================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-K
(Mark One)
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended December 31, 1996; or
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ______ to ______
Commission File No. 1-9369
----------------
HORIZON/CMS HEALTHCARE CORPORATION
----------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 91-1346899
- -------------------------------------- ------------------------------------
(State or Other Jurisdiction (I.R.S. Employer Identification No.)
of Incorporation or Organization)
6001 INDIAN SCHOOL ROAD, N.E.,
ALBUQUERQUE, NM 87110
- ---------------------------------------- ----------
(Address of Principal Executive Office) (Zip Code)
Registrant's telephone number, including area code: (505) 878-6100
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on which Registered
- ----------------------- -----------------------
COMMON STOCK, PAR VALUE NEW YORK STOCK EXCHANGE
$.001 PER SHARE
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
At August 27, 1997, the registrant had 53,345,328 shares of Common Stock
outstanding. The aggregate market value on August 31, 1997 of the registrant's
Common Stock held by nonaffiliates of the registrant was $1,078,997,668 (based
on the closing price of these shares as quoted on such date on the New York
Stock Exchange).
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Stockholders to be
held, if necessary, in November 1997 will be incorporated into Part III of this
Form 10-K.
================================================================================
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
PART I
Item 1. Business ........................................................................ 1
General Overview ........................................................................ 1
Proposed Merger of Horizon/CMS with HEALTHSOUTH Corporation ........................... 1
Industry Background ..................................................................... 2
Strategy .............................................................................. 3
Services .............................................................................. 4
Organization ........................................................................... 6
Facilities .............................................................................. 11
Sources of Revenues ..................................................................... 12
Competition ........................................................................... 13
Employees .............................................................................. 14
Acquisitions and Expansion ............................................................ 14
Reimbursement by Third Party Payors ................................................... 14
Medicaid and Medicare .................................................................. 15
Regulation .............................................................................. 18
Insurance .............................................................................. 23
Directors and Executive Officers ...................................................... 24
Item 2. Properties ..................................................................... 26
Item 3. Legal Proceedings ............................................................... 26
Item 4. Submission of Matters to a Vote of Security Holders .............................. 31
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters ............ 32
Item 6. Selected Financial Data ......................................................... 33
Item 7. Management's Discussion and Analysis of Financial Condition and Results of 36
Operations.
Item 8. Financial Statements and Supplementary Data .................................... 42
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial 85
Disclosure.
PART III
Item 10. Directors and Executive Officers of the Registrant .............................. 85
Item 11. Executive Compensation ......................................................... 85
Item 12. Security Ownership of Certain Beneficial Owners and Management .................. 85
Item 13. Certain Relationships and Related Transactions ................................. 85
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K ............... 85
Signatures .............................................................................. 92
</TABLE>
i
<PAGE>
PART I
ITEM 1. BUSINESS
GENERAL OVERVIEW
Horizon/CMS Healthcare Corporation (herein called "Horizon/CMS" or the
"Company") is a leading provider of post-acute healthcare services and long-term
health care services, principally in the Midwest, Southwest and Northeast
regions of the United States. Post-acute care is the provision of a continuum of
care to patients for the twelve-month period following discharge from an acute
care hospital. Horizon/CMS provides inpatient post-acute care services through
freestanding acute rehabilitation hospitals and managed rehabilitation units
within acute care hospitals in 14 states, specialty hospitals and subacute care
units in 11 states, and outpatient post-acute care services including outpatient
rehabilitative services through 288 clinics in 25 states, home healthcare
agencies in four states, and home respiratory/home infusion therapy supplies and
services in nine states. Horizon/CMS also provides post-acute patient care
services to a variety of customers under contractual arrangements including
contract rehabilitation therapy services in 36 states, physician and allied
health professional placement/staffing services throughout the United States,
institutional pharmacy services in 16 states, a clinical laboratory, physician
practice management in three states, and mobile x-ray services in eight states.
The Company provides long-term care services (including Alzheimer's care,
assisted living services and hospice care) through 135 long-term care facilities
in 17 states and five assisted living facilities in three states.
Post-acute care services that the Company provides include: (a) inpatient
and outpatient rehabilitative services; (b) subacute care; (c) contract
rehabilitation therapy services; (d) home health care services; (e) pharmacy and
related services; (f) clinical laboratory services; (g) physician placement
services; (h) non-invasive medical diagnostic services; (i) home respiratory
supplies and services; (j) home infusion supplies and services; and (k) hospice
care. Horizon/CMS's integrated post-acute health care system is intended to
provide continuity of care for its patients and enable payors to contract with
one provider to provide for virtually all of the patient's needs during the
period following discharge from an acute care facility. In addition, as
corollaries to, and complements of, this integrated post-acute care delivery
system are the Company's owned physician practice and its physician practice
management services.
PROPOSED MERGER OF HORIZON/CMS WITH HEALTHSOUTH CORPORATION
On February 17, 1997, Horizon/CMS entered into a Plan and Agreement of
Merger (the "Plan") dated as of that date among Horizon/CMS, HEALTHSOUTH
Corporation ("HEALTHSOUTH") and a wholly owned subsidiary of HEALTHSOUTH (the
"Subsidiary"). The Plan provides that the Subsidiary would merge with and into
Horizon/CMS (the "Merger") and, upon consummation of the Merger, Horizon/CMS
would become a wholly owned subsidiary of HEALTHSOUTH and each issued and
outstanding share of common stock, par value $.001 per share, of Horizon/CMS
("Common Stock") would be converted in the Merger into .084338 of one share of
common stock, par value $.01 per share, of HEALTHSOUTH ("HEALTHSOUTH Common
Stock"). Horizon/CMS and HEALTHSOUTH are sometimes herein together called the
"Combining Companies."
The obligation of each of HEALTHSOUTH, the Subsidiary and Horizon/CMS to
consummate the Merger is subject to certain conditions, including approval of
the Plan by the stockholders of Horizon/ CMS, certain regulatory approvals and
confirmation by each of HEALTHSOUTH and Horizon/CMS of its representations and
warranties contained in the Plan as of the closing date. The status of certain
of these conditions is as follows:
(i) Regulatory Approvals. A major regulatory approval required by the
Plan is that required by the Hart-Scott-Rodino Antitrust Improvements Act of
1976, as amended (the "HSR Act"). The HSR Act provides that certain business
combinations (including the Merger) may not be consummated until certain
information has been furnished to the Department of Justice (the "DOJ") and
the Federal Trade Commission (the "FTC") and certain waiting period
requirements have been satisfied. On April 11, 1997, HEALTHSOUTH and
Horizon/CMS made their respective filings with
1
<PAGE>
the DOJ and the FTC with respect to the Plan. Under the HSR Act, the filings
commenced a waiting period of up to 30 days during which the Merger could not
be consummated, which waiting period was originally to expire on May 11,
1997, unless extended by a request for additional information. In order to
provide an additional period of time for the Companies to provide certain
information to the FTC on a voluntary basis, HEALTHSOUTH withdrew its HSR
filing on May 7, 1997, and refiled it on May 8, 1997, beginning a new 30 day
waiting period. On June 6, 1997, the Combining Companies received a request
for additional information from the FTC. The request for additional
information related exclusively to the competitive effect the Merger would
have on the Johnson City, Tennessee market area. The effect of that request
was to extend the waiting period under the HSR Act until 20 days after
HEALTHSOUTH and Horizon/CMS substantially comply with such request, unless
earlier terminated by the FTC. The issues in the Johnson City, Tennessee
market involve the location in that market of two rehabilitation hospitals,
one which is owned by HEALTHSOUTH and the other is owned by a joint venture
between Horizon/CMS and another company. Thus far, the efforts of Horizon/CMS
to sell its interest in the joint venture have been unavailing. The Combining
Companies are continuing to work to resolve these issues to the satisfaction
of the FTC, and expect to enter into a consent order requiring the divestit-
ure of Horizon/ CMS's interest in the joint venture.
(ii) Approval of Horizon/CMS Stockholders. Horizon/CMS currently intends
to call a Special Meeting of the stockholders of the Company to be held in
October 1997 for the purpose of considering and voting upon a proposal to
approve the Plan. Only holders of record of shares of Common Stock at the
close of business on August 14, 1997 (the "Record Date") will be entitled
to notice of and to vote at the Special Meeting. Horizon/CMS anticipates
that it will mail a notice of the Special Meeting, together with a
prospectus-proxy statement containing information with respect to the Plan
and related matters, to the stockholders of record on the Record Date in
September 1997.
INDUSTRY BACKGROUND
The post-acute care industry encompasses a broad range of health care
services for patients with medically complex needs who can be cared for outside
of acute care hospitals. The Company believes that it is well positioned to
create a post-acute health care delivery system in each geographic region it
serves by capitalizing on favorable industry trends, which include:
Cost Containment Initiatives
In response to rapidly rising costs, governmental and private pay sources
have adopted cost containment measures that encourage reduced length of stays in
acute care hospitals. These third party payors have implemented strong case
management and utilization review procedures. In addition, traditional private
insurers have begun to limit reimbursement to predetermined "reasonable
charges," while managed care organizations such as health maintenance
organizations and preferred provider organizations are attempting to limit
hospitalization costs by monitoring and reducing hospital utilization and by
negotiating discounted rates for hospital services or fixed charges for
procedures regardless of length of stay. As a result, average acute care
hospital stays have been shortened, and many patients are discharged despite a
continuing need for specialty health care services or nursing care.
