% of related
revenues. New store operating expenses were $99,428,000, or 62.2% of related
revenues. Corporate general and administrative expenses increased from
$65,424,000 in 1995 to $79,354,000 in 1996. As a percentage of revenues,
corporate general and administrative expenses were 3.1% in both 1995 and 1996.
Total operating expenses were $1,746,602,000, or 68.0% of revenues, for 1996,
compared to $1,506,483,000, or 71.1% of revenues, for 1995. The provision for
doubtful accounts was $58,637,000, or 2.3% of revenues, for 1996, compared to
$42,305,000, or 2.0% of revenues, for 1995.
Depreciation and amortization expense was $207,132,000 for 1996, compared
to $160,901,000 for 1995. The increase resulted from the investment in
additional assets by the Company. Interest expense decreased to $98,751,000 in
1996, compared to $105,517,000 for 1995, primarily because of the favorable
interest rates on the Company's revolving credit facility (see "Liquidity and
Capital Resources"). For 1996, interest income was $6,034,000, compared to
$8,009,000 for 1995. The decrease in interest income resulted primarily from a
decrease in the average amount outstanding in interest-bearing investments.
Merger expenses in 1996 of $41,515,000 represent costs incurred or accrued
in connection with completing the SCA Acquisition ($19,727,000), the Advantage
Health Acquisition ($9,212,000), the PSCM Acquisition ($5,513,000) and the
ReadiCare Acquisition ($7,063,000). For further discussion, see Note 2 of "Notes
to Consolidated Financial Statements".
Income before minority interests and income taxes for 1996 was
$384,162,000, compared to $238,382,000 for 1995. Minority interests reduced
income before income taxes by $50,369,000 in 1996, compared to $43,753,000 for
1995. The provision for income taxes for 1996 was $143,929,000, compared to
$86,161,000 for 1995, resulting in effective tax rates of 43.1% for 1996 and
44.3% for 1995. Net income for 1996 was $189,864,000.
Twelve-Month Periods Ended December 31, 1996 and 1997
The Company operated approximately 1,150 outpatient rehabilitation
locations at December 31, 1997, compared to 739 outpatient rehabilitation
locations at December 31, 1996. In addition, the Company operated 133 inpatient
rehabilitation facilities, 172 surgery centers, 101 diagnostic centers and four
medical centers at December 31, 1997, compared to 96 inpatient rehabilitation
facilities, 135 surgery centers, 72 diagnostic centers and five medical centers
at December 31, 1996.
The Company's operations generated revenues of $3,017,269,000 in 1997, an
increase of $449,114,000, or 17.5%, as compared to 1996 revenues. Same store
revenues for the twelve months ended December 31, 1997 were $2,834,528,000, an
increase of $266,373,000, or 10.4%, as compared to the same period in 1996. New
store revenues for 1997 were $182,741,000. New store revenues reflect primarily
the addition of 30 inpatient rehabilitation hospitals and 275 outpatient centers
from the Horizon/CMS Acquisition, the addition of 29 outpatient surgery centers
from the ASC Acquisition, and the acquisition of outpatient rehabilitation
operations in 28 new markets (see Note 9 of "Notes to Consolidated Financial
Statements"). The increase in revenues is primarily attributable to the addition
of these operations and increases in patient volume. Revenues generated from
patients under the Medicare and Medicaid programs respectively accounted for
36.9% and 2.3% of total revenues for 1997, compared to 37.8% and 2.9% of total
revenues for 1996. Revenues from any other single third-party payor were not
significant in relation to the Company's total revenues. During 1997, same store
outpatient visits, inpatient days, surgical cases and diagnostic cases increased
20.6%, 10.8%, 8.8% and 12.3%, respectively. Revenue per outpatient visit,
inpatient day, surgical case and diagnostic case for same store operations
increased (decreased) by 2.6%, 1.6%, (0.4)% and (0.3) %, respectively.
B-10
<PAGE>
Operating expenses, at the operating unit level, were $1,888,435,000, or
62.6% of revenues, for 1997, compared to 64.9% of revenues for 1996. The
decrease in operating expenses as a percentage of revenues is primarily
attributable to the 10.4% increase in same store revenues noted above. In same
store operations, the incremental costs associated with increased revenues are
significantly lower as a percentage of those increased revenues. Same store
operating expenses for 1997 were $1,752,208,000, or 61.8% of related revenues.
New store operating expenses were $136,227,000, or 74.5% of related revenues.
New store revenues and operating expenses for 1997 include two months of
operations of the facilities acquired from Horizon/CMS, in which aggregate
operating expenses are significantly higher as a percentage of related revenues
than the Company's other facilities. Corporate general and administrative
expenses increased from $79,354,000 in 1996 to $82,757,000 in 1997. As a
percentage of revenues, corporate general and administrative expenses decreased
from 3.1% in 1996 to 2.7% in 1997. Total operating expenses were $1,971,192,000,
or 65.3% of revenues, for 1997, compared to $1,746,602,000, or 68.0% of
revenues, for 1996. The provision for doubtful accounts was $71,468,000, or 2.4%
of revenues, for 1997, compared to $58,637,000, or 2.3% of revenues, for 1996.
Depreciation and amortization expense was $250,010,000 for 1997, compared
to $207,132,000 for 1996. The increase resulted from the investment in
additional assets by the Company. Interest expense increased to $111,504,000 in
1997, compared to $98,751,000 for 1996, primarily because of the increased
amount outstanding under the Company's revolving credit facility (see "Liquidity
and Capital Resources"). For 1997, interest income was $4,414,000, compared to
$6,034,000 for 1996. The decrease in interest income resulted primarily from a
decrease in the average amount outstanding in interest-bearing investments.
Merger expenses in 1997 of $15,875,000 represent costs incurred or accrued
in connection with completing the Health Images Acquisition. For further
discussion, see Note 2 of "Notes to Consolidated Financial Statements".
Income before minority interests and income taxes for 1997 was
$601,634,000, compared to $384,162,000 for 1996. Minority interests reduced
income before income taxes by $64,873,000 in 1997, compared to $50,369,000 for
1996. The provision for income taxes for 1997 was $206,153,000, compared to
$143,929,000 for 1996, resulting in effective tax rates of 38.4% for 1997 and
43.1% for 1996. Net income for 1997 was $330,608,000.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company had working capital of $566,751,000,
including cash and marketable securities of $152,399,000. Working capital at
December 31, 1996 was $564,529,000, including cash and marketable securities of
$153,831,000. For 1997, cash provided by operations was $415,848,000, compared
to $388,345,000 for 1996. For 1997, investing activities provided $366,514,000,
compared to using $485,193,000 for 1996. The change is primarily due to the
proceeds from the sale of the long-term care assets of Horizon/CMS to IHS in
1997. Additions to property, plant and equipment and acquisitions accounted for
$346,141,000 and $270,218,000, respectively, during 1997. Those same investing
activities accounted for $204,792,000 and $91,391,000, respectively, in 1996.
Financing activities used $784,360,000 and provided $95,107,000 during 1997 and
1996, respectively. The change is primarily due to the Company's use of proceeds
from the IHS sale to pay down outstanding indebtedness. Net borrowing
(reductions) proceeds for 1997 and 1996 were $(771,570,000) and $101,366,000,
respectively.
Net accounts receivable were $745,994,000 at December 31, 1997, compared to
$540,389,000 at December 31, 1996. The number of days of average annual revenues
in ending receivables was 75.8 at December 31, 1997, compared to 76.8 at
December 31, 1996. The concentration of net accounts receivable from patients,
third-party payors, insurance companies and others at December 31, 1997 was
consistent with the related concentration of revenues for the period then ended.
The Company has a $1,250,000,000 revolving credit facility with
NationsBank, N.A. ("NationsBank") and other participating banks (the "1996
Credit Agreement"). The 1996 Credit Agreement replaced a previous $1,000,000,000
revolving credit agreement, also with NationsBank. Interest is paid based on
LIBOR plus a predetermined margin, a base rate or competitively bid rates from
the participating
B-11
<PAGE>
banks. This credit facility has a maturity date of March 31, 2001. The Company
provided a negative pledge on all assets for the 1996 Credit Agreement. Pursuant
to the terms of the 1996 Credit Agreement, the Company has elected to convert
$350,000,000 of the $1,250,000,000 1996 Credit Agreement into a two-year
amortizing term note maturing on December 31, 1999. The Company has received a
$350,000,000 commitment from NationsBank for an additional 364-day facility (the
"Interim Revolving Credit Facility") which is on substantially the same terms as
the 1996 Credit Agreement. The effective interest rate on the average
outstanding balance under the 1996 Credit Agreement was 5.87% for the twelve
months ended December 31, 1997, compared to the average prime rate of 8.44%
during the same period. At December 31, 1997, the Company had drawn
$1,175,000,000 under the 1996 Credit Agreement. For further discussion, see Note
7 of "Notes to Consolidated Financial Statements".
In connection with the Horizon/CMS Acquisition, the Company obtained a
$1,250,000,000 Senior Bridge Credit Facility from NationsBank, N.A. and nine
other banks on substantially the same terms as the 1996 Credit Agreement. At the
time of the closing of the Horizon/CMS Acquisition, approximately $1,000,000,000
was drawn under the Senior Bridge Credit Facility, primarily to repay certain
existing indebtedness of Horizon/CMS. The Company repaid all amounts drawn as of
December 31, 1997 under the Senior Bridge Credit Facility upon the closing of
the sale of the Horizon/ CMS long-term care assets to IHS, thereby permanently
reducing the amount available thereunder to $500,000,000. The effective interest
rate on the average outstanding balance under the Senior Bridge Credit Facility
was 6.52% for the twelve months ended December 31, 1997 (see Note 7 of "Notes to
Consolidated Financial Statements").
In 1994, the Company issued $115,000,000 principal amount of 5% Convertible
Subordinated Debentures due 2001 (the "2001 Debentures"). The Company called the
2001 Debentures for redemption on April 1, 1997. Prior to the redemption date,
the holders of the 2001 Debentures surrendered substantially all of the 2001
Debentures for conversion into approximately 12,226,000 shares of the Company's
Common Stock.
On March 20, 1998, the Company issued $500,000,000 principal amount of
3.25% Convertible Subordinated Debentures due 2003 (the "2003 Debentures").
Proceeds from the sale of the 2003 Debentures were used to pay off all amounts
under the Senior Bridge Credit Facility and reduce outstanding amounts under the
1996 Credit Agreement. Effective with the sale of the Debentures, the Senior
Bridge Credit Facility was terminated.
The Company intends to pursue the acquisition or development of additional
healthcare operations, including outpatient rehabilitation facilities, inpatient
rehabilitation facilities, ambulatory surgery centers, outpatient diagnostic
centers and companies engaged in the provision of rehabilitation-related
services, and to expand certain of its existing facilities. While it is not
possible to estimate precisely the amounts which will actually be expended in
the foregoing areas, the Company anticipates that over the next twelve months,
it will spend approximately $100,000,000 on maintenance and expansion of its
existing facilities and approximately $300,000,000 on development of the
Integrated Service Model.
Although the Company is continually considering and evaluating acquisitions
and opportunities for future growth, the Company has not entered into any
agreements with respect to material future acquisitions. The Company believes
that existing cash, cash flow from operations and borrowings under the revolving
line of credit and the interim revolving credit facility will be sufficient to
satisfy the Company's estimated cash requirements for the next twelve months,
and for the reasonably foreseeable future. In addition, the Company expects to
explore other opportunities within the capital markets as a result of its
reduced leverage and investment grade rating.
Inflation in recent years has not had a significant effect on the Company's
business, and is not expected to adversely affect the Company in the future
unless it increases significantly.
EXPOSURES TO MARKET RISK
The Company is exposed to market risk related to changes in interest rates.
Because of its favorable borrowing arrangements and current market conditions,
the Company currently does not use derivatives, such as swaps or caps, to alter
the interest characteristics of its debt instruments and investment
B-12
<PAGE>
securities. The impact on earnings and value of market risk-sensitive financial
instruments (principally marketable security investments and long-term debt) is
subject to change as a result of movements in market rates and prices. The
Company uses sensitivity analysis models to evaluate these impacts.
The Company's investment in marketable securities was $4,326,000 at
December 31, 1997, which represents less than 0.1% of total assets at that date.
These securities are generally short-term, highly-liquid instruments and,
accordingly, their fair value approximates cost. Earnings on investments in
marketable securities are not significant to the Company's results of
operations, and therefore any changes in interest rates would have a minimal
impact on future pre-tax earnings.