Aging Population
According to the U.S. Bureau of the Census, approximately 1.4% of people
65-74 years of age received care in long-term care facilities in 1990, while
6.1% of people 75-84 years of age and 24.5% of people over age 84 received such
care. The U.S. Bureau of the Census estimates that the U.S. population over age
75 will increase from approximately 13 million, or 5.2% of the population, in
1990 to approximately 17 million, or 6.1% of the population, by the year 2000.
In particular, the segment of the U.S. population over 85 years of age, which
comprises 45-50% of residents at long-term care facilities nationwide, is
projected to increase by more than 30%, from approximately 3 million, or 1.2% of
the population, in 1990 to more than 4 million, or 1.6% of the population in
2000. The population over age 65 suffers from a greater incidence of chronic
2
<PAGE>
illnesses and disabilities than the rest of the population and currently
accounts for more than two-thirds of total health care expenditures in the
United States. As the number of Americans over age 65 increases, the need for
long-term care services is also expected to increase.
Advances in Medical Technology
Advances in medical technology have increased the life expectancy of a
growing number of patients who require a high degree of care traditionally not
available outside acute care hospitals. For such patients, home health care
often is not a viable alternative because of the complexity of medical services
and equipment required. As a result, the Company believes that there is an
increasing need for care facilities that provide 24 hours-a-day supervision and
specialty care at a significantly lower cost than traditional acute care and
rehabilitation hospitals. In addition, the Company believes that there is an
increased need for home health care services for those individuals who can
receive care in the home and that do not require institutional care.
Industry Consolidation
Recently, the industry has been subject to competitive pressures that have
resulted in a trend towards consolidation of smaller, local operators into
larger, more established regional or national operators. The increasing
complexity of medical services, growing regulatory and compliance requirements
and increasingly complicated reimbursement systems have resulted in
consolidation of small operators who lack the sophisticated management
information systems, geographic diversity, operating efficiencies and financial
resources to compete effectively.
STRATEGY
In response to current health care reform and ongoing changes in the health
care marketplace, Horizon/CMS has implemented and continues to implement a
strategy of extending the continuum of services offered by the Company beyond
traditional long-term and subacute care to create a post-acute health care
delivery system in each geographic region that it serves. The Company's strategy
is designed to improve its profit margins, occupancy levels and payor mix.
Continued implementation of this strategy will require the following:
Leveraging Existing Facilities
Horizon/CMS uses its rehabilitation, long-term care and subacute care
facilities as platforms to provide a cost-effective continuum of post-acute care
to managed care, private and government payors. This allows Horizon/CMS to
provide its services to the increasing number of patients who continue to
require rehabilitation, subacute care, long-term care or home health care after
being discharged from acute care hospitals. Many of these patients often cannot
receive proper care in the home because of the complex monitoring and
specialized medical treatment required. For those patients who can receive
proper care in the home, Horizon/CMS's integrated post-acute care delivery
system now also includes the provision of a wide array of home health care
services. Horizon/CMS is able to offer these complex medical services at a
significantly lower cost than acute care hospitals because its facilities have
lower capital and operating costs than acute care hospitals.
Expanding Specialty Health Care Services Offered
The Company believes that by providing a broad range of cost effective
services, it meets the needs of managed care and other payors. The Company
continues to assess the roles the various specialty health care services can
play in the rapidly changing health care industry and in the Company's
integrated post-acute care delivery system.
Cross-Selling Broad Service Offering
In response to payors' demands for a broad range of services, the Company
cross-sells the variety of services provided by its business units. As a result
of these efforts, the Company has achieved significant market positions in large
markets, such as Texas and Nevada, where it offers a full continuum of
post-acute care through the integration of rehabilitation, subacute, long-term
care, home health care and other medical services.
3
<PAGE>
Concentrating Operations in Targeted Geographic Areas
To realize operating efficiencies, economies of scale and growth
opportunities, Horizon/CMS concentrates its operations in clusters of operating
units in selected geographic areas. In effecting this concentration of
operations, the Company accesses and identifies those assets, services and
revenue that the Company believes are integral to the continued growth of the
Company. Thus, this concentration effort may involve the disposition of selected
operations in selected geographic markets. The Company believes that
concentration of its rehabilitation hospitals and long-term care facilities
within selected geographic regions (a) provides Horizon/CMS with a platform from
which it can expand its specialty health care services, (b) enhances the
development of stronger local referral sources through concentrated marketing
efforts and (c) facilitates the establishment of effective working relationships
with the regulatory and legislative authorities in the states in which the
Company operates.
Effect of Merger with HEALTHSOUTH
The business strategy described under this caption is the strategy of
Horizon/CMS operating as an independent entity. If the Merger is consummated,
Horizon/CMS will become subject to the management and control of HEALTHSOUTH.
The business strategy of Horizon/CMS may thereafter be changed and modified to
reflect the views and objectives of management of HEALTHSOUTH.
SERVICES
The following table summarizes revenues for each of the Company's business
units for the periods indicated:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED MAY 31,
---------------------------------------------------------------------
1997 1996 1995
--------------------- --------------------- ---------------------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
Acute Rehabilitation .................. $ 398 22.1% $ 449 25.6% $ 404 24.9%
Subacute Care ........................ 185 10.3 216 12.3 195 12.0
Long-Term Care ........................ 403 22.4 384 21.8 340 21.0
Contract Rehabilitation ............... 379 21.1 392 22.3 395 24.3
Outpatient Rehabilitation ............ 147 8.2 97 5.5 93 5.7
Institutional Pharmacy Services ...... 62 3.4 45 2.6 39 2.4
Alzheimer's Care ..................... 27 1.5 25 1.4 21 1.3
Other Services ........................ 170 9.4 119 6.8 121 7.5
Other Operating Revenue ............... 29 1.6 30 1.7 15 0.9
------- ------ ------- ------ ------- ------
Total .............................. $1,800 100.0% $1,757 100% $1,623 100.0%
======= ====== ======= ====== ======= ======
</TABLE>
Inpatient Care Services
Acute Rehabilitation Hospitals/Unit Management. At May 31, 1997,
Horizon/CMS operated 30 freestanding, comprehensive acute rehabilitation
hospitals with a total of 1,976 beds, 1,790 of which are certified as acute
rehabilitation beds, in 14 states. Horizon/CMS operates many of its
rehabilitation hospitals through joint ventures with local general acute care
hospitals, physicians and other investors. The acute rehabilitation hospitals
also typically provide on-site outpatient rehabilitation services.
In addition, Select Rehab, Horizon/CMS's rehabilitation unit management
group, operates inpatient and outpatient rehabilitation programs within acute
care hospitals. At May 31, 1997, Horizon/CMS managed 15 rehabilitation units
with more than 270 beds in such acute care hospitals.
Specialty Hospitals/Subacute Care Units. Horizon/CMS provides subacute care
to high acuity patients with medically complex conditions who require ongoing,
multi-disciplinary nursing and medical supervision and access to specialized
equipment and services but who do not require many other services provided by an
acute care hospital. Horizon/CMS provides subacute care services through its
specialty hospitals and subacute care units. Generally, these specialty
hospitals and subacute care units are lo-
4
<PAGE>
cated in separate areas within the physical structures of the Company's
long-term care facilities and are supervised by separate nursing and
administrative staffs employed by Horizon/CMS. At May 31, 1997, Horizon/CMS
operated 36 specialty hospitals and subacute care units, including one
freestanding specialty hospital, with 852 beds in 11 states.
Horizon/CMS's specialty hospitals each hold hospital licenses and are
certified for participation in the Medicare program as long-term acute care
hospitals. In contrast, Horizon/CMS's subacute care units are operated under
long-term care facility licenses and are certified for participation in the
Medicare program as skilled nursing facilities. The hospital licenses, and the
consequent long-term acute care hospital certifications, permit Horizon/CMS to
provide higher acuity services and to receive, where appropriate, higher
reimbursement rates than the subacute care units.
Long-Term Care Facilities - General. Horizon/CMS's long-term care
facilities provide routine basic patient services to geriatric and other
patients with respect to daily living activities and general medical needs.
These basic patient services include daily dietary services, recreational
activities, social services, housekeeping and laundry services, pharmaceutical
and medical supplies and 24 hours-a-day access to registered nurses, licensed
practical nurses and related services prescribed by the patient's physician. At
May 31, 1997, Horizon/CMS operated 135 long-term care facilities (16,792 beds),
of which 44 were owned (5,577 beds) and 79 were leased (9,630 beds), and also
managed 12 long-term care facilities (1,585 beds), located in a total of 17
states.