With respect to the Company's interest-bearing liabilities, approximately
$1,175,000,000 in long-term debt at December 31, 1997 is subject to variable
rates of interest, while the remaining balance in long-term debt of $426,824,000
is subject to fixed rates of interest (see Note 7 of "Notes to Consolidated
Financial Statements for further description). The fair value of the Company's
total long-term debt, based on discounted cash flow analyses, approximates its
carrying value at December 31, 1997. Based on a hypothetical 1% increase in
interest rates, the potential losses in future pre-tax earnings would be
approximately $11,175,000. The impact of such a change on the carrying value of
long-term debt would not be significant. These amounts are determined
considering the impact of the hypothetical interest rates on the Company's
borrowing cost and long-term debt balances. These analyses do not consider the
effects, if any, of the potential changes in the overall level of economic
activity that could exist in such an environment. Further, in the event of a
change of significant magnitude, management would expect to take actions
intended to further mitigate its exposure to such change. Subsequent to December
31, the Company issued $500,000,000 in principal amount of the 2003 Debentures
(see Note 14 of "Notes to Consolidated Financial Statements"). The proceeds were
used to pay down existing variable-rate indebtedness, which will in effect
further reduce the Company's exposure to market risk related to interest rate
fluctuations.
Foreign operations, and the related market risks associated with foreign
currency, are currently insignificant to the Company's results of operations and
financial position.
COMPUTER TECHNOLOGIES AND YEAR 2000 COMPLIANCE
The Company is aware of the issues associated with the programming code in
existing computer systems as the year 2000 approaches. Many existing computer
programs use only two digits to identify a year in the date field. The issue is
whether such code exists in the Company's mission-critical applications and if
that code will produce accurate information with relation to date-sensitive
calculations after the turn of the century.
The Company has completed a thorough review of its material computer
applications and determined that such applications contain very few
date-sensitive calculations. The Company's computer applications are divided
into two categories, those maintained internally by the Company's Information
Technology Group and those maintained externally by the applications' vendors.
For internally maintained applications, revisions are currently being made and
are expected to be implemented by the first quarter of 1999. The Company expects
that the total cost associated with these revisions will be less than
$1,000,000. These costs will be primarily incurred during 1998 and be charged to
expense as incurred. For externally maintained systems, the Company has received
written confirmation from the vendors that each system is currently year 2000
compliant or will be made year 2000 compliant during 1998. The cost to be
incurred by the Company related to externally maintained systems is expected to
be minimal.
The Company has initiated a program to determine whether the computer
applications of its significant payors and suppliers will be upgraded in a
timely manner. The Company has not completed this review; however, initial
responses indicate that no significant problems are currently expected to arise.
The Company has also initiated a program to determine whether embedded
applications which control certain medical and other equipment will be affected.
The nature of the Company's business is such that any failure of these type
applications is not expected to have a material adverse effect on its business.
Because of the many uncertainties associated with year 2000 compliance
issues, and because the Company's assessment is necessarily based on information
from third party-vendors, payors and suppliers, there can be no assurance that
the Company's assessment is correct or as to the materiality or effect of any
failure of such assessment to be correct.
B-13
<PAGE>
FORWARD-LOOKING STATEMENTS
Statements contained in this Appendix B which are not historical facts are
forward-looking statements. In addition, the Company, through its senior
management, from time to time makes forward-looking public statements concerning
its expected future operations and performance and other developments. Such
forward-looking statements are necessarily estimates reflecting the Company's
best judgment based upon current information and involve a number of risks and
uncertainties, and there can be no assurance that other factors will not affect
the accuracy of such forward-looking statements. While is impossible to identify
all such factors, factors which could cause actual results to differ materially
from those estimated by the Company include, but are not limited to, changes in
the regulation of the healthcare industry at either or both of the federal and
state levels, changes in reimbursement for the Company's services by
governmental or private payors, competitive pressures in the healthcare industry
and the Company's response thereto, the Company's ability to obtain and retain
favorable arrangements with third-party payors, unanticipated delays in the
Company's implementation of its Integrated Service Model, general conditions in
the economy and capital markets, and other factors which may be identified from
time to time in the Company's Securities and Exchange Commission filings and
other public announcements.
B-14
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors
HEALTHSOUTH Corporation
We have audited the accompanying consolidated balance sheets of HEALTHSOUTH
Corporation and Subsidiaries as of December 31, 1996 and 1997, and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the three years in the period ended December 31, 1997. 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 in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
HEALTHSOUTH Corporation and Subsidiaries at December 31, 1996 and 1997, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997, in conformity with generally
accepted accounting principles.
ERNST & YOUNG LLP
Birmingham, Alabama
February 25, 1998, except for Note 14,
as to which the date is March 20, 1998
B-15
<PAGE>
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------
1996 1997
-------------- -------------
(IN THOUSANDS)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents (Note 3) ........................................ $ 150,071 $ 148,073
Other marketable securities (Note 3) ...................................... 3,760 4,326
Accounts receivable, net of allowances for
doubtful accounts of $75,360,000
in 1996 and $123,545,000 in 1997......................................... 540,389 745,994
Inventories ............................................................... 47,408 64,029
Prepaid expenses and other current assets ................................. 128,174 120,776
Deferred income taxes (Note 10) ........................................... 15,238 --
---------- ----------
Total current assets ....................................................... 885,040 1,083,198
Other assets:
Loans to officers ......................................................... 1,396 1,007
Assets held for sale (Note 9) ............................................. -- 60,400
Other (Note 4) ............................................................ 84,016 162,311
---------- ----------
85,412 223,718
Property, plant and equipment, net (Note 5) ................................ 1,464,833 1,850,765
Intangible assets, net (Note 6) ............................................ 1,094,421 2,243,372
---------- ----------
Total assets ............................................................... $3,529,706 $5,401,053
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable .......................................................... $ 116,451 $ 124,058
Salaries and wages payable ................................................ 67,793 121,768
Accrued interest payable and other liabilities ............................ 75,936 97,506
Income taxes payable ...................................................... 13,242 92,507
Deferred income taxes (Note 10) ........................................... -- 34,119
Current portion of long-term debt (Note 7) ................................ 47,089 46,489
---------- ----------
Total current liabilities .................................................. 320,511 516,447
Long-term debt (Note 7) .................................................... 1,513,054 1,555,335
Deferred income taxes (Note 10) ............................................ 51,790 76,613
Deferred revenue and other long-term liabilities ........................... 3,964 1,538
Minority interests-limited partnerships (Note 1) ........................... 71,286 93,692
Commitments and contingencies (Note 11) Stockholders' equity (Notes 8 and 12):
Preferred stock, $.10 par value--1,500,000 shares authorized;
issued and outstanding- none ............................................... -- --
Common stock, $.01 par value--500,000,000 shares authorized; issued--
326,493,000 in 1996 and 395,233,000 in 1997 ............................. 3,265 3,952
Additional paid-in capital ................................................ 1,060,012 2,317,821
Retained earnings ......................................................... 525,718 853,641
Treasury stock, at cost (182,000 shares in 1996 and 1997) ................. (323) (323)
Receivable from Employee Stock Ownership Plan ............................. (14,148) (12,247)
Notes receivable from stockholders ........................................ (5,423) (5,416)
---------- ----------
Total stockholders' equity ................................................. 1,569,101 3,157,428
---------- ----------
Total liabilities and stockholders' equity ................................. $3,529,706 $5,401,053
========== ==========
See accompanying notes.
</TABLE>
B-16
<PAGE>
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------
1995 1996 1997
------------- ------------- -------------
(IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
<S> <C> <C> <C>
Revenues ............................................... $2,118,681 $2,568,155 $3,017,269
Operating unit expenses ................................ 1,441,059 1,667,248 1,888,435
Corporate general and administrative expenses .......... 65,424 79,354 82,757
Provision for doubtful accounts ........................ 42,305 58,637 71,468
Depreciation and amortization .......................... 160,901 207,132 250,010
Merger and acquisition related expenses (Notes 2 and 9). 19,553 41,515 15,875
Loss on impairment of assets (Note 13) ................. 53,549 37,390 --
Interest expense ....................................... 105,517 98,751 111,504
Interest income ........................................ (8,009) (6,034) (4,414)
---------- ---------- ----------
1,880,299 2,183,993 2,415,635
---------- ---------- ----------
Income from continuing operations before
income taxes, minority interests and
extraordinary item ................................... 238,382 384,162 601,634
Provision for income taxes (Note 10) ................... 86,161 143,929 206,153
---------- ---------- ----------
152,221 240,233 395,481
Minority interests ..................................... 43,753 50,369 64,873
---------- ---------- ----------
Income from continuing operations before
extraordinary item .................................... 108,468 189,864 330,608
Loss from discontinued operations ...................... (1,162) -- --
Extraordinary item ( Note 2) ........................... (9,056) -- --
---------- ---------- ----------
Net income ............................................. $ 98,250 $ 189,864 $ 330,608
========== ========== ==========
Weighted average common shares outstanding ............. 289,594 321,367 346,872
========== ========== ==========
Net income per common share: ...........................
Continuing operations ................................. $ 0.37 $ 0.59 $ 0.95
Discontinued operations ............................... 0.00 -- --
Extraordinary item .................................... ( 0.03) -- --
---------- ---------- ----------
$ 0.34 $ 0.59 $ 0.95
========== ========== ==========
Weighted average common shares outstanding
- assuming dilution .................................. 320,018 349,033 365,546
========== ========== ==========
Net income per common share - assuming dilution:
Continuing operations ................................. $ 0.35 $ 0.55 $ 0.91
Discontinued operations ............................... 0.00 -- --
Extraordinary item .................................... ( 0.03) -- --
---------- ---------- ----------
$ 0.32 $ 0.55 $ 0.91
========== ========== ==========
See accompanying notes.
</TABLE>
B-17
<PAGE>
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
---------------------- PAID-IN
SHARES AMOUNT CAPITAL
----------- ---------- --------------
(IN THOUSANDS)
<S> <C> <C> <C>
Balance at December 31, 1994 ......................................... 145,029 $1,451 $ 607,024
Adjustment for ReLife Merger (Note 2) ................................ 2,732 27 7,114
Proceeds from exercise of options (Note 8) ........................... 1,136 11 10,218
Proceeds from issuance of common shares .............................. 15,232 152 334,896
Income tax benefits related to incentive stock options (Note 8) ...... -- -- 6,653
Reduction in receivable from ESOP .................................... -- -- --
Loans made to stockholders ........................................... -- -- --
Purchase of limited partnership units ................................ -- -- --
Purchases of treasury stock .......................................... -- -- --
Net income ........................................................... -- -- --
Translation adjustment ............................................... -- -- --
Dividends paid ....................................................... -- -- --
------- ------ ----------
Balance at December 31, 1995 ......................................... 164,129 1,641 965,905
Adjustment for Advantage Health Merger (Note 2) ...................... -- -- --
Adjustment for 1996 mergers (Note 2) ................................. 4,047 40 68,785
Proceeds from exercise of options (Note 8) ........................... 3,514 36 34,380
Income tax benefits related to incentive stock options (Note 8) ...... -- -- 23,767
Reduction in receivable from ESOP .................................... -- -- --
Payments received on stockholders' notes receivable .................. -- -- --
Purchase of limited partnership units ................................ -- -- --
Purchase of treasury stock ........................................... -- -- --
Retirement of treasury stock ......................................... (1,835) (18) (31,259)
Net income ........................................................... -- -- --
Translation adjustment ............................................... -- -- --
Dividends paid ....................................................... -- -- --
Stock split .......................................................... 156,638 1,566 (1,566)
------- ------ ----------
Balance at December 31, 1996 ......................................... 326,493 3,265 1,060,012
Common shares issued in connection with acquisitions (Note 9) ........ 46,245 462 996,068
Value of options exchanged in connection with the
Horizon/CMS acquisition (Note 9) .................................. -- -- 23,191
Common shares issued upon conversion of 5% Convertible
Subordinated Debentures due 2001 (Note 7) ............................ 12,226 122 113,050
Proceeds from exercise of options (Note 8) ........................... 10,269 103 58,921
Income tax benefits related to incentive stock options (Note 8) ...... -- -- 66,579
Reduction in receivable from ESOP .................................... -- -- --
Payments received on stockholders' notes receivable .................. -- -- --
Purchase of limited partnership units ................................ -- -- --
Net income ........................................................... -- -- --
Translation adjustment ............................................... -- -- --
------- ------ ----------
Balance at December 31, 1997 ......................................... 395,233 $3,952 $2,317,821
======= ====== ==========
<CAPTION>
TREASURY STOCK
RETAINED ------------------------- RECEIVABLE
EARNINGS SHARES AMOUNT FROM ESOP
------------ ----------- ------------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Balance at December 31, 1994 ......................................... $ 273,768 2,482 $ (22,367) $ (17,477)
Adjustment for ReLife Merger (Note 2) ................................ (3,734) -- -- --
Proceeds from exercise of options (Note 8) ........................... -- -- -- --
Proceeds from issuance of common shares .............................. -- -- -- --
Income tax benefits related to incentive stock options (Note 8) ...... -- -- -- --
Reduction in receivable from ESOP .................................... -- -- -- 1,591
Loans made to stockholders ........................................... -- -- -- --
Purchase of limited partnership units ................................ (4,767) -- -- --
Purchases of treasury stock .......................................... -- 588 (8,497) --
Net income ........................................................... 98,250 -- -- --
Translation adjustment ............................................... 247 -- -- --
Dividends paid ....................................................... (8,403) -- -- --
--------- ----- --------- ---------
Balance at December 31, 1995 ......................................... 355,361 3,070 (30,864) (15,886)
Adjustment for Advantage Health Merger (Note 2) ...................... (17,638) -- -- --
Adjustment for 1996 mergers (Note 2) ................................. (1,256) -- -- --
Proceeds from exercise of options (Note 8) ........................... -- -- -- --
Income tax benefits related to incentive stock options (Note 8) ...... -- -- -- --
Reduction in receivable from ESOP .................................... -- -- -- 1,738
Payments received on stockholders' notes receivable .................. -- -- -- --
Purchase of limited partnership units ................................ (83) -- -- --
Purchase of treasury stock ........................................... -- 89 (736) --
Retirement of treasury stock ......................................... -- (3,068) 31,277 --
Net income ........................................................... 189,864 -- -- --
Translation adjustment ............................................... 692 -- -- --
Dividends paid ....................................................... (1,222) -- -- --
Stock split .......................................................... -- 91 -- --
--------- ------ --------- ---------
Balance at December 31, 1996 ......................................... 525,718 182 (323) (14,148)
Common shares issued in connection with acquisitions (Note 9) ........ -- -- -- --
Value of options exchanged in connection with the
Horizon/CMS acquisition (Note 9) .................................... -- -- -- --
Common shares issued upon conversion of 5% Convertible
Subordinated Debentures due 2001 (Note 7) ........................... -- -- -- --
Proceeds from exercise of options (Note 8) ........................... -- -- -- --
Income tax benefits related to incentive stock options (Note 8) ...... -- -- -- --
Reduction in receivable from ESOP .................................... -- -- -- 1,901
Payments received on stockholders' notes receivable .................. -- -- -- --
Purchase of limited partnership units ................................ (2,465) -- -- --
Net income ........................................................... 330,608 -- -- --
Translation adjustment ............................................... (220) -- -- --
--------- ------ --------- ---------
Balance at December 31, 1997 ......................................... $ 853,641 182 $ (323) $ (12,247)
========= ====== ========= =========
<CAPTION>
NOTES
RECEIVABLE TOTAL
FROM STOCKHOLDERS'
STOCKHOLDERS EQUITY
------------- --------------
(IN THOUSANDS)
<S> <C> <C>
Balance at December 31, 1994 ......................................... $ (5,240) $ 837,159
Adjustment for ReLife Merger (Note 2) ................................ -- 3,407
Proceeds from exercise of options (Note 8) ........................... -- 10,229
Proceeds from issuance of common shares .............................. -- 335,048
Income tax benefits related to incentive stock options (Note 8) ...... -- 6,653
Reduction in receivable from ESOP .................................... -- 1,591
Loans made to stockholders ........................................... (1,231) (1,231)
Purchase of limited partnership units ................................ -- (4,767)
Purchases of treasury stock .......................................... -- (8,497)
Net income ........................................................... -- 98,250
Translation adjustment ............................................... -- 247
Dividends paid ....................................................... -- (8,403)
-------- ----------
Balance at December 31, 1995 ......................................... (6,471) 1,269,686
Adjustment for Advantage Health Merger (Note 2) ...................... -- (17,638)
Adjustment for 1996 mergers (Note 2) ................................. -- 67,569
Proceeds from exercise of options (Note 8) ........................... -- 34,416
Income tax benefits related to incentive stock options (Note 8) ...... -- 23,767
Reduction in receivable from ESOP .................................... -- 1,738
Payments received on stockholders' notes receivable .................. 1,048 1,048
Purchase of limited partnership units ................................ -- (83)
Purchase of treasury stock ........................................... -- (736)
Retirement of treasury stock ......................................... -- --
Net income ........................................................... -- 189,864
Translation adjustment ............................................... -- 692
Dividends paid ....................................................... -- (1,222)
Stock split .......................................................... -- --
-------- ----------
Balance at December 31, 1996 ......................................... (5,423) 1,569,101
Common shares issued in connection with acquisitions (Note 9) ........ -- 996,530
Value of options exchanged in connection with the
Horizon/CMS acquisition (Note 9) ..................................... -- 23,191
Common shares issued upon conversion of 5% Convertible Subordi-
nated Debentures due 2001 (Note 7) .................................. -- 113,172
Proceeds from exercise of options (Note 8) ........................... -- 59,024
Income tax benefits related to incentive stock options (Note 8) ...... -- 66,579
Reduction in receivable from ESOP .................................... -- 1,901
Payments received on stockholders' notes receivable .................. 7 7
Purchase of limited partnership units ................................ -- (2,465)
Net income ........................................................... -- 330,608
Translation adjustment ............................................... -- (220)
-------- ----------
Balance at December 31, 1997 ......................................... $ (5,416) $3,157,428
======== ==========
</TABLE>
See accompanying notes.
B-18
<PAGE>
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------
1995 1996 1997
------------ ------------- ---------------
(IN THOUSANDS)
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income ...................................................................... $ 98,250 $ 189,864 $ 330,608
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization .................................................. 160,901 207,132 250,010
Provision for doubtful accounts ................................................ 42,305 58,637 71,468
Provision for losses on impairment of assets ................................... 53,549 37,390 --
Merger and acquisition related expenses ........................................ 19,553 41,515 15,875
Loss on extinguishment of debt ................................................. 14,606 -- --
Income applicable to minority interests of limited partnerships ................ 43,753 50,369 64,873
Provision for deferred income taxes ............................................ 396 14,308 12,520
Provision for deferred revenue ................................................. (1,990) (1,255) (406)
Changes in operating assets and liabilities, net of effects of acquisitions:
Accounts receivable ........................................................... (69,754) (141,323) (196,623)
Inventories, prepaid expenses and other current assets ........................ 1,370 (35,084) 20,092
Accounts payable and accrued expenses ......................................... (12,880) (33,208) (152,569)
---------- ---------- ------------
Net cash provided by operating activities ....................................... 350,059 388,345 415,848
INVESTING ACTIVITIES
Purchases of property, plant and equipment ...................................... (183,867) (204,792) (346,141)
Proceeds from sale of property, plant and equipment ............................. 16,026 -- --
Proceeds from sale of non-strategic assets ...................................... -- -- 1,136,571
Additions to intangible assets, net of effects of acquisitions .................. (117,900) (175,380) (61,887)
Assets obtained through acquisitions, net of liabilities assumed ................ (517,773) (91,391) (270,218)
Changes in other assets ......................................................... (6,963) (14,214) (91,245)
Proceeds received on sale of other marketable securities ........................ 22,513 584 773
Investments in other marketable securities ...................................... (11,304) -- (1,339)
---------- ---------- ------------
Net cash (used in) provided by investing activities ............................. (799,268) (485,193) 366,514
FINANCING ACTIVITIES
Proceeds from borrowings ........................................................ 721,973 205,873 1,763,243
Principal payments on long-term debt ............................................ (502,152) (104,507) (2,534,813)
Early retirement of debt ........................................................ (14,606) -- --
Proceeds from exercise of options ............................................... 10,083 34,415 59,024
Proceeds from issuance of common stock .......................................... 330,954 -- --
Purchase of treasury stock ...................................................... (8,497) (736) --
Reduction in receivable from ESOP ............................................... 1,591 1,738 1,901
(Loans made to) payments received from stockholders ............................. (1,231) 1,048 7
Dividends paid .................................................................. (8,403) (1,222) --
Proceeds from investment by minority interests .................................. 1,103 510 2,572
Purchase of limited partnership units ........................................... (10,076) (3,064) (2,685)
Payment of cash distributions to limited partners ............................... (36,697) (38,948) (73,609)
---------- ---------- ------------
Net cash provided by (used in) financing activities ............................. 484,042 95,107 (784,360)
---------- ---------- ------------
Increase (decrease) in cash and cash equivalents ................................ 34,833 (1,741) (1,998)
Cash and cash equivalents at beginning of year (Note 2) ......................... 116,121 155,449 150,071
---------- ---------- ------------
Cash flows related to mergers (Note 2) .......................................... 4,495 (3,637) --
---------- ---------- ------------
Cash and cash equivalents at end of year ........................................ $ 155,449 $ 150,071 $ 148,073
========== ========== ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the year for:
Interest ....................................................................... $ 103,973 $ 97,024 $ 112,223
Income taxes ................................................................... 85,714 67,975 137,778
</TABLE>
Non-cash investing activities:
The Company assumed liabilities of $84,820,000, $19,197,000 and $
1,153,825,000 during the years ended December 31, 1995, 1996 and 1997,
respectively, in connection with its acquisitions.
During the year ended December 31, 1996, the Company issued approximately
8,095,000 common shares as consideration for mergers (see Note 2).
During the year ended December 31, 1997, the Company issued 46,245,000 common
shares with a market value of $996,530,000 as consideration for acquisitions
accounted for as purchases.
Non-cash financing activities:
During 1995 and 1997, the Company effected two-for-one stock splits of its
common stock which were effected in the form of 100% stock dividends.
The Company received a tax benefit from the disqualifying disposition of
incentive stock options of $6,653,000, $23,767,000 and $66,579,000 for the
years ended December 31, 1995, 1996 and 1997, respectively.
During 1997, the holders of the Company's $115,000,000 in aggregate principal
amount of 5% Convertible Subordinated Debentures due 2001 surrendered the
Debentures for conversion into approximately 12,226,000 shares of the
Company's Common Stock.
See accompanying notes.
B-19
<PAGE>
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
1. SIGNIFICANT ACCOUNTING POLICIES
The significant accounting policies followed by HEALTHSOUTH Corporation and
its subsidiaries ("the Company") are presented as an integral part of the
consolidated financial statements.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of HEALTHSOUTH
Corporation ("HEALTHSOUTH") and its wholly-owned subsidiaries, as well as its
majority ownership or controlling interest in limited partnerships and limited
liability companies. All significant intercompany accounts and transactions have
been eliminated in consolidation.
HEALTHSOUTH is engaged in the business of providing comprehensive
rehabilitative, clinical, diagnostic and surgical healthcare services on an
inpatient and outpatient basis, primarily in the United States.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the accompanying consolidated
financial statements and notes. Actual results could differ from those
estimates.
MARKETABLE SECURITIES
Marketable securities and debt securities are classified as
available-for-sale. Available-for-sale securities are carried at fair value,
with the unrealized gains and losses, if material, reported as a separate
component of stockholders' equity, net of tax. The cost of the specific security
sold method is used to compute gain or loss on the sale of securities. Interest
and dividends on securities classified as available-for-sale are included in
interest income. Marketable securities and debt securities held by the Company
have maturities of less than one year.
ACCOUNTS RECEIVABLE AND THIRD-PARTY REIMBURSEMENT ACTIVITIES
Receivables from patients, insurance companies and third-party contractual
insured accounts (Medicare and Medicaid) are based on payment agreements which
generally result in the Company's collecting an amount different from the
established rates. Net third-party settlement receivables included in accounts
receivable were $21,138,000 and $36,759,000 at December 31, 1996 and 1997,
respectively. Final determination of the settlement is subject to review by
appropriate authorities. The differences between original estimates made by the
Company and subsequent revisions (including final settlement) were not material
to the operations of the Company. Adequate allowances are provided for doubtful
accounts and contractual adjustments. Uncollectible accounts are written off
against the allowance for doubtful accounts after adequate collection efforts
are made. Net accounts receivable include only those amounts estimated by
management to be collectible.