Horizon/CMS announced on May 12, 1997 that it had agreed to terminate
certain agreements ("Management Agreements") between its wholly-owned
subsidiary, Horizon Facilities Management, Inc. ("HFM"), and Texas Health
Enterprises, Inc. and certain of its affiliates (collectively, the "HEA Group").
Under the Management Agreements, which were originally effective January 1,
1996, HFM provided management and administrative services for 126 nursing
facilities located in Texas, Oklahoma and Michigan.
Alzheimer's Care Units. Horizon/CMS offers a specialized program for
persons diagnosed with Alzheimer's disease through its Alzheimer's centers. At
May 31, 1997, Horizon/CMS had instituted this program at 27 of its long-term
care facilities, with a total of 865 beds. Each Alzheimer's center is located in
a designated wing of a long-term care facility. Horizon/CMS designed its
Alzheimer's care program to address the problems of disorientation experienced
by Alzheimer's patients and to help reduce stress and agitation resulting from a
short attention span and hyperactivity.
Assisted Living Facilities. Horizon/CMS's assisted living facilities
provide a full array of services to people who can no longer live by themselves,
but who do not require the high level of nursing services provided by a
long-term care facility. Residents live in upscale studio or one or two bedroom
units and have a number of services available, including three meals, weekly
housekeeping, laundry, social and recreational activities, personal support and
health care services. Horizon/CMS currently operates five assisted living
facilities with 345 beds in three states.
Hospice Care. Horizon/CMS provides hospice care in Texas to
institutionalized, terminally ill patients. Hospice care includes the provision
of all durable medical equipment, intravenous therapies and pharmaceuticals
incident to such care.
Outpatient Care Services
Outpatient Rehabilitation Clinics. Horizon/CMS provides rehabilitation
therapy services to ambulatory patients recovering from industrial injuries,
sports-related injuries and other general orthopedic conditions. Horizon/CMS's
outpatient clinics provide rehabilitation programs dedicated to industrial
reconditioning, sports medicine, aquatic therapy, back stabilization, arthritis,
osteoporosis, pain management, total joint replacement and general
rehabilitation. At May 31, 1997, Horizon/CMS provided outpatient rehabilitation
services through 288 outpatient clinics in 25 states.
Home Health Care. Horizon/CMS provides home health care services in Nevada,
Texas, Florida and Virginia. Horizon/CMS provides specialized home nursing
services, outpatient health care services, home medical equipment, intravenous
therapy and management and consulting services for hospital-home care
departments, skilled nursing facilities and rural health clinics.
5
<PAGE>
Physician Practices. Horizon/CMS owns and operates orthopedic practices
and one neurology practice in South Florida as a complement to its outpatient
rehabilitative services in that geographic area.
Home Respiratory/Home Infusion. Horizon/CMS provides home respiratory care
services and supplies to home care patients in Texas, Oklahoma, Arkansas,
Louisiana, Tennessee and Kentucky through a physician referral base. Horizon/CMS
employs a fully-trained nursing staff to perform these services, which include
the provision of home infusion and intravenous therapies. Supplies provided by
Horizon/ CMS include gas and liquid oxygen cylinders, oxygen concentrators and
aerosol nebulizers.
Patient Care Services Provided Under Contract
Contract Rehabilitation Therapies. Horizon/CMS provides a comprehensive
range of rehabilitation therapies, including physical, occupational, respiratory
(including inpatient and outreach services) and speech therapy services to
skilled nursing facilities, general acute care hospitals, schools, home health
agencies, inpatient rehabilitation hospitals and outpatient clinics. As of May
31, 1997, Horizon/CMS provided these services through 1,453 contracts in 36
states, 156 of which are with Horizon/CMS operated long-term care facilities,
specialty hospitals and subacute facilities, and the remainder of which are with
third party long-term care facilities, home health agencies, hospitals,
outpatient clinics or schools systems.
Physician/Allied Health Professional Placement Services. Horizon/CMS
provides physician and allied health professional placement services ("locum
tenens" services) to institutional providers and physician practice groups
throughout the United States. Horizon/CMS recruits, credentials and places these
healthcare professionals in appropriate short-term, long-term or permanent
positions in most physician and allied healthcare specialties. Horizon/CMS also
provides credentialling assistance, recruitment outsourcing, staff planning
services and educational programs for physicians and healthcare executives.
Institutional Pharmacy. Horizon/CMS has established a network of 35
regionally located pharmacies in 22 states through which it provides under
contract a full range of prescription drugs and infusion therapy services, such
as antibiotic therapy, pain management and chemotherapy, to facilities operated
by Horizon/CMS or third parties. These facilities contain, in the aggregate,
approximately 44,400 beds.
Physician Practice Management. Horizon/CMS provides physician practice
management services in Southern California, Pennsylvania and Southern Florida.
Clinical Laboratory Services. Horizon/CMS operates a comprehensive clinical
laboratory, located in Dallas, Texas, to serve the long-term care industry. The
clinical laboratory provides bodily fluid testing services to assist in
detecting, diagnosing and monitoring diseases. At May 31, 1997, the laboratory
provided services under contract to 108 facilities. Of these facilities, which
contain in the aggregate approximately 13,478 beds, 11,922 are operated by
Horizon/CMS and 1,556 are operated by third parties.
Mobile X-Ray Services. Horizon/CMS provides portable x-ray services by way
of mobile units to patients in both the hospital and the skilled nursing
facility settings. Horizon/CMS provides these services in Arizona, Texas, New
Mexico, Florida, Oklahoma, Nevada, Georgia and Ohio.
ORGANIZATION
The Company organizes its operations principally according to the services
provided. The Company's objective is to delegate operational responsibility to
operational managers located within local communities to the extent practicable.
Regional managers in each business unit report to business unit managers who, in
turn, report to senior management. The Company's corporate and regional staffs
provide a broad range of support services to these managers. These support
services include marketing assistance, training, quality assurance oversight,
human resource management, reimbursement expertise, accounting, risk management,
cash management, legal services and management support. The Company has
established standardized operating procedures for its units and monitors the
units to assure consistency of operations.
Inpatient Care Services
Acute Rehabilitation Hospitals/Unit Management. The Company's acute
rehabilitation business is supervised by a divisional president and is
organized into two regions. Acute rehabilitation services are provided in
freestanding comprehensive rehabilitation hospitals and provide care including
physical, psycholog-
6
<PAGE>
ical, social and vocational rehabilitative services. Each rehabilitation
hospital is supervised by a chief executive officer. Services are provided by a
number of different types of health care professionals, predominately physicians
specializing in rehabilitation medicine, nurses and physical, speech,
occupational, recreation and respiratory therapists, aides and assistants.
Specialty Hospitals/Subacute Care Units. The Company's specialty hospitals
and subacute care operations are organized into two geographic regions, each of
which is supervised by a director of operations. Each of the subacute care
facilities and specialty hospitals is supervised by a licensed administrator and
a governing board. Each of the subacute care facilities and specialty hospitals
employs a director of nursing services, who supervises a staff of registered
nurses, licensed practical nurses and nurses' aides. A medical director and a
staff of resident medical professionals supervise the medical management of all
patients.
Long-Term Care Operations. The Company's long-term care facilities
(including its Alzheimer's centers) are organized into three regions, each of
which is supervised by a vice president of operations. For every six to twelve
centers within each region, a district director, clinical nurse consultant and
dietary consultant are responsible for monitoring operations. Each facility
operated by the Company is supervised by a licensed administrator and employs a
director of nursing services, who supervises a staff of registered nurses,
licensed practical nurses and nurses' aides. To supervise and enhance the care
provided in the Company's long-term care facilities, the director of nursing
works with a district director of clinical services. This clinic services
director acts as a resource in the areas of management of resident care,
education and clinical performance. In turn, these district directors of
clinical services report to the long-term care division's director of clinical
services. A medical director supervises the medical management of all patients.
Other personnel include dietary staff, housekeeping, laundry and maintenance
staff, activities and social services staff and a business office staff.
Assisted Living Services. The Company's five assisted living facilities are
supervised by a director of operations located at the Company's headquarters in
Albuquerque, New Mexico. Each facility has an administrator and a director of
nursing services. Other personnel include dietary staff, housekeeping, laundry
and maintenance staff, activities and social services staff and a business
office staff.
Hospice Care. The Company's hospice care business is currently organized
into two regional operational offices. Each regional office recruits, hires,
trains and supervises the nursing and clergy staff who provide the hospice care.
These regional offices are supervised by a director of operations located at the
Company's headquarters in Albuquerque, New Mexico.
Outpatient Care Services
Outpatient Rehabilitation. Certain of the Company's outpatient
rehabilitation clinics are operated through the acute rehabilitation hospitals
as ambulatory clinics within a hospital setting (while not necessarily part of
the physical structure of the hospital). Other clinics are operated through the
contract therapy division as freestanding clinics. In fiscal 1996, the Company
created a new outpatient rehabilitation division, which directly operates
freestanding outpatient clinics. Throughout fiscal 1997, the Company has
acquired or developed 102 freestanding outpatient clinics, including its
acquisition of approximately 70 clinics owned by Pacific Rehabilitation and
Sports Medicine, Inc. ("Pacific Rehab"). In addition, certain of the
freestanding clinics previously operated through the Company's contract therapy
division are now operated by this new division. In each of these cases, the day
to day operations of the clinic are supervised by a therapy manager with general
oversight provided by either a hospital administrator or contract therapy
regional manager. These individuals recruit, hire, train and supervise the
physical, occupational and speech pathology therapists, as well as the
administrative and marketing personnel who operate the outpatient clinics.