The concentration of net accounts receivable from third-party contractual
payors and others, as a percentage of total net accounts receivable, was as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1996 1997
-------- --------
<S> <C> <C>
Medicare ......... 26% 25%
Medicaid ......... 5 4
Other ............ 69 71
-- --
100% 100%
=== ===
</TABLE>
B-20
<PAGE>
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
INVENTORIES
Inventories are stated at the lower of cost or market using the specific
identification method.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost. Upon sale or retirement
of property, plant or equipment, the cost and related accumulated depreciation
are eliminated from the respective account and the resulting gain or loss is
included in the results of operations.
Interest cost incurred during the construction of a facility is
capitalized. The Company incurred interest of $108,382,000, $102,694,000 and
$113,995,000, of which $2,865,000, $3,943,000 and $2,491,000 was capitalized,
during 1995, 1996 and 1997, respectively.
Depreciation and amortization is computed using the straight-line method
over the estimated useful lives of the assets or the term of the lease, as
appropriate. The estimated useful life of buildings is 30-40 years and the
general range of useful lives for leasehold improvements, furniture, fixtures
and equipment is 10-15 years.
INTANGIBLE ASSETS
Cost in excess of net asset value of purchased facilities is amortized over
20 to 40 years using the straight-line method. Organization and partnership
formation costs are deferred and amortized on a straight-line basis over a
period of 36 months. Organization, partnership formation and start-up costs for
a project that is subsequently abandoned are charged to operations in that
period. Debt issue costs are amortized over the term of the debt. Noncompete
agreements are amortized using the straight-line method over the term of the
agreements.
Effective July 1, 1997, the Company began expensing amounts reflecting the
costs of implementing its clinical and administrative programs and protocols at
acquired facilities in the period in which such costs are incurred. Previously,
the Company had capitalized such costs and amortized them over 36 months. Such
costs at June 30, 1997 aggregated $64,643,000, net of accumulated amortization.
These capitalized costs will be amortized in accordance with the Company's
existing policy and will be fully amortized by June 2000.
Through June 30, 1997, the Company has assigned value to and capitalized
organization and partnership formation costs which have been incurred by the
Company or obtained by the Company in acquisitions accounted for as purchases.
Effective July 1, 1997, the Company no longer assigned value to organization and
partnership formation costs obtained in acquisitions accounted for as purchases
except to the extent that objective evidence exists that such costs will provide
future economic benefits to the Company after the acquisition. Such organization
and partnership formation costs at June 30, 1997 which were obtained by the
Company in purchase transactions aggregated $8,380,000, net of accumulated
amortization. Such costs at June 30 will be amortized in accordance with the
Company's existing policy and will be fully amortized by June 2000.
MINORITY INTERESTS
The equity of minority investors in limited partnerships and limited
liability companies of the Company is reported on the consolidated balance
sheets as minority interests. Minority interests reported in the consolidated
income statements reflect the respective interests in the income or loss of the
limited partnerships or limited liability companies attributable to the minority
investors (ranging from 1% to 50% at December 31, 1997), the effect of which is
removed from the results of operations of the Company.
B-21
<PAGE>
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
REVENUES
Revenues include net patient service revenues and other operating revenues.
Other operating revenues include cafeteria revenue, gift shop revenue, rental
income, trainer/contract revenue, management and administrative fee revenue
(related to non-consolidated subsidiaries and affiliates) and transcriptionist
fees which are insignificant to total revenues. Net patient service revenues are
reported at the estimated net realizable amounts from patients, third-party
payors and others for services rendered, including estimated retroactive
adjustments under reimbursement agreements with third-party payors.
INCOME PER COMMON SHARE
In 1997, the Financial Accounting Standards Board issued Statement No. 128,
"Earnings per Share". Statement 128 replaced the calculation of primary and
diluted earnings per share with basic and diluted earnings per share. Unlike
primary earnings per share, basic earnings per share excludes any dilutive
effects of options, warrants and convertible securities. Diluted earnings per
share is similar to the previously reported fully diluted earnings per share.
All earnings per share amounts for all periods have been presented, and where
appropriate, restated to conform to the Statement 128 requirements.
The following table sets forth the computation of basic and diluted
earnings per share:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
1995 1996 1997
-------------- -------------- --------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
Numerator:
Income from continuing operations before extraordinary item....... $ 108,468 $ 189,864 $ 330,608
---------- ---------- ----------
Numerator for basic earnings per share--income available to
common stockholders ............................................ 108,468 189,864 330,608
Effect of dilutive securities:
Elimination of interest and amortization on 5% Convertible
Subordinated Debentures due 2001, less the related effect of
the provision for income taxes ................................. 3,826 3,839 968
---------- ---------- ----------
Numerator for diluted earnings per share-income available to
common stockholders after assumed conversion ................... $ 112,294 $ 193,703 $ 331,576
========== ========== ==========
Denominator:
Denominator for basic earnings per share - weighted-average
shares ......................................................... 289,594 321,367 346,872
Effect of dilutive securities:
Net effect of dilutive stock options ........................... 18,198 15,440 15,617
Assumed conversion of 5% Convertible Subordinated De-
bentures due 2001 ............................................. 12,226 12,226 3,057
---------- ---------- ----------
Dilutive potential common shares ............................... 30,424 27,666 18,674
---------- ---------- ----------
Denominator of diluted earnings per share - adjusted
weighted-average shares and assumed conversions ............... 320,018 349,033 365,546
========== ========== ==========
Basic earnings per share .......................................... $ 0.37 $ 0.59 $ 0.95
========== ========== ==========
Diluted earnings per share ........................................ $ 0.35 $ 0.55 $ 0.91
========== ========== ==========
</TABLE>
B-22
<PAGE>
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
IMPAIRMENT OF ASSETS
The Company records impairment losses on long-lived assets used in
operations when events and circumstances indicate that the assets might be
impaired and the undiscounted cash flows estimated to be generated by those
assets are less than the carrying amounts of those assets.
With respect to the carrying value of the excess of cost over net asset
value of purchased facilities and other intangible assets, the Company
determines on a quarterly basis whether an impairment event has occurred by
considering factors such as the market value of the asset; a significant adverse
change in legal factors or in the business climate; adverse action by a
regulator; a history of operating or cash flow losses; or a projection of
continuing losses associated with an operating entity. The carrying value of
excess cost over net asset value of purchased facilities and other intangible
assets will be evaluated if the facts and circumstances suggest that it has been
impaired. If this evaluation indicates that the value of the asset will not be
recoverable, as determined based on the undiscounted cash flows of the entity
acquired over the remaining amortization period, an impairment loss is
calculated based on the excess of the carrying amount of the asset over the
asset's fair value.
SELF-INSURANCE
The Company is self-insured for professional liability and comprehensive
general liability. Liabilities for asserted and unasserted claims are accrued
based upon specific claims and incidents and the claims history of the Company.
The reserves for estimated liabilities for asserted and unasserted claims, which
are not material in relation to the Company's consolidated financial position at
December 31, 1996 and 1997, are included with accrued interest payable and other
liabilities in the accompanying consolidated balance sheets.
RECLASSIFICATIONS
Certain amounts in 1995 and 1996 financial statements have been
reclassified to conform with the 1997 presentation. Such reclassifications had
no effect on previously reported consolidated financial position and
consolidated net income.
FOREIGN CURRENCY TRANSLATION
The Company translates the assets and liabilities of its foreign
subsidiaries stated in local functional currencies to U.S. dollars at the rates
of exchange in effect at the end of the period. Revenues and expenses are
translated using rates of exchange in effect during the period. Gains and losses
from currency translation are included in stockholders' equity. Currency
transaction gains or losses are recognized in current operations and have not
been significant to the Company's operating results in any period.
B-23
<PAGE>
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED )
2. MERGERS
Effective June 13, 1995, a wholly-owned subsidiary of the Company merged
with Surgical Health Corporation ("SHC") and in connection therewith the Company
issued 17,062,960 shares of its common stock in exchange for all of SHC's common
and preferred stock. Prior to the merger, SHC operated a network of 36
freestanding surgery centers and five mobile lithotripters in eleven states,
with an aggregate of 156 operating and procedure rooms. Costs and expenses of
approximately $4,588,000 incurred by the Company in connection with the SHC
merger have been recorded in operations during 1995 and reported as merger
expenses in the accompanying consolidated statements of income. Fees related to
legal, accounting and financial advisory services accounted for $3,400,000 of
the expense. Costs related to employee separations were approximately
$1,188,000. Also in connection with the SHC Merger, the Company recognized a
$14,606,000 extraordinary loss as a result of the retirement of the SHC Notes
(see Note 7). The extraordinary loss consisted primarily of the associated debt
discount plus premiums and costs associated with the retirement, and is reported
net of income tax benefits of $5,550,000.
Effective October 26, 1995, a wholly-owned subsidiary of the Company merged
with Sutter Surgery Centers, Inc. ("SSCI"), and in connection therewith, the
Company issued 3,552,002 shares of its common stock in exchange for all of
SSCI's outstanding common stock. Prior to the merger, SSCI operated a network of
12 freestanding surgery centers in three states, with an aggregate of 54
operating and procedure rooms. Costs and expenses of approximately $4,965,000,
primarily legal, accounting and financial advisory fees, incurred by the Company
in connection with the SSCI merger have been recorded in operations during 1995
and reported as merger expenses in the accompanying consolidated statements of
income.
Effective January 17, 1996, a wholly-owned subsidiary of the Company merged
with Surgical Care Affiliates, Inc. ("SCA"), and in connection therewith the
Company issued 91,856,678 shares of its common stock in exchange for all of
SCA's outstanding common stock. Prior to the merger, SCA operated 67 surgery
centers in 24 states. Costs and expenses of approximately $19,727,000, primarily
legal, accounting and financial advisory fees, incurred by the Company in
connection with the SCA merger have been recorded in operations during 1996 and
recorded as merger expenses in the accompanying consolidated statements of
income.
Effective March 14, 1996, a wholly-owned subsidiary of the Company merged
with Advantage Health Corporation ("Advantage Health"), and in connection
therewith the Company issued 18,203,978 shares of its common stock in exchange
for all of Advantage Health's outstanding common stock. Prior to the merger,
Advantage Health operated a network of 136 sites of service, including four
freestanding rehabilitation hospitals, one freestanding multi-use hospital, one
nursing home, 68 outpatient rehabilitation facilities, 14 inpatient managed
rehabilitation units, 24 rehabilitation services management contracts and six
managed subacute rehabilitation units. Costs and expenses of approximately
$9,212,000, primarily legal, accounting and financial advisory fees, incurred by
the Company in connection with the Advantage Health merger have been recorded in
operations during 1996 and reported as merger expenses in the accompanying
consolidated statements of income.
Effective March 3, 1997, a wholly-owned subsidiary of the Company merged
with Health Images, Inc. ("Health Images"), and in connection therewith the
Company issued 10,343,470 shares of its common stock in exchange for all of
Health Images' outstanding common stock. Prior to the merger, Health Images
operated 49 freestanding diagnostic imaging centers in 13 states and six in the
United Kingdom. Costs and expenses of approximately $15,875,000, primarily
legal, accounting and financial advisory fees, incurred by the Company in
connection with the Health Images merger have been recorded in operations during
1997 and reported as merger expenses in the accompanying consolidated statements
of income.
B-24
<PAGE>
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
2. MERGERS - (CONTINUED)
The mergers of the Company with SHC, SSCI, SCA, Advantage Health and Health
Images were accounted for as poolings of interests and, accordingly, the
Company's consolidated financial statements have been restated to include the
results of the acquired companies for all periods presented. There were no
material transactions between the Company, SHC, SSCI, SCA, Advantage Health and
Health Images prior to the mergers. The effects of conforming the accounting
policies of the combined companies are not material.
Combined and separate results of the Company and its 1997 merger with
Health Images are as follows (in thousands):
<TABLE>
<CAPTION>
HEALTH
HEALTHSOUTH IMAGES COMBINED
------------- ------------ --------------
<S> <C> <C> <C>
Year ended December 31, 1995
Revenues .................. $ 2,003,146 $ 115,535 $ 2,118,681
Net income ................ 92,521 5,729 98,250
Year ended December 31, 1996
Revenues .................. $ 2,436,537 $ 131,618 $ 2,568,155
Net income (loss) ......... 220,818 (30,954) 189,864
Year ended December 31, 1997
Revenues .................. $ 2,995,782 $ 21,487 $ 3,017,269
Net income ................ 327,206 3,402 330,608
</TABLE>
Prior to its merger with the Company, Advantage Health reported on a fiscal
year ending on August 31. Accordingly, the historical financial statements of
Advantage Health have been recast to a November 30 fiscal year end to more
closely conform to the Company's calendar fiscal year end. The restated
financial statements for all periods prior to and including December 31, 1995
are based on a combination of the Company's results for its December 31 fiscal
year and Advantage Health's results for its recast November 30 fiscal year.
Beginning January 1, 1996, all facilities acquired in the Advantage Health
merger adopted a December 31 fiscal year end; accordingly, all consolidated
financial statements for periods after December 31, 1995 are based on a
consolidation of all of the Company's subsidiaries on a December 31 year end.
Advantage Health's historical results of operations for the one month ended
December 31, 1995 are not included in the Company's consolidated statements of
income or cash flows. An adjustment has been made to stockholders' equity as of
January 1, 1996 to adjust for the effect of excluding Advantage Health's results
of operations for the one month ended December 31, 1995. The following is a
summary of Advantage Health's results of operations and cash flows for the one
month ended December 31, 1995 (in thousands):
<TABLE>
<S> <C>
Statement of Income Data:
Revenues .............................................. $16,111
Operating unit expenses ............................... 14,394
Corporate general and administrative expenses ......... 1,499
Provision for doubtful accounts ....................... 1,013
Depreciation and amortization ......................... 283
Loss on impairment of assets .......................... 21,111
Interest expense ...................................... 288
Interest income ....................................... (16)
-------
38,572
-------
</TABLE>
B-25
<PAGE>
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
2. MERGERS - (CONTINUED)
<TABLE>
<S> <C>
Loss before income taxes and minority interests ......... (22,461)
Benefit for income taxes ................................ (4,959)
Minority interests ...................................... 136
-------
Net loss ................................................ $ (17,638)
=========
Statement of Cash Flow Data:
Net cash used in operating activities ................... $ (2,971)
Net cash provided by investing activities ............... 105
Net cash used in financing activities ................... (771)
---------
Net decrease in cash .................................... $ (3,637)
=========
</TABLE>
In December 1995, Advantage Health recorded an asset impairment charge of
approximately $21,111,000 relating to goodwill and tangible assets identifiable
with one inpatient rehabilitation hospital, one subacute facility and 32
outpatient rehabilitation centers, all acquired by the Company in the Advantage
Health merger. The Company intends to operate these facilities on an ongoing
basis.
The Company has historically assessed recoverability of goodwill and other
long-lived assets using undiscounted cash flows estimated to be received over
the useful lives of the related assets. In December 1995, certain events
occurred which significantly impacted the Company's estimates of future cash
flows to be received from the facilities described above. Those events primarily
related to a decline in operating results combined with a deterioration in the
reimbursement environment at these facilities. As a result of these events, the
Company revised its estimates of undiscounted cash flows to be received over the
remaining estimated useful lives of these facilities and determined that
goodwill and other long-lived assets (primarily property and equipment) had been
impaired. The Company developed its best estimates of future operating cash
flows at these locations, considering future requirements for capital
expenditures as well as the impact of inflation. The projections of cash flows
also took into account estimates of significant one-time expenses as well as
estimates of additional revenues and resulting income from future marketing
efforts in the respective locations. The amount of the impairment charge was
determined by discounting the estimates of future cash flows, using an estimated
8.5% incremental borrowing rate, which management believes is commensurate with
the risks involved. The resulting net present value of future cash flows was
then compared to the historical net book value of goodwill and other long-lived
assets at each operating location, which resulted in an impairment loss relative
to these centers of $21,111,000.
During 1996, wholly-owned subsidiaries of the Company merged with
Professional Sports Care Management, Inc. ("PSCM"), Fort Sutter Surgery Center,
Inc. ("FSSCI") and ReadiCare, Inc. ("ReadiCare"). In connection with these
mergers the Company issued an aggregate of 8,094,598 shares of its common stock.
Costs and expenses of approximately $12,576,000, primarily legal, accounting and
financial advisory fees, incurred by the Company in connection with the mergers
have been recorded in operations during 1996 and reported as merger expenses in
the accompanying consolidated statements of income.
The PSCM and ReadiCare mergers were accounted for as poolings of interests.
However, due to the immateriality of these mergers, the Company's historical
financial statements for all periods prior to the quarters in which the
respective mergers were completed have not been restated. Instead, stockholders'
equity has been increased by $43,230,000 to reflect the effects of the PSCM
merger and $15,431,000 to reflect the effects of the ReadiCare merger. The
results of operations of PSCM and ReadiCare are included in the accompanying
financial statements from the date of acquisition forward. In addition, the
FSSCI merger was a stock-for-stock acquisition. Stockholders' equity has been
increased by $8,908,000 to reflect the effects of the merger.
B-26
<PAGE>
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED )
3. CASH, CASH EQUIVALENTS AND OTHER MARKETABLE SECURITIES
Cash, cash equivalents and other marketable securities consisted of the
following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1996 1997
------------ ------------
(IN THOUSANDS)
<S> <C> <C>
Cash .................................................... $ 140,278 $ 135,399
Cash equivalents ........................................ 9,793 12,674
--------- ---------
Total cash and cash equivalents ....................... 150,071 148,073
Certificates of deposit ................................. 1,765 1,256
Municipal put bonds ..................................... 495 1,570
Municipal put bond mutual funds ......................... 500 500
Collateralized mortgage obligations ..................... 1,000 1,000
--------- ---------
Total other marketable securities ....................... 3,760 4,326
--------- ---------
Total cash, cash equivalents and other marketable securi-
ties (approximates market value) ...................... $ 153,831 $ 152,399
========= =========
</TABLE>
For purposes of the consolidated balance sheets and statements of cash
flows, marketable securities purchased with an original maturity of ninety days
or less are considered cash equivalents.
4. OTHER ASSETS
Other assets consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1996 1997
----------- -----------
(IN THOUSANDS)
<S> <C> <C>
Notes receivable ............................... $ 38,359 $ 70,655
Investment in Caretenders Health Corp. ......... 7,370 7,809
Prepaid long-term lease ........................ 8,397 9,190
Other equity investments ....................... 15,362 37,027
Real estate investments ........................ 10,020 21,911
Trusteed funds ................................. 1,879 921
Other .......................................... 2,629 14,798
-------- ---------
$ 84,016 $ 162,311
======== =========
</TABLE>
The Company has a 19% ownership interest in Caretenders Health Corp.
("Caretenders") which is being accounted for using the equity method of
accounting. The investment was initially valued at $7,250,000. The Company's
equity in earnings of Caretenders for the years ended December 31, 1995, 1996
and 1997 was not material to the Company's consolidated results of operations.
It was not practicable to estimate the fair value of the Company's various
other equity investments (involved in operations similar to those of the
Company) because of the lack of a quoted market price and the inability to
estimate fair value without incurring excessive costs. The carrying amount at
December 31, 1997 represents the original cost of the investments, which
management believes is not impaired.
B-27
<PAGE>
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED )
5. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1996 1997
------------ -------------
(IN THOUSANDS)
<S> <C> <C>
Land .............................................................. $ 93,631 $ 112,944
Buildings ......................................................... 844,775 1,030,849
Leasehold improvements ............................................ 112,149 186,003
Furniture, fixtures and equipment ................................. 801,443 1,044,374
Construction-in-progress .......................................... 73,815 32,426
---------- ----------
1,925,813 2,406,596
Less accumulated depreciation and amortization .................... 460,980 555,831
---------- ----------
$1,464,833 $1,850,765
========== ==========
</TABLE>
6. INTANGIBLE ASSETS
Intangible assets consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
1996 1997
-------------- --------------
(IN THOUSANDS)
<S> <C> <C>
Organizational, partnership formation and start-up costs
(see Note 1) .................................................... $ 238,126 $ 255,810
Debt issue costs .................................................. 34,905 33,114
Noncompete agreements ............................................. 86,566 121,581
Cost in excess of net asset value of purchased facilities ......... 947,104 2,103,085
----------- -----------
1,306,701 2,513,590
Less accumulated amortization ..................................... 212,280 270,218
----------- -----------
$ 1,094,421 $ 2,243,372
=========== ===========
</TABLE>
7. LONG-TERM DEBT
Long-term debt consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1996 1997
------------ --------------
(IN THOUSANDS)
<S> <C> <C>
Notes and bonds payable:
Advances under a $1,250,000,000 credit agreement with banks.......... $ 995,000 $ 1,175,000
9.5% Senior Subordinated Notes due 2001 ............................. 250,000 250,000
5.0% Convertible Subordinated Debentures due 2001 ................... 115,000 --
Notes payable to banks and various other notes payable, at interest
rates from 5.5% to 14.9% .......................................... 151,384 114,899
Hospital revenue bonds payable ...................................... 22,503 14,836
Noncompete agreements payable with payments due at intervals
ranging through December 2004 ..................................... 26,256 47,089
---------- -----------
1,560,143 1,601,824
Less amounts due within one year .................................... 47,089 46,489
---------- -----------
$1,513,054 $ 1,555,335
========== ===========
</TABLE>
B-28
<PAGE>
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
7. LONG-TERM DEBT - (CONTINUED)
The fair value of total long-term debt approximates book value at December
31, 1996 and 1997. The fair values of the Company's long-term debt are estimated
using discounted cash flow analysis, based on the Company's current incremental
borrowing rates for similar types of borrowing arrangements.
During 1995, the Company entered into a Credit Agreement with NationsBank,
N.A. ("NationsBank") and other participating banks (the "1995 Credit Agreement")
which consisted of a $1,000,000,000 revolving credit facility. On April 18,
1996, the Company amended and restated the 1995 Credit Agreement to increase the
size of the revolving credit facility to $1,250,000,000 (the "1996 Credit
Agreement"). Interest is paid based on LIBOR plus a predetermined margin, a base
rate, or competitively bid rates from the participating banks. The Company is
required to pay a fee on the unused portion of the revolving credit facility
ranging from 0.08% to 0.25%, depending on certain defined ratios. The principal
amount is payable in full on March 31, 2001 (see also Note 14). The Company
provided a negative pledge on all assets for the 1996 Credit Agreement and the
lenders released the first priority security interest in all shares of stock of
the Company's subsidiaries and rights and interests in the Company's controlled
partnerships which had been granted under the 1995 Credit Agreement. At December
31, 1997, the effective interest rate associated with the 1996 Credit Agreement
was approximately 6.13%.
In connection with the Horizon/CMS acquisition in 1997 (see Note 9), the
Company entered into a Bridge Credit Agreement with NationsBank and other banks
(the "Bridge Credit Agreement") which provided for a $1,250,000,000 Senior
Bridge Loan Facility on substantially the same terms as the 1996 Credit
Agreement. At the time of the closing of Horizon/CMS acquisition, approximately
$1,000,000,000 was drawn under the Senior Bridge Credit Facility, primarily to
repay certain existing indebtedness of Horizon/CMS. The Company repaid all
amounts drawn under the Bridge Credit Agreement upon the closing of the sale of
the Horizon/CMS long-term care assets to Integrated Health Services, Inc. on
December 31, 1997 (see Note 9), thereby permanently reducing the amount
available thereunder to $500,000,000. Any amounts drawn under the Bridge Credit
Agreement are payable in full on October 31, 1998.
On March 24, 1994, the Company issued $250,000,000 principal amount of 9.5%
Senior Subordinated Notes due 2001 (the "Notes"). Interest is payable on April 1
and October 1. The Notes are senior subordinated obligations of the Company and
as such are subordinated to all existing and future senior indebtedness of the
Company, and also are effectively subordinated to all existing and future
liabilities of the Company's subsidiaries and partnerships. The Notes rank
senior to all subordinated indebtedness of the Company. The Notes mature on
April 1, 2001.
Also on March 24, 1994, the Company issued $100,000,000 principal amount of
5% Convertible Subordinated Debentures due 2001 (the "Convertible Debentures").
An additional $15,000,000 of Convertible Debentures was issued in April 1994 to
cover underwriters' over allotments. Interest is payable on April 1 and October
1. The Convertible Debentures were convertible into Common Stock of the Company
at the option of the holder at a conversion price of $9.406 per share, subject
to adjustment in the occurrence of certain events. Substantially all of the
Convertible Debentures were converted into approximately 12,226,000 shares of
the Company's Common Stock on or prior to April 1, 1997.