Physician Practices. Each of the four physician practices owned by the
Company is managed by the senior physicians of each practice. These physicians
each report to an officer of the management services organization ("MSO") that
owns these practices. The officers of the MSO, in turn, report to the Company's
contract therapy division, RehabWorks. All human resources, payroll and legal
support are provided through RehabWorks. Financial and accounting support are
provided by RehabWorks.
7
<PAGE>
Home Health Care. In its home health care operations, the Company provides
services through teams of clinicians, including homemakers, home health aides,
licensed practical nurses, licensed registered nurses, registered pharmacists,
physical therapists, occupational therapists, speech pathologists, and medical
social workers. Each of these clinicians is supervised by a regional manager who
oversees seven to eight home health agencies. These regional managers report to
a clinical director who, in turn, reports to the director of operations. The
director of operations reports to the Company's vice president of medical
specialty services.
Home Respiratory/Home Infusion. The Company's home respiratory service
businesses are organized into four geographic regions, each of which is
supervised by a director of operations. These regional directors report to the
Company's vice president of specialty medical services. Each regional office
recruits, hires, trains, and supervises the nursing staff employed by the
Company.
Patient Care Services Provided Under Contract
Contract Rehabilitation Therapies. The Company's contract rehabilitation
therapy operations are organized into nine regional operational divisions, each
of which is supervised by a director of operations. These regional divisions
each recruit, hire, train and supervise the physical, occupational and speech
pathology therapists that provide the "hands on" therapy services to the
Company's facilities and, to a greater extent, third parties. Each of the
directors of operations is responsible not only for the productivity of the
therapists employed by the Company but also for the compliance with the
Company's policies and procedures in billing for services rendered.
Physician Placement Services. The Company's locum tenens business is
organized into two divisions, physicians and allied health care professionals,
each supervised by a division leader. These divisions each recruit, hire,
credential, market and provide risk management assistance for the physicians and
other health care professionals provided to hospitals, physician practices and
managed care payors on a temporary basis.
Institutional Pharmacy Services. The Company's institutional pharmacy
business is organized into geographic pharmacy distribution centers in each of
the states where the Company provides these services. In each of the pharmacy
distribution centers, the Company employs pharmacists to fill prescriptions
ordered in each of the facilities with which the Company has contracted. Each of
these pharmacy distribution centers also prepares and provides enteral and
parenteral supplies as ordered in addition to all legally required
pharmaceutical consulting services. In addition, the regional managers recruit,
hire, train and supervise the pharmacists employed by the Company. These
operations are supervised by a vice president of pharmacy services.
Physician Practice Management. The Company's physician practice management
company is divided into two geographic regions, one in the East and one in the
West. In the East, the Company's physician practice management company provides
management and administrative services to two independent physician associations
("IPAs"). In the West, the Company's physician practice management company
provides management and administrative services to eleven IPAs. Each region is
headed by a regional director of operations. Each of these regional director of
operations, in turn, reports to the president of the management company. The
president, in turn, reports to the Company's senior vice president of subsidiary
operations.
Clinical Laboratory Services. The Company's clinical laboratory operation
is based in Dallas, Texas, and is operated by the vice president of operations
for the clinical laboratory. A medical director supervises the testing of
samples at the laboratory. When a facility physician orders lab testing for a
patient, the necessary samples are drawn at the facility and shipped by
overnight delivery service to the Company's clinical laboratory. The ordered
tests are completed and the results are transmitted electronically back to the
facility.
Mobile X-Ray Services. The Company's mobile x-ray services are
headquartered in Albuquerque, New Mexico and are divided into several geographic
regions. Each of these regions is supervised by a regional supervisor, who
recruits, hires, trains and supervises diagnostic technicians who work in the
Company's mobile units.
8
<PAGE>
MARKETING
The Company believes that the selection of a post-acute care provider is
strongly influenced by advice rendered by physicians, managed care providers and
hospital discharge planners. As a result, the Company has focused its marketing
efforts at the community level and attempts to identify, develop and maintain
relationships with these primary referral sources. These efforts have been
supplemented by corporate management, which emphasizes the diverse array of
services offered by the Company and the significant opportunities for
cross-selling these services. Where appropriate, the Company consolidates its
marketing efforts to benefit all the facilities in a regional cluster.
FINANCIAL AND MANAGERIAL CONTROLS
The Company has implemented a comprehensive program of financial and
managerial controls to ensure adequate monitoring of its diverse business units.
Financial control is maintained through financial and accounting policies that
are established at the corporate level for use at, and with respect to, each
facility. The Company's financial reporting system enables it to monitor certain
key financial data at each facility, such as payor mix, admissions and
discharges, cash collections, net patient care revenues and staffing. Managerial
control is maintained through standard operating procedures that establish and
promote consistency of operations. All support and development functions are
centralized at the Company's headquarters in Albuquerque, New Mexico. This
system allows corporate management access to information from any acute
rehabilitation hospital, subacute care or long-term care facility in its network
on a daily basis and provides for monthly review of results of operations by
corporate and regional personnel as well as periodic site visits for more
detailed reviews. In addition, payroll information is routinely examined
biweekly.
Each business unit develops monthly budgets that are then reviewed by
corporate management and compared to the prior year's budget and actual results
prior to approval. Once approved, the actual results are compared to budgeted
performance on a monthly basis.
QUALITY ASSURANCE AND CONTINUOUS QUALITY IMPROVEMENT
The Company has developed a comprehensive quality assurance program
intended to maintain a high standard of care with respect to all of the services
it provides to patients.
Inpatient Care Services
Under the Company's acute rehabilitation hospital quality assurance
program, the quality of the care and services provided at the hospitals is
supervised and evaluated on a continuous basis by a full time quality manager in
each hospital. Quality and risk management measures are captured in a
hospital-based program throughout the month and summarized results are routinely
evaluated against company-wide measures and national benchmarks. The corporate
office has access to the hospital-based data enabling a coordinated quality
assurance effort. Patient surveys are also collected at the time of discharge to
evaluate patient satisfaction. Patient outcomes are similarly evaluated by
corporate management.
Under the Company's long-term and subacute care quality assurance program,
the care and services provided at each facility are evaluated semi-annually by a
quality assurance team that reports directly to the Company's management and to
the administrator of each facility. The long-term and subacute program is
comprised of a quality assurance checklist and a patient satisfaction survey and
evaluation. The checklist, completed semi-annually by the regional quality
assurance nurses employed by the Company, provides for ongoing evaluation. To
assist patients and their families in resolving any concerns they may have, the
Company has also established a resident advocacy program. In addition to the
foregoing, the Company is enhancing its current quality assurance program by
establishing an improved assessment system that will focus on clinical outcomes
and resident satisfaction. This system will be driven by the same clinical data
base utilized within each facility to reflect resident conditions and health
status. This system will also allow the Company to compare benchmarking,
facility by facility, against comparable facilities statewide and nationwide as
well as against the Company's corporate standards. By utilizing the data from
this assessment system, the Company is endeavoring to enhance constantly the
services it provides to its customers by applying the principles of total
quality management and contin-
9
<PAGE>
uous quality improvement ("TQM/CQI"). Finally, the Company has a clinical
training department to work with facility personnel to assist them in applying
clinical outcomes and resident satisfaction information within the TQM/CQI
process. The training department will also keep facility and divisional
personnel up-to-date on changes in state and federal legislation and regulations
as well as the health care environment within which the facilities operate.
Outpatient Care Services
Outpatient Rehab - In the Company's outpatient rehabilitation division, the
Company utilizes an outcomes management process including patient satisfaction,
cost, and utilization of services. This information is collected at the regional
level and disseminated to all clinics. The corporate office has access to all
information. Peer reviews are conducted consisting of quarterly chart reviews at
the clinic level. Based on the findings in these reviews the clinic manager
institutes appropriate changes in care and documentation. The division's
policies and procedures are based on Medicare standards for outpatient
rehabilitation agencies. All clinics, whether serving Medicare patients or not,
implement these policies and each clinic manager ensures annual compliance to
these standards. All information is utilized in the division's continuous
quality improvement efforts.
Home Health Care. Under the Company's home health care programs, the
Company has established written policies and procedures prescribing standards
for patient care and has established an internal quality assurance program
including medical records audits, pharmacy surveys, patient interviews and
customer questionnaires. The Company conducts clinical and operational audits of
each branch office on a periodic basis to assure compliance with these
standards. The clinical staff actively participate with the corporate staff in
the quality assurance program. To assist in maintaining high standards for
quality care, the Company has established medical advisory boards comprised of
prominent physicians that provide advice on specific medical issues. The Company
also consults from time to time with medical specialists on clinical procedures
and new therapies. The Company's health care specialists and home nursing staff
must meet experience and training criteria. In accordance with state and federal
regulations, each member of such staff is tested and evaluated at the time of
employment, prior to providing patient care.