In June 1994, SHC (see Note 2) issued $75,000,000 principal amount of 11.5%
Senior Subordinated Notes due July 15, 2004 (the "SHC Notes"). The proceeds of
the SHC Notes were used to pay down indebtedness outstanding under other
existing credit facilities. During 1995, the Company purchased $67,500,000 of
the $75,000,000 outstanding principal amount of the SHC Notes in a tender offer
at 115% of the face value of the Notes, and the remaining $7,500,000 balance was
purchased on the open market, using proceeds from the Company's other long-term
credit facilities. The loss on retirement of the SHC Notes totaled approximately
$14,606,000. The loss consists of the premium, write-off of unamortized bond
issue costs and other fees and is reported as an extraordinary loss on early
extinguishment of debt in the accompanying 1995 consolidated statement of income
(see Note 2).
B-29
<PAGE>
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
7. LONG-TERM DEBT - (CONTINUED)
Principal maturities of long-term debt are as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31, (IN THOUSANDS)
- - --------------------------------- ---------------
<S> <C>
1998 .......................... $ 46,489
1999 .......................... 378,564
2000 .......................... 20,953
2001 .......................... 1,088,656
2002 .......................... 28,426
After 2002 .................... 38,736
----------
$1,601,824
==========
</TABLE>
8. STOCK OPTIONS
The Company has various stockholder-approved stock option plans which
provide for the grant of options to directors, officers and other key employees
to purchase Common Stock at 100% of the fair market value as of the date of
grant. The Audit and Compensation Committee of the Board of Directors
administers the stock option plans. Options may be granted as incentive stock
options or as non-qualified stock options. Incentive stock options vest 25%
annually, commencing upon completion of one year of employment subsequent to the
date of grant. Certain of the non-qualified stock options are not subject to any
vesting provisions, while others vest on the same schedule as the incentive
stock options. The options expire at dates ranging from five to ten years from
the date of grant.
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"). SFAS 123 is effective for fiscal years beginning
after December 15, 1995 and allows for the option of continuing to account for
stock-based compensation under Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25"), and related
interpretations, or selecting the fair value method of expense recognition as
described in SFAS 123. The Company has elected to follow APB 25 in accounting
for its employee stock options. The Company follows SFAS 123 in accounting for
its non-employee stock options. The total compensation expense associated with
non-employee stock options granted in 1996 and 1997 was not material.
Pro forma information regarding net income and earnings per share is
required by SFAS 123, and has been determined as if the Company had accounted
for its employee stock options under the fair value method of SFAS 123. The fair
value for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions for 1995,
1996 and 1997, respectively: risk-free interest rates of 5.87%, 6.01% and 6.12%;
dividend yield of 0%; volatility factors of the expected market price of the
Company's common stock of .36, .37 and .37; and a weighted-average expected life
of the options of 4.3 years for 1995 and 1996, and 6.2 years for 1997.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
B-30
<PAGE>
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
8. STOCK OPTIONS - (CONTINUED)
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1995 1996 1997
------------- -------------- --------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
Pro forma net income ......... $ 80,059 $ 162,463 $ 290,517
Pro forma earnings per share:
Basic ....................... 0.28 0.51 0.84
Diluted ..................... 0.26 0.48 0.80
</TABLE>
The effect of compensation expense from stock options on 1995 pro forma net
income reflects only the vesting of 1995 awards. The 1996 pro forma net income
reflects the second year of vesting of the 1995 awards and the first year of
vesting of 1996 awards. The 1997 pro forma net income reflects the third year of
vesting of the 1995 awards, the second year of vesting the 1996 awards and the
first year of vesting of the 1997 awards. Not until 1998 will the full effect of
recognizing compensation expense for stock options be representative of the
possible effects on pro forma net income for future years.
A summary of the Company's stock option activity and related information
for the years ended December 31 follows:
<TABLE>
<CAPTION>
1995 1996 1997
------------------------ ------------------------ -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
OPTIONS EXERCISE OPTIONS EXERCISE OPTIONS EXERCISE
(000) PRICE (000) PRICE (000) PRICE
----------- ---------- ----------- ---------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding January 1 ................ 30,150 $ 4 35,068 $ 5 32,806 $ 7
Granted ..................................... 7,639 9 4,769 17 10,485 22
Exercised ................................... (2,237) 4 (6,709) 5 (9,604) 7
Canceled .................................... (484) 5 (322) 6 (995) 20
------ ------ ------
Options outstanding at December 31 ........... 35,068 $ 5 32,806 $ 7 32,692 $12
Options exercisable at December 31 ........... 26,293 $ 5 27,678 $ 6 28,125 $11
Weighted average fair value of options granted
during the year ............................. $ 3.81 $ 7.13 $ 10.59
</TABLE>
The following table summarizes information about stock options outstanding
at December 31, 1997.
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------- -------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
DECEMBER 31, REMAINING EXCERCISE DECEMBER 31, EXCERCISE
1997 LIFE PRICE 1997 PRICE
---------------- ----------- ----------- --------------- ----------
(IN THOUSANDS) (YEARS) (IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Under $8.40.............. 17,933 5.44 $ 5.29 16,719 $ 5.07
$8.40 -- $20.15.......... 8,580 8.04 16.64 7,238 16.69
$20.16 and above......... 6,179 8.89 23.39 4,168 23.29
</TABLE>
B-31
<PAGE>
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED )
9. ACQUISITIONS
1995 ACQUISITIONS
Effective April 1, 1995, the Company acquired the rehabilitation hospitals
division of NovaCare, Inc. ("NovaCare"), consisting of 11 rehabilitation
hospitals, 12 other facilities and certificates of need to build two other
facilities. The total purchase price for the NovaCare facilities was
approximately $235,000,000 in cash. The cost in excess of net asset value was
approximately $173,000,000. Of this excess, approximately $129,000,000 was
allocated to leasehold value and the remaining $44,000,000 to cost in excess of
net asset value of purchased facilities. As part of the acquisition, the Company
acquired approximately $4,790,000 in deferred tax assets. The Company also
provided approximately $10,000,000 for the write-down of certain assets to net
realizable value as the result of a planned facility consolidation in a market
where the Company's existing services overlapped with those of an acquired
facility. The planned employee separations and facility consolidation were
completed by the end of 1995.
Effective December 1, 1995, the Company acquired Caremark Orthopedic
Services Inc. ("Caremark"). At the time of the acquisition, Caremark owned and
operated approximately 120 outpatient rehabilitation centers in 13 states. The
total purchase price was approximately $127,500,000 in cash.
Also at various dates during 1995, the Company acquired 70 separate
outpatient rehabilitation operations located throughout the United States, three
physical therapy practices, one home health agency, one nursing home, 75
licensed subacute beds, five outpatient surgery centers and 16 outpatient
diagnostic imaging operations. The combined purchase prices of these
acquisitions was approximately $178,393,000. The form of consideration
constituting the combined purchase prices was approximately $152,833,000 in cash
and $25,560,000 in notes payable.
In connection with these transactions, the Company entered into noncompete
agreements with former owners totaling $16,222,000. In general, these noncompete
agreements are payable in monthly or quarterly installments over periods ranging
from five to ten years.
The fair value of the total net assets relating to the 1995 acquisitions
described above, excluding the NovaCare acquisition, was approximately
$81,455,000. The total cost of these acquisitions exceeded the fair value of the
net assets acquired by approximately $224,438,000. Based on the evaluation of
each acquisition utilizing the criteria described above, the Company determined
that the cost in excess of net asset value of purchased facilities relating to
the 1995 acquisitions should be amortized over periods ranging from 25 to 40
years on a straight-line basis. No other identifiable intangible assets were
recorded in the acquisitions described above.
All of the 1995 acquisitions described above were accounted for as
purchases and, accordingly, the results of operations of the acquired businesses
are included in the accompanying consolidated financial statements from their
respective dates of acquisition. With the exception of the NovaCare
rehabilitation hospitals acquisition, none of the above acquisitions were
material individually or in the aggregate.
1996 ACQUISITIONS
At various dates during 1996, the Company acquired 80 outpatient
rehabilitation facilities, three outpatient surgery centers, one inpatient
rehabilitation hospital and one diagnostic imaging center. The acquired
operations are located throughout the United States. The total purchase price of
the acquired operations was approximately $104,321,000. The form of
consideration constituting the total purchase prices was approximately
$92,319,000 in cash and $12,002,000 in notes payable.
In connection with these transactions, the Company entered into noncompete
agreements with former owners totaling $11,900,000. In general, these noncompete
agreements are payable in monthly or quarterly installments over periods ranging
from five to ten years.
B-32
<PAGE>
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
9. ACQUISITIONS - (CONTINUED)
The fair value of the total net assets relating to the 1996 acquisitions
described above was approximately $40,259,000. The total cost of the 1996
acquisitions exceeded the fair value of the net assets acquired by approximately
$64,062,000. Based on the evaluation of each acquisition utilizing the criteria
described above, the Company determined that the cost in excess of net asset
value of purchased facilities relating to the 1996 acquisitions should be
amortized over periods ranging from 25 to 40 years on a straight-line basis. No
other identifiable intangible assets were recorded in the acquisitions described
above.
All of the 1996 acquisitions described above were accounted for as
purchases and, accordingly, the results of operations of the acquired businesses
(not material individually or in the aggregate) are included in the accompanying
consolidated financial statements from their respective dates of acquisition.
1997 ACQUISITIONS
Effective October 29, 1997, the Company acquired Horizon/CMS Healthcare
Corporation ("Horizon/CMS") in a stock-for-stock merger in which the
stockholders of Horizon/CMS received 0.84338 of a share of the Company's common
stock per share of Horizon/CMS common stock. At the time of the acquisition,
Horizon/CMS operated 30 inpatient rehabilitation hospitals and approximately 275
outpatient rehabilitation centers, among other strategic businesses, as well as
certain long-term care businesses. In the transaction, the Company issued
approximately 45,261,000 shares of its common stock, valued at $975,824,000,
exchanged options to acquire 3,313,000 shares of common stock, valued at
$23,191,000, and assumed approximately $740,000,000 in long-term debt.
Effective December 31, 1997, the Company sold certain non-strategic assets
of Horizon/CMS to Integrated Health Services, Inc. ("IHS"). Under the terms of
the sale, the Company sold 139 long-term care facilities, 12 specialty
hospitals, 35 institutional pharmacy locations and over 1,000 rehabilitation
therapy contracts with long-term care facilities. The transaction was valued at
approximately $1,224,000,000, including the payment by IHS of approximately
$1,130,000,000 in cash (net of certain adjustments) and the assumption by IHS of
approximately $94,000,000 in debt.
In accordance with Emerging Issues Task Force Issue 87-11, "Allocation of
Purchase Price to Assets to be Sold" ("EITF 87-11"), the results of operations
of the non-strategic assets sold to IHS from the acquisition date to December
31, 1997, including a net loss of $7,376,000, have been excluded from the
Company's results of operations in the accompanying financial statements. The
gain on the disposition of the assets sold to IHS, totaling $10,996,000, has
been accounted for as an adjustment to the original Horizon/CMS purchase price
allocation.
The following table summarizes the unaudited pro forma combined results of
operations for the Company and Horizon/CMS, assuming the Horizon/CMS acquisition
and subsequent sale of non-strategic assets to IHS had occurred at the beginning
of each of the following periods:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1996 1997
--------------------- ----------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C>
Revenues .................................... $ 3,285,096 $ 3,615,123
Net income .................................. 199,773 292,651
Net income per common share -- assuming dilu-
tion ....................................... 0.52 0.72
</TABLE>
The Company also intends to sell the physician and allied health
professional placement service business it acquired in the Horizon/CMS
acquisition (the "Physician Placement Services Subsidiary"). This sale is
currently expected to be completed by mid-1998. Accordingly, a portion of the
Horizon/CMS
B-33
<PAGE>
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
9. ACQUISITIONS - (CONTINUED)
purchase price has been allocated to the Physician Placement Services Subsidiary
and this amount is classified as assets held for sale in the accompanying
December 31, 1997 consolidated balance sheet. The allocated amount of
$60,400,000 represents the net assets of the Physician Placement Services
Subsidiary, plus anticipated cash flows from (a) operations of the Physician
Placement Services Subsidiary during the holding period and (b) proceeds from
the sale of the Physician Placement Services Subsidiary. The results of
operations of the Physician Placement Services Subsidiary from the acquisition
date to December 31, 1997, including net income of $1,230,000, have been
excluded from the Company's results of operations in the accompanying financial
statement in accordance with EITF 87-11.