Patient Care Services Provided Under Contract
Under the Company's contract therapy programs, the Company maintains a
comprehensive quality assurance program developed to ensure high quality patient
care and monitor clinical staff care practices. Like many of the Company's other
divisions, the contract therapy division employs the principles of continuous
quality improvement. Among other things, the quality improvement and infection
control departments each educate therapists as to proper documentation of
skilled intervention, infection control issues and OSHA guidelines. Finally, the
Company has developed a comprehensive outcome and rehabilitation management
software program which measures the effectiveness and efficiency of the
Company's rehabilitation therapies.
Under the Company's institutional pharmacy services program, the services
provided by the pharmacy are evaluated semi-annually by a survey completed by
the director of nursing of each client facility. These surveys are summarized
and tabulated in such a manner that comparison between pharmacies as well as a
comparison to the standard is possible. Each pharmacy manager is required to
develop an action plan to deal effectively with any negative variances to the
standard that are indicated by the applicable survey. These action plans and the
individual surveys are reviewed by corporate pharmacy management for issues
dealing with specific clients, pharmacies and services.
The Company's physician practice services division also maintains a
comprehensive quality improvement program. Quality improvement personnel create
procedures for and participate in the monitoring of provider credentialing;
client screening; incident reporting and follow-up; specific monitoring of
physician care; and educational programs for employees. Medical consultants in
the areas of OB/GYN, anesthesia, family practice, orthopedic surgery, radiology,
radiation oncology, general surgery and pathology have assisted quality
improvement personnel in developing credentialing policies and procedures for
each medical specialty on an ongoing basis, training personnel and supporting
practitioners in the field.
10
<PAGE>
Under the Company's other health care programs, the Company has also
established comprehensive, outcome-oriented programs designed to maintain
quality at all levels.
The Company believes that its quality assurance and continuous quality
improvement programs are adequate and customary for its businesses. There can be
no assurance, however, that these quality assurance and continuous quality
improvement programs will prevent deviations from the Company's standards for
quality of care and quality service. See - "Regulation - Facility Operating
Requirements."
FACILITIES
At May 31, 1997, the Company operated (a) 30 acute rehabilitation
hospitals, of which 15 were owned (either directly or through joint venture
arrangements) and the balance were leased; (b) 12 specialty hospitals; (c) 24
subacute care units; (d) 135 long-term care facilities including 12 which were
operated by the Company under management contracts and 123 which were owned or
leased; (e) 288 outpatient rehabilitation units; and (f) 35 pharmacy units.
Horizon/CMS announced on May 12, 1997 that it had agreed to terminate Management
Agreements between its wholly-owned subsidiary, HFM, and the HEA Group. Under
the Management Agreements, which were originally effective January 1, 1996, HFM
provided management and administrative services for 126 nursing facilities
located in Texas, Oklahoma and Michigan. Certain information regarding the
facilities operated by the Company as of May 31, 1997 is provided in the
following tables:
<TABLE>
<CAPTION>
ACUTE OUTPATIENT
REHABILITATION SPECIALTY LONG-TERM REHABILITATION
HOSPITALS HOSPITALS SUBACUTE CARE CLINICS PHARMACY
--------------- -------------- -------------- ---------------- --------------- ---------
STATE UNITS BEDS UNITS BEDS UNITS BEDS UNITS BEDS UNITS UNITS
- ---------------------- ------- ------- ------- ------ ------- ------ ------- -------- --------------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Alabama ............ - - - - - - - - 1 -
Arizona ............ 1 60 - - - - - - 6 -
Arkansas ............ 3 170 - - 1 10 - - 12 2
California ......... - - - - - - - - 9 -
Colorado ............ 1 64 - - - - 2 362 10 -
Connecticut(1) ...... - - - - - - 3 585 - 1
Florida(2) ......... 1 60 - - 3 76 9 909 25 1
Georgia ............ - - - - - - - - 1 -
Hawaii ............... - - - - - - - - 5 -
Idaho ............... - - - - - - 2 224 - -
Illinois ............ - - - - - - - - 1 -
Indiana ............ 3 127 - - 3 53 - - 5 1
Kansas ............... 3 192 2 54 2 32 4 404 12 1
Kentucky ............ 1 40 - - - - - - 2 -
Louisiana ............ 4 234 - - 4 39 1 112 10 -
Maryland ............ 1 20 - - - - - - 11 -
Massachusetts ...... 1 187 - - 5 139 7 957 25 1
Michigan ............ - - - - 2 46 7 942 18 1
Mississippi ......... - - - - - - - - 5 -
Montana ............ - - - - - - 5 684 - 1
Nevada ............... 2 108 1 27 1 16 11 1,518 16 4
New Mexico ......... - - 1 25 - - 27 2,609 - 3
North Carolina ...... - - - - - - 1 125 - -
Ohio ............... - - - - - - 18 1,809 - 1
Oklahoma(3) ......... 1 46 2 74 1 14 4 388 1 2
Oregon ............... - - - - - - - - 16 -
Pennsylvania ......... - - - - - - 1 140 2 -
Rhode Island ......... - - - - - - - - - 1
Tennessee ............ 1 60 - - - - - - 19 1
Texas ............... 7 422 6 219 2 28 31 4,757 31 14
Virginia ............ - - - - - - - - 2 -
Washington ......... - - - - - - - - 43 -
Wisconsin(4) ......... - - - - - - 2 267 - -
--- ------ --- ---- --- ---- ---- ------- ---- ---
Totals ............
30 1,790 12 399 24 453 135 16,792 288 35
--- ------ --- ---- --- ---- ---- ------- ---- ---
</TABLE>
11
<PAGE>
<TABLE>
<CAPTION>
ACUTE LONG-TERM LONG-TERM
REHABILITATION SPECIALTY CARE/SUBACUTE CARE/SUBACUTE
HOSPITALS HOSPITALS OCCUPANCY(5) OCCUPANCY(5)
OCCUPANCY(5) OCCUPANCY(5) LEASED/OWNED MANAGED
--------------- --------------- --------------- ----------------
STATE 1997 1996 1997 1996 1997 1996 1997 1996
- ---------------------- ------ ------ ------ ------ ------ ------ ------ -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Arizona ............ 44% 43% -% -% -% -% -% -%
Arkansas ............ 89 89 - - 90 - - -
California ......... - 50 - - - 61 - -
Colorado ............ 59 71 - - 85 96 - -
Connecticut(1) ...... - - - - - - 93 92
Florida(2) ......... 80 87 - - 93 91 92 91
Idaho ............... - - - - 78 88 - -
Illinois ............ - - - - - - - -
Indiana ............ 76 54 - - 93 - - -
Kansas ............... 55 59 58 53 82 91 - -
Kentucky ............ 70 74 - - - - - -
Louisiana ............ 53 74 - - 62 85 - -
Maryland ............ 77 82 - - - 85 - -
Massachusetts ...... 85 92 - - 91 95 - -
Michigan ............ - - - - 85 89 - 76
Missouri ............ - - - - - - - -
Montana ............ - - - - 91 93 - -
Nevada ............... 88 82 92 61 93 94 - -
New Mexico ......... - - 40 46 89 91 - 76
North Carolina ...... - - - - 90 96 - -
Ohio ............... - - - - 85 87 - -
Oklahoma(3) ......... 59 60 69 85 91 95 89 56
Pennsylvania ......... - - - - 90 89 - -
Tennessee ............ 58 58 - - - - - -
Texas ............... 79 79 47 48 86 88 - 57
Virginia ............ - - - - - - - -
Wisconsin(4) ......... - - - - 83 81 88 -
-- -- -- -- --- --- --- ------
Totals ............ 72% 72% 54% 54% 88% 90% 92% 62%(6)
=== === === === === === === ======
</TABLE>
- ----------
(1) Consists of three long-term care facilities operating 485 beds managed by
the Company.
(2) Includes seven long-term care facilities and one subacute care unit
operating 726 beds and 24 beds, respectively, managed by the Company.
(3) Includes 1 long-term care facility operating 118 beds managed by the
Company.
(4) Includes 1 long-term care facility operating 156 beds managed by the
Company.
(5) Weighted average occupancy is computed be dividing the total bed days
occupied by the total licensed bed days available for the month ended May
31, 1997 or 1996, as appropriate.
(6) In January 1996, the Company began managing 134 facilities leased and
operated by the HEA Group. At that time, the weighted average occupancy of
the HEA Group facilities was approximately 61%. This contract was
terminated on May 12, 1997.
SOURCES OF REVENUES
The Company derives substantially all of its revenues from private pay
patients, non-affiliated long-term care facilities and public funding through
the Medicare, Medicaid, Veterans' Administration and other governmental benefit
programs.
The Company's charges for private pay patients are established by the
Company from time to time and the level of such charges is generally not subject
to regulatory control. The Company classifies payments made directly for
services without government assistance as private pay revenues. The private
12
<PAGE>
pay classification includes revenues from sources such as commercial insurers
and health maintenance organizations. The Company bills private pay sources and
rehabilitation therapy customers (or their insurers or health maintenance
organizations) for services rendered on a periodic basis no less frequently than
monthly. These billings are due and payable upon receipt. The Company typically
receives payments on a current basis from individuals and within 60 to 90 days
of billing from commercial insurers and health maintenance organizations.
Under the Medicare program and some state Medicaid programs, the Company's
acute rehabilitation hospitals, subacute care facilities, specialty hospitals
and long-term care facilities are periodically paid in amounts designed to
approximate the facilities' reimbursable costs or the applicable payment rate.
Actual costs incurred are reported by each facility annually. Such cost reports
are subject to audit, which may result in upward or downward adjustment of
Medicare payments received. Most of the Company's Medicaid payments are
prospective payments intended to approximate costs, and normally no retroactive
adjustment is made to such payments. Under certain of the Company's specialty
health care businesses, however, the Company's Medicare reimbursement is either
on a fee screen or fee for service basis. The Company is generally paid for
these services within 60 to 90 days.
The following table identifies the Company's revenues attributable to each
of its revenue sources for the periods indicated below:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED MAY 31,
---------------------------------------------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Private pay ...... $ 855,266 47% $ 862,458 49% $ 881,453 55%
Medicare ......... 606,538 34 582,899 33 458,131 28
Medicaid ......... 338,020 19 311,177 18 283,074 17
----------- ---- ----------- ---- ----------- ----
Total ............ $1,799,824 100% $1,756,534 100% $1,622,658 100%
=========== ==== =========== ==== =========== ====
</TABLE>
COMPETITION
The primary competitive factors in the rehabilitation services business are
quality outcomes and cost efficiency. As managed care companies increase their
influence within the markets the Company serves, the Company's competitive
position in such markets will increasingly depend on its ability to negotiate
provider contracts with organized purchasers of health care services, including
health maintenance and preferred provider organizations, medical groups and
other third party payors.
Competition for acute rehabilitation services includes other inpatient
rehabilitation hospitals as well as local acute care hospitals. The Company
believes recent cost containment efforts of federal and state governments,
health maintenance and preferred provider organizations and other third party
payors are designed to encourage more efficient utilization of health care
services and have resulted in lower acute care hospital occupancy, motivating
some of these acute care hospitals to convert to, or add, specialized post-acute
facilities in an attempt to meet patient care needs in a more cost efficient
manner.
Competition for subacute care patients is increasing by virtue of market
entry by other care providers. These market entrants include acute care
hospitals, rehabilitation hospitals and other specialty service providers.
Important competitive factors include the reputation of the facility in the
community, the services offered, the availability of qualified nurses, local
physicians and hospital support, physical therapists and other personnel, the
appearance of the facility and the cost of services.
Competition for contract rehabilitation therapy services comes, primarily,
from small locally-based firms. Increasingly, the Company faces competition from
inpatient health care providers seeking to insource rehabilitation therapy
services. The Company believes it will be able to compete successfully with
local firms by maintaining its strong reputation in the local communities and by
establishing new relationships through internal expansion and strategic
acquisitions. The Company also believes its variety of service delivery settings
will allow it to compete successfully for therapists with providers seeking to
insource such services.
13
<PAGE>
The Company's long-term care facilities principally compete for patients
with other long-term care facilities and, to a lesser extent, with home health
care providers and acute care hospitals. In competing for patients, a facility's
local reputation is a critical factor. Referrals typically come from acute care
hospitals, physicians, religious groups, other community organizations, health
maintenance organizations and patients' families and friends. Members of a
patient's family generally actively participate in selecting a long-term care
facility. Other factors that affect a facility's ability to attract patients
include the physical plant condition, the ability to identify and meet
particular health care needs in the community, the rates charged for services,
and the availability of personnel to provide the requisite care.
The Company also faces competition in its other specialty health care lines
of business: institutional pharmacy services, home health care services,
Alzheimer's care, noninvasive medical diagnostic services, physician placement
services, physician practice and physician practice management and clinical
laboratory services. The degree of competition varies depending on local market
conditions. Competitive factors include nature and quality of the services
offered, timeliness of delivery of services and availability of qualified
personnel.
EMPLOYEES
As of May 31, 1997, the Company employed approximately 37,500 persons, and
approximately 2,800 or 7.5% of the Company's employees were covered by
collective bargaining contracts. Of the 38 collective bargaining contracts
covering the Company's employees, six will expire in calendar year 1997, 12 will
expire in calendar year 1998, 19 will expire in calendar year 1999 and one will
expire in calendar year 2000. The Company believes it has had good relationships
with the unions that represent its employees, but it cannot predict the effect
of continued union representation or organizational activities on its future
activities. The Company also believes that it has good relationships with its
non-union employees.
Although the Company believes it is able to employ sufficient personnel to
staff its facilities adequately, a shortage of therapists or nurses in key
geographic areas could affect the ability of the Company to attract and retain
qualified professional health care personnel or could increase the Company's
labor costs. The Company competes with other health care providers for both
professional and non-professional employees and with non-health care providers
for non-professional employees.
ACQUISITIONS
Since its inception in 1986, Horizon/CMS has rapidly expanded both the size
and the diversity of its operations through (i) strategic mergers and
acquisitions such as the acquisition of Continental Medical Systems, Inc.
("CMS") and the acquisitions of Medical Innovations, Inc. ("Medical
Innovations") and Pacific Rehab, (ii) the acquisition of long-term care
facilities, including the acquisitions of Greenery Rehabilitation Group, Inc.
("Greenery") and the peopleCARE Heritage Group ("peopleCARE"), (iii) the
development of specialty hospitals and subacute care units and (iv) the
acquisition and development of other specialty health care businesses. Growth
through acquisition entails certain risks in that acquired operations could be
subject to unanticipated business uncertainties or legal liabilities. Horizon/
CMS seeks to minimize these risks through investigation and evaluation of the
operations proposed to be acquired and through transaction structure and
indemnification. In addition, each such business combination presents the risk
that currently unanticipated difficulties may arise in integrating the
operations of the combined entities. Moreover, such business combinations
present the risk that the synergies expected from the combined operations may
not be realized. The various risks associated with the integration of recent and
future acquisitions and the subsequent performance of such acquired operations
may adversely affect the results of operations of Horizon/CMS. In addition, the
ability of Horizon/ CMS to acquire additional operations depends upon its
ability to identify appropriate acquisition candidates and to obtain appropriate
financing and personnel.
REIMBURSEMENT BY THIRD PARTY PAYORS
For fiscal years 1997, 1996 and 1995, Horizon/CMS derived approximately
34%, 33% and 28%, respectively, of its revenues from Medicare, and 19%, 18% and
17%, respectively, of its revenues from Medicaid (excluding certain out-of-state
Medicaid revenues). Changes in the mix of patients among
14
<PAGE>
different types of private pay sources and among private pay sources, Medicare
and Medicaid can significantly affect the revenues and profitability of the
operations of Horizon/CMS. Moreover, third party payors continue to limit
increases in reimbursement rates for medical services and are insisting that
providers control health care costs. There can be no assurance that payments
under governmental and third party payor programs will remain at current levels
or that Horizon/CMS will continue to attract and retain private pay patients or
maintain its current payor or revenue mixes. In attempts to limit the federal
budget deficit, there have been, and Horizon/CMS expects that there will
continue to be, a number of legislative enactments and other proposals designed
to limit Medicare and Medicaid reimbursement for certain services. Horizon/CMS
cannot now predict whether any of these pending proposals will be adopted or, if
adopted and implemented, what effect such proposals would have on Horizon/CMS.
Medicare and Medicaid
Medicare is a federal insurance program under the Social Security Act
("SSA") primarily for individuals age 65 and over and is supervised by the
Health Care Financing Administration ("HCFA"), a division of DHHS. The Medicare
program reimburses for skilled nursing services and rehabilitative care on the
basis of the reasonable cost of providing care and for covered specialty
services on the basis of established charges. Like the various state Medicaid
programs, the federal Medicare program is regulated and subject to change. With
certain exceptions, Medicare is a retrospective cost-based reimbursement system
for long-term and subacute care and acute long-term care hospital providers in
which each facility receives an interim payment during the year, which is later
adjusted upward or downward to reflect actual allowable direct and indirect
costs of services (subject to certain cost ceilings) based on the submission of
a cost report at the end of each year. Historically, Medicare reimbursement for
services rendered to Medicare patients generally has covered the costs incurred
by the Company in delivering such services, but there can be no assurance that
Medicare will continue to reimburse skilled nursing and rehabilitation services
on a reasonable cost basis that covers the actual costs of rendering such
services.