Effective September 30, 1997, the Company acquired ASC Network Corporation
("ASC") in a cash-for-stock merger. At the time of the acquisition, ASC operated
29 outpatient surgery centers in eight states. The total purchase price for ASC
was approximately $130,827,000 in cash, plus the assumption of approximately
$61,000,000 in long-term debt.
Effective October 23, 1997, the Company acquired National Imaging
Affiliates, Inc. ("NIA") in a stock-for-stock merger. At the time of the
acquisition, NIA operated eight diagnostic imaging centers in six states and a
radiology management services business. In conjunction with the transaction, NIA
spun off its radiology management services business, which continues to be owned
by the former NIA stockholders. In the transaction, the Company issued
approximately 984,000 shares of its common stock, valued at $20,706,000, in
exchange for all of the outstanding shares of NIA.
At various dates and in separate transactions throughout 1997, the Company
acquired 135 outpatient rehabilitation facilities, four outpatient surgery
centers and eight diagnostic imaging facilities located throughout the United
States. The Company also acquired an inpatient rehabilitation hospital located
in Australia. The total purchase price of the acquired operations was
approximately $136,819,000. The form of consideration constituting the total
purchase prices was $134,519,000 in cash and $2,300,000 in notes payable.
In connection with these transactions, the Company entered into noncompete
agreements with former owners totaling $29,275,000. In general, these noncompete
agreements are payable in monthly or quarterly installments over periods ranging
from five to ten years.
The fair value of the total net assets relating to the 1997 acquisitions
described above was approximately $233,469,000. The total cost of the 1997
acquisitions exceeded the fair value of the net assets acquired by approximately
$1,053,898,000. Based on the evaluation of each acquisition utilizing the
criteria described above, the Company determined that the cost in excess of net
asset value of purchased facilities relating to the 1997 acquisitions should be
amortized over a period of twenty-five to forty years on a straight-line basis.
At December 31, 1997 the purchase price allocation associated with the 1997
acquisitions is preliminary in nature. During 1998 the Company will make
adjustments, if necessary, to the purchase price allocation based on revisions
to the fair value of the assets acquired.
All of the 1997 acquisitions described above were accounted for as
purchases and, accordingly, the results of operations of the acquired businesses
are included in the accompanying consolidated financial statements from their
respective dates of acquisition. With the exception of the operations acquired
in the Horizon/CMS acquisition (for which pro forma data has been disclosed
above), the results of operations of the acquired businesses were not material
individually or in the aggregate to the Company's consolidated results of
operations and financial position.
10. INCOME TAXES
HEALTHSOUTH and its subsidiaries file a consolidated federal income tax
return. The limited partnerships and limited liability companies file separate
income tax returns. HEALTHSOUTH's allocable portion of each partnership's income
or loss is included in the taxable income of the Company. The remaining income
or loss of each partnership and limited liability company is allocated to the
limited partners.
B-34
<PAGE>
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
10. INCOME TAXES - (CONTINUED)
The Company utilizes the liability method of accounting for income taxes,
as required by Financial Accounting Standards Board (FASB) Statement No. 109,
"Accounting for Income Taxes". Deferred income taxes reflect the net effects of
temporary differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes.
Significant components of the Company's deferred tax assets and liabilities as
of December 31, 1996 are as follows:
<TABLE>
<CAPTION>
CURRENT NONCURRENT TOTAL
--------- ------------ -------------
(IN THOUSANDS)
<S> <C> <C> <C>
Deferred tax assets:
Acquired net operating loss .................. $ -- $ 5,283 $ 5,283
Development costs ............................ -- 849 849
Accruals ..................................... 6,634 -- 6,634
Allowance for bad debts ...................... 34,700 -- 34,700
Other ........................................ 2,433 2,597 5,030
------- --------- ---------
Total deferred tax assets ..................... 43,767 8,729 52,496
Deferred tax liabilities:
Depreciation and amortization ................ -- 30,441 30,441
Purchase price accounting .................... -- 4,802 4,802
Non-accrual experience method ................ 17,694 -- 17,694
Contracts .................................... 3,849 -- 3,849
Capitalized costs ............................ 5,013 22,672 27,685
Other ........................................ 1,973 2,604 4,577
------- --------- ---------
Total deferred tax liabilities ................ 28,529 60,519 89,048
------- --------- ---------
Net deferred tax assets (liabilities) ......... $15,238 $ (51,790) $ (36,552)
======= ========= =========
</TABLE>
At December 31, 1997, the Company has net operating loss carryforwards of
approximately $28,755,000 for income tax purposes expiring through the year
2017. Those carryforwards resulted from the Company's acquisitions of Diagnostic
Health Corporation, Renaissance Rehabilitation Center, Inc., Rebound, Inc.,
Health Images and Horizon/CMS.
Significant components of the Company's deferred tax assets and liabilities
as of December 31, 1997 are as follows:
<TABLE>
<CAPTION>
CURRENT NONCURRENT TOTAL
------------- ------------ --------------
(IN THOUSANDS)
<S> <C> <C> <C>
Deferred tax assets:
Accruals .............................. $ 19,564 $ -- $ 19,564
Net operating loss .................... -- 11,039 11,039
Other ................................. -- 2,834 2,834
--------- --------- ----------
Total deferred tax assets .............. 19,564 13,873 33,437
Deferred tax liabilities:
Depreciation and amortization ......... -- 90,486 90,486
Capitalized costs ..................... 9,038 -- 9,038
Allowance for bad debts ............... 41,023 -- 41,023
Other ................................. 3,622 -- 3,622
--------- --------- ----------
Total deferred tax liabilities ......... 53,683 90,486 144,169
--------- --------- ----------
Net deferred tax liabilities ........... $ (34,119) $ (76,613) $ (110,732)
========= ========= ==========
</TABLE>
B-35
<PAGE>
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
10. INCOME TAXES - (CONTINUED)
The provision for income taxes was as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------
1995 1996 1997
---------- ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Currently payable:
Federal ......... $70,629 $116,023 $166,884
State ........... 9,586 13,598 26,749
------- -------- --------
80,215 129,621 193,633
Deferred expense :
Federal ......... 367 13,281 10,790
State ........... 29 1,027 1,730
------- -------- --------
396 14,308 12,520
------- -------- --------
$80,611 $143,929 $206,153
======= ======== ========
</TABLE>
As part of the acquisitions of Horizon/CMS, ASC and NIA, the Company
acquired approximately $6,729,000 in deferred tax liabilities.
The Company made a retroactive election under Internal Revenue Code Section
475 which allowed it to mark certain assets to fair market value, resulting in
refunded income taxes and an increase to deferred tax liabilities of
approximately $54,931,000.
The difference between the provision for income taxes and the amount
computed by applying the statutory federal income tax rate to income before
taxes was as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1995 1996 1997
------------ ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Federal taxes at statutory rates ................... $ 78,322 $ 134,457 $ 210,572
Add (deduct):
State income taxes, net of federal tax benefit..... 6,250 9,506 18,511
Minority interests ................................ (15,102) (17,303) (22,705)
Disposal/impairment charges ....................... 9,955 6,563 1,576
Other ............................................. 1,186 10,706 (1,801)
--------- --------- ---------
$ 80,611 $ 143,929 $ 206,153
========= ========= =========
</TABLE>
11. COMMITMENTS AND CONTINGENCIES
The Company is a party to legal proceedings incidental to its business. In
the opinion of management, any ultimate liability with respect to these actions
will not materially affect the consolidated financial position or results of
operations of the Company.
Beginning December 1, 1993, the Company became self-insured for
professional liability and comprehensive general liability. The Company
purchased coverage for all claims incurred prior to December 1, 1993. In
addition, the Company purchased underlying insurance which would cover all
claims once established limits have been exceeded. It is the opinion of
management that at December 31, 1997 the Company has adequate reserves to cover
losses on asserted and unasserted claims.
Prior to consummation of the SCA and Advantage Health mergers (see Note 2),
these companies carried professional malpractice and general liability
insurance. The policies were carried on a claims
B-36
<PAGE>
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
11. COMMITMENTS AND CONTINGENCIES - (CONTINUED)
made basis. The companies had policies in place to track and monitor incidents
of significance. Management is unaware of any claims that may result in a loss
in excess of amounts covered by existing insurance.
In connection with the Horizon/CMS acquisition, the Company assumed
Horizon/CMS's open professional and general liability claims. The Company has
entered into an agreement with an insurance carrier to assume responsibility for
the majority of open claims. Under this agreement, a "risk transfer" is being
conducted which will convert Horizon/CMS's self-insured claims to insured
liabilities consistent with the terms of the underlying insurance policy.
Horizon/CMS is currently a party, or is subject, to certain litigation
matters and disputes. The Company itself is, in general, not a party to such
litigation. These matters include actions on investigations initiated by the
Securities and Exchange Commission, New York Stock Exchange, various federal and
state regulatory agencies, stockholders of Horizon/CMS and other parties. Both
Horizon/CMS and the Company are working to resolve these matters and cooperating
fully with the various regulatory agencies involved. As of December 31, 1997, it
was not possible for the Company to predict the ultimate outcome or effect of
these matters. In management's opinion, the ultimate resolution of these matters
will not have a material effect on the Company's financial position.
At December 31, 1997, anticipated capital expenditures for the next twelve
months are $400,000,000. This amount includes expenditures for maintenance and
expansion of the Company's existing facilities as well as development and
integration of the Company's services in selected metropolitan markets.
Operating leases generally consist of short-term lease agreements for
buildings where facilities are located. These leases generally have 5-year
terms, with one or more renewal options, with terms to be negotiated at the time
of renewal. Total rental expense for all operating leases was $103,308,000,
$131,994,000 and $160,404,000 for the years ended December 31, 1995, 1996 and
1997, respectively.
The following is a schedule of future minimum lease payments under all
operating leases having initial or remaining non-cancelable lease terms in
excess of one year:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31, (IN THOUSANDS)
- - ------------------------------------------------------ ---------------
<S> <C>
1998 ..................................... $179,658
1999 ..................................... 150,855
2000 ..................................... 125,479
2001 ..................................... 98,643
2002 ..................................... 72,600
After 2002 ............................... 313,403
--------
Total minimum payments required .......... $940,638
========
</TABLE>
12. EMPLOYEE BENEFIT PLANS
The Company has a 401(k) savings plan which matches 15% of the first 4% of
earnings that an employee contributes. All contributions are in the form of
cash. All employees who have completed one year of service with a minimum of
1,000 hours worked are eligible to participate in the plan. Company
contributions are gradually vested over a seven-year service period.
Contributions to the plan by the Company were approximately $1,408,000,
$2,420,000 and $2,628,000 in 1995, 1996 and 1997, respectively.
In 1991, the Company established an Employee Stock Ownership Plan ("ESOP")
for the purpose of providing substantially all employees of the Company the
opportunity to save for their retirement and acquire a proprietary interest in
the Company. The ESOP currently owns approximately 3,320,000 shares of the
Company's common stock, which were purchased with funds borrowed from the
Company, $10,000,000
B-37
<PAGE>
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
12. EMPLOYEE BENEFIT PLANS - (CONTINUED)
in 1991 (the "1991 ESOP Loan") and $10,000,000 in 1992 (the "1992 ESOP Loan").
At December 31, 1997, the combined ESOP Loans had a balance of $12,247,000. The
1991 ESOP Loan, which bears an interest rate of 10%, is payable in annual
installments covering interest and principal over a ten-year period beginning in
1992. The 1992 ESOP Loan, which bears an interest rate of 8.5%, is payable in
annual installments covering interest and principal over a ten-year period
beginning in 1993. Company contributions to the ESOP began in 1992 and shall at
least equal the amount required to make all ESOP loan amortization payments for
each plan year. The Company recognizes compensation expense based on the shares
allocated method. Compensation expense related to the ESOP recognized by the
Company was $3,524,000, $3,198,000 and $3,249,000 in 1995, 1996 and 1997,
respectively. Interest incurred on the ESOP Loans was approximately $1,460,000,
$1,298,000 and $1,121,000 in 1995, 1996 and 1997, respectively. Approximately
1,508,000 shares owned by the ESOP have been allocated to participants at
December 31, 1997.