The Company's contract rehabilitation therapy, institutional pharmacy and
clinical laboratory businesses provide Medicare and Medicaid covered services
and supplies to long-term and subacute care facilities and acute long-term care
hospitals under arrangements with both facilities of the Company and
non-affiliated facilities. Under these arrangements, the Company's
rehabilitation therapy and institutional pharmacy subsidiaries bill and are paid
by the facility for the services actually rendered and the details of billing
the Medicare and Medicaid programs are handled directly by the facility. As a
result, the Company's contract rehabilitation therapy business is not Medicare
and Medicaid certified and does not enter into provider agreements with the
Medicare and Medicaid programs. The Company's institutional pharmacy business
is, however, authorized to bill the Medicaid program directly for parenteral and
enteral services, which encompasses a narrow range of supplies, equipment and
nutrients. The institutional pharmacy business is also authorized to bill the
Medicaid program directly for prescription services related to Medicaid
patients. In addition, the Company's home respiratory therapy, non-invasive
medical diagnostic and sleep diagnostic business maintain Medicare and, in
certain instances, Medicaid billing numbers and directly bill Medicare and/or
Medicaid for services rendered.
Special regulations apply to Medicare reimbursement for rehabilitation
therapy and institutional pharmacy services provided by the Company at Company
operated facilities. In order for the Company to obtain reimbursement for more
than merely its cost of services these Medicare regulations generally require,
among other things, that (i) the Company's rehabilitation therapy and
institutional pharmacy subsidiaries must each be a bona fide separate
organization; (ii) a substantial part of the rehabilitation therapy services or
institutional pharmacy services, as the case may be, of the relevant subsidiary
must be transacted with non-affiliated entities, and there must be an open,
competitive market for the relevant services; (iii) rehabilitation therapy
services and institutional pharmacy services, as the case may be, must be
commonly obtained by long-term and/or subacute care facilities and/or acute
long-term care hospitals from other organizations and must not be a basic
element of patient care ordinarily furnished directly to patients by such
facilities and/or hospitals; and (iv) the prices charged to the Company's
long-term care facilities by the Company's rehabilitation therapy and
institutional pharmacy subsidiaries must be in line with the charges for such
services in the open market and no more than the prices
15
<PAGE>
charged by the Company's rehabilitation therapy and institutional pharmacy
subsidiaries under comparable circumstances to non-affiliated long-term or
subacute care facilities and/or acute long-term care hospitals. The Company
believes that each of the foregoing requirements is satisfied with respect to
its rehabilitation therapy and institutional pharmacy subsidiaries, and,
therefore, the Company believes that it satisfies the requirements of those
regulations.
In April 1995, the HCFA issued a memorandum to its Medicare fiscal
intermediaries (the "Fiscal Intermediaries") providing guidelines for assessing
costs incurred by inpatient providers ("Care Providers") relating to payment of
occupational and speech language pathology services furnished under arrangements
that include contracts between therapy providers and Care Providers. While not
binding on the Fiscal Intermediaries, the HCFA memorandum suggested certain
rates to the Fiscal Intermediaries to assist them in making annual "prudent
buyer" assessments of speech and occupational therapy rates paid by Care
Providers during the Fiscal Intermediary's reviews of the Care Providers' cost
reports. The HCFA memorandum acknowledges that the rates noted in the memorandum
are not absolute limits and should only be used by the Fiscal Intermediaries for
comparative purposes. Following the issuance of the HCFA memorandum, meetings
between industry representatives and HCFA have been held concerning the merits
of the HCFA memorandum. On March 28, 1997, HCFA released a Proposed Rule for
Occupational Therapy, Speech-Language Pathology and Physical Therapy (the
"Proposed Rule"). Public comments on the Proposed Rule, including those of the
Company, were accepted by HCFA through May 27, 1997. To date, HCFA is still
considering those public comments. After HCFA has considered the comments and
made any changes to the Proposed Rule it deems appropriate, HCFA will then
publish a final rule. Any final rule will not become effective until 60 days
after it is published. The Proposed Rule would change the current rate system in
two basic ways. First, the Proposed Rule would establish salary equivalency
rates for occupational therapy and speech-language pathology. Second, the
underlying methodology upon which the Proposed Rule is based is different from
HCFA's current method of rate determination. The Proposed Rule sets basic hourly
index payment rates for occupational therapy, speech-language pathology,
physical therapy, and respiratory therapy. The indexed rates are then adjusted
according to additional factors such as overhead, fringe benefits and, most
significantly, geographic location. Based on the changes outlined in the
recently enacted 1997 Balanced Budget Act as they relate to the establishment of
a prospective payment system, it now appears unlikely that the Proposed Rule
will be enacted in final form. The Company cannot yet determine whether the
rates suggested in the proposed rule will be used by HCFA. Although management
of the Company has developed strategies to deal with these changes, there can be
no assurance that future changes in the administration or interpretation of
governmental health care programs will not have an adverse effect on the results
of operations of the Company.
The Balanced Budget Act ("the Balanced Budget Act") seeks to achieve a
balanced federal budget by, among other things, reducing federal spending on the
Medicare and Medicaid programs. The law contains numerous changes in the
Medicare payments to skilled nursing facilities, home health agencies, therapy
providers, and hospices, and repeals the federal payment standard for Medicaid
nursing facilities and hospitals. There can be no assurance that these changes
will not adversely effect Horizon/CMS as they are implemented.
More specifically, the Balanced Budget Act requires the establishment of a
prospective payment system ("PPS") for Medicare skilled nursing facilities
("SNFs") under which facilities will be paid a federal per diem rate for
virtually all covered nursing facility services. This PPS will be phased in over
three cost reporting periods, starting with cost reporting periods beginning on
or after July 1, 1998. The Balanced Budget Act also institutes consolidated
billing or "bundling" for SNF services in a manner similar to that required for
hospital services. Specifically, payment for non-physician Medicare Part B
services for beneficiaries who are no longer eligible for Medicare Part A SNF
care will be made to the facility, regardless of whether the item or service was
furnished by the facility, by others under arrangement, or under any other
contracting or consulting arrangement. The new bundling requirement is effective
for items or services furnished on or after July 1, 1998.
The Balanced Budget Act establishes a PPS for inpatient rehabilitation
hospital services under which the United States Department of Health and Human
Servies (the "DHHS") will establish classes of rehabilitation facility
discharges by patient case mix groups and will be phased in between October 1,
16
<PAGE>
2000 and before October 1, 2002. The PPS will be fully implemented on October 1,
2002. The Balanced Budget Act also requires the DHHS to establish a PPS for
hospital outpatient department services (other than therapy or ambulance
services paid under a fee schedule), effective for services furnished beginning
in 1999. Under the provision, the Secretary must develop a classification system
for covered outpatient department services.
The Balanced Budget Act includes a number of provisions that will limit
payments to certain hospitals currently exempted from the hospital PPS such as
the Company's specialty hospitals. These limits include, without limitation,
reduced capital payment amounts by 15 percent for the years 1998 through 2002,
the establishment of caps on certain allowable costs under the Tax Equity and
Fiscal Responsibility Act of 1982 the ("TEFRA"), limits on TEFRA bonus payments,
the establishment of payment and target amount rules for long-term acute care
hospitals that first receive Medicare payments on or after October 1, 1997 and a
requirement that the Secretary to submit to Congress by October 1, 1999 a
legislative proposal to establish a PPS from long-term acute care hospitals.
A similar PPS is required to be established for home health services, to be
implemented beginning October 1, 1999. The legislation also requires home health
agencies ("HHAs") to submit claims for all services, and all payments will be
made to the HHA regardless of whether the item or service was furnished by the
agency, by others under arrangement, or under any contracting or consulting
arrangement.
The law also contains provisions affecting outpatient rehabilitation
agencies and providers, including a 10 percent reduction in operating and
capital costs for 1998, a fee schedule for therapy services beginning in 1999,
and the application of per beneficiary therapy caps currently applicable to
independent therapists to all outpatient rehabilitation services, beginning in
1999.
With regard to hospices, the Balanced Budget Act limits reimbursement by
setting payment rate increase at market basket minus 1.0 percentage point for
fiscal years 1998 through 2002. The law also institutes a number of reforms of
the hospice benefit, including a requirement that hospices be reimbursed based
on the location where care if furnished (rather than the location of the
hospice), effective for cost reporting periods beginning on or after October 1,
1997.
Other provisions limit Medicare payments for certain drugs and biologicals,
durable medical equipment, parenteral and enteral nutrition nutrients and
supplies.
The Medicaid program is a joint federal/state medical assistance program
for individuals who meet certain income and resource standards. Participating
states administer their own Medicaid programs pursuant to state plans approved
by the DHHS. Facilities participating in the Medicaid program are required to
meet state licensing requirements, to be certified in accordance with state and
federal regulations and to enter into contracts with the state to provide
services at the rates established by the state. All long-term care facilities
operated by the Company (other than its subacute care units and assisted living
facilities) are certified under the appropriate state Medicaid programs.
Although all state Medicaid programs are subject to federal approval, the
reimbursement methodologies and rates vary significantly from state to state.