During 1993, the American Institute of Certified Public Accountants issued
Statement of Position 93-6, "Employers Accounting for Employee Stock Ownership
Plans" ("SOP 93-6"). Among other provisions, SOP 93-6 requires that compensation
expense relating to employee stock ownership plans be measured based on the fair
market value of the shares when allocated to the employees. The provisions of
SOP 93-6 apply only to leveraged ESOPs formed after December 31, 1992, or shares
newly acquired by an existing leveraged ESOP after December 31, 1992. Because
all shares owned by the Company's ESOP were acquired prior to December 31, 1992,
the Company's accounting policies for the shares currently owned by the ESOP are
not affected by SOP 93-6.
13. IMPAIRMENT OF LONG-TERM ASSETS
In 1995, the Company recorded an asset impairment charge of approximately
$53,549,000 relating to goodwill and tangible assets identifiable with fourteen
surgery centers. Approximately $47,984,000 of this charge related to ten surgery
centers which the Company intends to operate on an ongoing basis, while the
remaining loss of $5,565,000 is identifiable with four surgery centers which the
Company decided during the fourth quarter of 1995 to close.
With respect to the ten surgery centers the Company intends to continue
operating, certain events occurred in the fourth quarter of 1995 which
significantly impacted the Company's estimates of future cash flows to be
received from these centers. Those events primarily related to a decline in
operating results combined with a deterioration in relationships with key
physicians at certain of those locations. As a result of these events, the
Company revised its estimates of undiscounted cash flows to be received over the
remaining estimated useful lives of these centers and determined that goodwill
and other long-lived assets (primarily property and equipment) had been
impaired. The Company developed its best estimates of future operating cash
flows at these locations considering future requirements for capital
expenditures as well as the impact of inflation. The projections of cash flows
also took into account estimates of significant one-time expenses as well as
estimates of additional revenues and resulting income from future marketing
efforts in the respective locations. The amount of the impairment charge was
determined by discounting the estimates of future cash flows, using an estimated
8.5% incremental borrowing rate which management believes is commensurate with
the risks involved. The resulting net present value of future cash flows was
then compared to the historical net book value of goodwill and other long-lived
assets at each operating location which resulted in an impairment loss relative
to these centers of $47,984,000. The above amounts are included in operations
for 1995 in the accompanying consolidated statement of income.
In 1996, the Company recorded an asset impairment charge of approximately
$37,390,000 relating to tangible assets identifiable with the development and
manufacture of the HI Standard and HI STAR MRI systems. Approximately
$28,665,000 of this charge related to the development and manufacture of the HI
STAR MRI system, while the remaining charge of $8,725,000 related to HI Standard
MRI systems already in service.
B-38
<PAGE>
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS- (CONTINUED)
13. IMPAIRMENT OF LONG-TERM ASSETS - (CONTINUED)
During the fourth quarter of 1996 the Company performed an evaluation of
the viability of continued development and manufacture, and the continued use of
mid-field (0.6 Tesla) MRI systems. Both the HI Standard and the HI STAR MRI
systems are mid-field MRI systems. The Company's evaluation revealed that due to
improvements in technology, high-field (1.5 Tesla) MRI systems could be
purchased at significantly lower costs than the production costs of the
Company's mid-field MRI systems. Additionally, it was noted that future
maintenance costs of the high-field MRI systems were significantly less than the
cost currently being incurred for maintenance of the internally developed
mid-field MRI systems. The evaluation also confirmed that procedures could be
performed in the high-field MRI systems in approximately one-third of the time
that the same procedure could be performed in a mid-field MRI system. In
addition, the Company was experiencing pressures from third-party payors and
referring physicians to implement high-field MRI systems due to increased
patient satisfaction from the reduced procedure time and the improved images
derived from such systems. Based on these facts and circumstances the Company
determined that there was a significant decrease in the market value of the
related assets. Accordingly, the Company decided to cease development and
manufacture of the HI STAR MRI system and developed a plan to replace all of its
HI Standard MRI systems during the following eighteen months.
With respect to the $28,665,000 charge related to the development and
manufacture of the HI STAR MRI system, approximately $20,503,000 was
work-in-process, $4,244,000 was a prototype HI STAR MRI system and inventory of
component parts and $3,918,000 was machinery and equipment used in the
development and manufacturing processes. The Company was not able to find any
application or use of these assets within its existing operations. Also, since
the HI STAR MRI system was not fully developed, the Company has not been able to
find a buyer for any of the assets. Therefore, the Company has assigned no fair
value at December 31, 1996 to the assets related to the development and
manufacture of the HI STAR MRI system.
With respect to the $8,725,000 charge related to the HI Standard MRI
systems already in service, the Company explored the market for the sale of
these systems in the open market or through trade with other manufacturers. For
the same reasons that led the Company to develop a plan to replace the HI
Standard MRI systems with high-field MRI systems, no potential purchaser, or
manufacturer willing to trade, has been found. Therefore, the Company has
assigned no fair value at December 31, 1996 to the HI Standard MRI systems to be
disposed of.
14. SUBSEQUENT EVENTS
On March 15, 1998, pursuant to the terms of the 1996 Credit Agreement (see
Note 7), the Company elected to convert $350,000,000 of the $1,250,000,000 1996
Credit Agreement into a two-year amortizing term note maturing on December 31,
1999. In conjunction with this election, the Company has received a $350,000,000
commitment from NationsBank for an additional 364-day facility (the "Interim
Revolving Credit Facility") which is on substantially the same terms as the 1996
Credit Agreement.
On March 20, 1998, the Company issued $500,000,000 in 3.25% Convertible
Subordinated Debentures due 2003 (the "Convertible Debentures due 2003") in a
private offering. The Convertible Debentures due 2003 are convertible into
Common Stock of the Company at the option of the holder at a conversion price of
$36.625 per share, subject to adjustment upon the occurrence of certain events.
The proceeds from this debt offering will be used by the Company to pay off all
amounts drawn subsequent to December 31, 1997 under the Bridge Credit Agreement
(see Note 7) and reduce outstanding amounts under the 1996 Credit Agreement.
Effective with the sale of the Convertible Debentures due 2003, the Bridge
Credit Agreement was terminated.
Because the Company intends to pay off the two-year term portion of the
1996 Credit Agreement with proceeds from the Interim Revolving Credit Facility
or other long-term financing arrangements, all amounts associated with the 1996
Credit Agreement outstanding at December 31, 1997 are classified as non-current.
B-39
<PAGE>
MARKET FOR REGISTRANT'S COMMON
EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is listed for trading on the New York Stock
Exchange (Symbol: HRC). The following table sets forth for the fiscal periods
indicated the high and low reported sale prices for the Company's Common Stock
as reported on the NYSE Composite Transactions Tape. All prices shown have been
adjusted for a two-for-one stock split effected in the form of a 100% stock
dividend paid on March 17, 1997.
<TABLE>
<CAPTION>
REPORTED
SALE PRICE
-------------------------
HIGH LOW
----------- -----------
<S> <C> <C>
1996
First Quarter .......... $ 19.07 $ 13.50
Second Quarter ......... 19.32 16.16
Third Quarter .......... 19.32 14.25
Fourth Quarter ......... 19.88 17.57
1997
First Quarter .......... $ 22.38 $ 17.94
Second Quarter ......... 27.12 17.75
Third Quarter .......... 28.94 23.12
Fourth Quarter ......... 28.31 22.00
</TABLE>
The closing price for the Common Stock on the New York Stock Exchange on
March 27, 1998, was $27.875.
There were approximately 5,977 holders of record of the Common Stock as of
March 13, 1998, excluding those shares held by depository companies for certain
beneficial owners.
The Company has never paid cash dividends on its Common Stock (although
certain of the companies acquired by the Company in poolings-of-interests
transactions had paid dividends prior to such acquisitions) and does not
anticipate the payment of cash dividends in the foreseeable future. The Company
currently anticipates that any future earnings will be retained to finance the
Company's operations.
RECENT SALES OF UNREGISTERED SECURITIES
On October 23, 1997, the Company issued an aggregate of 984,189 shares of
its Common Stock in connection with its acquisition of National Imaging
Affiliates, Inc. ("NIA"). The shares were issued to 100 persons and entities who
were, immediately prior to such acquisition, stockholders of NIA and were issued
pursuant to the exemptions provided in Section 4(2) of the Securities Act of
1933, as amended, and Rule 506 of Regulation D promulgated thereunder. The
Company believes that such exemptions are available because (a) the transaction
did not involve a public offering, (b) no more than 35 of the former NIA
stockholders were not "accredited investors", as such term is defined in
Regulation D, and (c) the Company otherwise complied with the requirements of
Rule 506. All such shares were registered for resale pursuant to a Registration
Statement on Form S-3 declared effective by the SEC on December 5, 1997.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
The Company has not changed independent accountants within the 24 months
prior to December 31, 1997.
B-40
<PAGE>
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PROXY
PRELIMINARY COPY
HEALTHSOUTH CORPORATION
ANNUAL MEETING OF STOCKHOLDERS -- MAY 21, 1998
THIS PROXY IS SOLICITED ON BEHALF OF
THE BOARD OF DIRECTORS
The undersigned hereby appoints RICHARD M. SCRUSHY and MICHAEL D. MARTIN or
____________________________________, and each of them, with several powers of
substitution, proxies to vote the shares of Common Stock, par value $.01 per
share, of HEALTHSOUTH Corporation which the undersigned could vote if personally
present at the Annual Meeting of Stockholders of HEALTHSOUTH Corporation to be
held at One HealthSouth Parkway, Birmingham, Alabama 35243, on Thursday, May 21,
1998, at 2:00 p.m., C.D.T., and any adjournment thereof:
1. ELECTION OF DIRECTORS
[ ] FOR all nominees listed below [ ] WITHHOLD AUTHORITY to vote (except as
marked to the contrary below) for all nominees listed below
INSTRUCTION: TO WITHHOLD AUTHORITY TO VOTE FOR ANY INDIVIDUAL NOMINEE, MARK
A LINE THROUGH THE NOMINEE'S NAME IN THE LIST
BELOW.
<TABLE>
<S> <C> <C>
Richard M. Scrushy C. Sage Givens Anthony J. Tanner
Phillip C. Watkins Larry R. House George H. Strong
Charles W. Newhall III James P. Bennett John S. Chamberlin
P. Daryl Brown Joel C. Gordon Michael D. Martin
</TABLE>
- - --------------------------------------------------------------------------------
- - --------------------------------------------------------------------------------
2.ADOPTION AND APPROVAL OF AN AMENDMENT TO THE COMPANY'S RESTATED CERTIFICATE
OF INCORPORATION TO INCREASE THE AUTHORIZED SHARES OF COMMON STOCK OF THE
COMPANY TO 600,000,000 SHARES OF COMMON STOCK, PAR VALUE $.01 PER SHARE
[ ] FOR [ ] AGAINST [ ] ABSTAIN
3. APPROVAL OF THE 1998 RESTRICTED STOCK PLAN OF THE COMPANY
[ ] FOR [ ] AGAINST [ ] ABSTAIN
4. APPROVAL OF A STOCKHOLDER PROPOSAL URGING THE BOARD OF DIRECTORS TO
ESTABLISH CERTAIN ADDITIONAL REQUIREMENTS FOR SERVICE ON THE COMPENSATION
COMMITTEE
[ ] FOR [ ] AGAINST [ ] ABSTAIN
5.IN THEIR DISCRETION, TO ACT UPON ANY MATTERS INCIDENTAL TO THE FOREGOING
AND SUCH OTHER BUSINESS AS MAY PROPERLY COME BEFORE THE ANNUAL MEETING OR
ANY ADJOURNMENT THEREOF.
This Proxy, when properly executed, will be voted in the manner directed
herein by the undersigned stockholder. IF NO DIRECTION IS MADE, THIS PROXY WILL
BE VOTED FOR ITEMS 1, 2 AND 3 AND AGAINST ITEM 4 ABOVE. Any stockholder who
wishes to withhold the discretionary authority referred to in Item 5 above
should mark a line through the entire Item.
DATED ______________________, 1998
------------------------------------------
Signature(s)
------------------------------------------
(Please sign exactly and as fully as your
name appears on your stock certificate. If
shares are held jointly, each stockholder
should sign.)
PLEASE MARK, SIGN, DATE AND RETURN PROMPTLY, USING THE ENCLOSED
ENVELOPE. NO POSTAGE IS REQUIRED.
- - --------------------------------------------------------------------------------