Reimbursement rates are typically determined by the state from "cost reports"
filed annually by each facility, on a prospective or retrospective basis. Under
a prospective system, per diem rates are established (generally on an annual
basis) based upon certain historical costs of providing services, adjusted to
reflect factors such as inflation and any additional services required to be
performed. Retroactive adjustments, if any, are based on a recomputation of the
applicable reimbursement rate following an audit of cost reports generally
submitted at the end of each year. Reimbursable costs normally include the costs
of providing health care services to patients, administrative and general costs,
and the costs of property and equipment. Not all costs incurred are reimbursed,
however, because of cost ceilings applicable to both operating and fixed costs.
Many state Medicaid programs, however, include an incentive allowance for
providers whose costs are less than the ceilings and who meet other
requirements. A provider may not bill a Medicaid recipient for the portion of
its costs for Medicaid-covered services that are not reimbursed by Medicaid. A
provider may bill a Medicaid recipient for requested goods or services that are
not covered by Medicaid. There can be no assurance that Medicaid reimbursement
will be sufficient to cover actual costs incurred by the Company with respect to
Medicaid services rendered.
17
<PAGE>
Prior to the recent enactment of the Balanced Budget Act, federal law
required state Medicaid programs to reimburse nursing facilities for the costs
that were incurred by efficiently and economically operated providers in order
to meet quality and safety standards. The Balanced Budget Act repealed this
payment standard, effective for services provided on or after October 1, 1997,
thereby granting states considerable flexibility in establishing payment rates.
There can be no assurance that budget constraints or other factors will not
cause states to reduce Medicaid reimbursement rates. The Company is not able to
predict whether any states will adopt changes in their Medicaid reimbursement
systems or, if adopted and implemented, what effect such initiatives would have
on the Company. Nevertheless, there can be no assurance that such changes in
Medicaid reimbursement to nursing facilities will not have an adverse effect on
the Company. Further, the Balanced Budget Act allows states to mandate
enrollment in managed care systems without seeking approval from the DHHS for
waivers from certain Medicaid requirements as long as certain standards are met.
Although historically these managed care programs have exempted institutional
care, no assurance can be given these waiver projects ultimately will not change
the reimbursement system for long-term care facilities from fee-for-service to
managed care negotiated or capitated rates or otherwise affect the levels of
payment to the Company.
REGULATION
The federal government and all states in which the Company operates
regulate various aspects of the Company's business. The Company's acute
rehabilitation, long-term care, specialty hospital and subacute care facilities
are subject to certain federal certification statutes and regulations and to
state statutory and regulatory licensing requirements. In addition, the
Company's facilities are subject to various local building codes and other
ordinances.
Labor Related Requirements
Pursuant to contracts at some of the Company's long-term care facilities
with the Veterans' Administration, the Company is a contractor to the United
States government and believes that it is in substantial compliance with all
laws and regulations governing federal contractors, including, but not limited
to the Service Contract Act ("SCA"), Executive Order 11246, the Rehabilitation
Act, and the Vietnam Era Veterans Readjustment Assistance Act ("VEVRA").
Under the SCA, the Company is required to pay nonexempt employees working
under any federal government service contract wages and fringe benefits
prevailing in the locality as determined by the U.S. Department of Labor. The
SCA also requires the Company to assure that no part of the services covered by
the SCA will be performed in buildings or surroundings or under working
conditions that are unsanitary, hazardous or dangerous to the health and safety
of the employees.
Executive Order 11246 prohibits discrimination in employment against
employees and applicants on the basis of race, color, religion, sex or national
origin. The Company is required to develop and implement written affirmative
action plans for women and minority group members.
The Rehabilitation Act prohibits discrimination against people with
physical or mental disabilities who are able to perform essential job functions,
with or without reasonable accommodation. The company is required to take
affirmative action to employ and promote qualified individuals with disabilities
and to make reasonable accommodation to their disabilities. VEVRA requires the
Company to take affirmative action in hiring and promoting Vietnam era veterans
as well as disabled veterans of all wars.
Facility Licensing Requirements
All of the Company's long-term care facilities (other than its specialty
hospitals and assisted living facilities) are licensed under applicable state
law and are certified or approved as providers under one or more of the
Medicaid, Medicare or Veterans Administration programs. Each of the Company's
specialty hospitals and certain of the Company's subacute and long-term care
facilities are either accredited by, or are in the process of obtaining
accreditation by, the Joint Commission on Accreditation of Healthcare
Organizations.
18
<PAGE>
Each of the Company's specialty hospitals is licensed as such under
applicable state law and is certified by Medicare as an acute long-term care
hospital. Both initial and continuing qualification of a long-term and/or
subacute care facility to participate in such programs depends upon many
factors, including accommodations, equipment, services, patient care, safety,
personnel, physical environment and adequate policies, procedures and controls.
Licensing, certification and other applicable standards vary from jurisdiction
to jurisdiction and are revised periodically. To be certified as an acute
long-term care hospital, the Company's specialty hospitals must satisfy certain
conditions. These include an average length of stay for patients of greater than
25 days and, when the specialty hospital is located within another health care
facility such as the Company's long-term care facilities, a separate governing
body, a separate medical director, a separate medical staff, a separate
administrator and separate self-sustained operating functions must be
maintained.
Each of the Company's acute rehabilitation hospitals is licensed as such
under applicable state law and is certified by Medicare as an acute
rehabilitation hospital. To be certified as an acute rehabilitation hospital,
the Company's acute rehabilitation hospitals must satisfy certain conditions.
These include a requirement that at least 75% of the patients must be able to
sustain four or more hours of rehabilitation therapy each day.
Effective October 1, 1990, the Omnibus Budget Reconciliation Act of 1987
("OBRA") eliminated the different certification standards for "skilled" and
"intermediate care" nursing facilities under the Medicaid program in favor of a
single "nursing facility" standard. This standard requires, among other things,
that the Company have for each long-term care facility at least one registered
nurse on each day shift and one licensed nurse on each other shift and increases
training requirements for nurses aides by requiring a minimum number of training
hours and a certification test before a nurse's aide can commence work. States
continue to be required to certify that nursing facilities provide "skilled
care" to obtain Medicare reimbursement.
As of May 31, 1997, substantially all of the Company's leased, owned and
managed long-term care facilities were certified to receive benefits provided
under Medicare as skilled nursing facilities. In areas where the demand for
skilled nursing services is low or where the availability of the requisite
registered nursing personnel is limited, the Company has opted not to seek such
skilled licensure and certification. As of May 31, 1997, virtually all of the
Company's licensed specialty hospitals are certified to participate in the
Medicare program as acute long-term care hospitals. See "-Facility Operating
Requirements" for information regarding a subsequent decertification of a
facility for participation in the Medicare program. Each of the Company's acute
rehabilitation hospitals is certified to participate in the Medicare program as
an acute rehabilitation hospital.
Facility Operating Requirements
In late 1994, DHHS published the final new OBRA enforcement regulations in
response to certain adverse judicial determinations concerning its previously
issued state operations manual pertaining to survey procedures. Certain aspects
of the new enforcement regulations became effective on July 1, 1995. The new
enforcement regulations dictate to each state what such state's OBRA compliance
plan must provide. Specifically, each state plan must contain the following
remedies to be enforced against facilities that provide substandard care: (a)
termination of the Medicaid provider agreement for the facility, (b) temporary
management of the facility, (c) denial of payment for new admissions, (d) civil
money penalties, (e) closure of the facility in emergency situations and
transfer of the residents, and (f) state monitoring of the facility. In
addition, each state is allowed to provide for certain alternative remedies
provided the state can demonstrate to the satisfaction of the HCFA that these
alternatives are effective in deterring non-compliance and in correcting
deficiencies. These alternative remedies include directed plans of correction to
bring the facility back into compliance and directed in-service training of
facility employees. While many of these remedies for substandard care have
existed in the past under prior regulations and procedures in each state, the
new enforcement regulations substantially curtail a facility's ability to
challenge the factual and/or legal propriety of a survey or the deficiencies
cited therein.
The Company believes that its facilities are in substantial compliance with
the various Medicare and Medicaid regulatory requirements applicable to them. In
the ordinary course of its business, however, the Company from time to time
receives notices of deficiencies for failure to comply with various
19
<PAGE>
regulatory requirements. The Company reviews such notices to examine them for
factual correctness and, based on such examination, either takes appropriate
corrective action or challenges the propriety of the survey results and the
deficiencies cited therein.
In most cases, the Company and the reviewing agency will agree upon the
measure to be taken to bring the facility into compliance. In some cases or upon
repeat violations, the reviewing agency has the authority to take various
adverse actions against a facility, including the imposition of fines, temporary
suspension of admission of new patients to the facility, suspension or
decertification from participation in the Medicare or Medicaid programs and, in
extreme circumstances, revocation of a facility's license. These actions would
adversely affect a facility's ability to continue to operate, the ability of the
Company to provide certain services, and its eligibility to participate in the
Medicare, Medicaid or Veterans Administration programs. Additionally, conviction
of abusive or fraudulent behavior with respect to one facility could subject
other facilities under common control or ownership to disqualification from
participation in the Medicare and Medicaid programs. Certain of the Company's
facilities have received notices in the past from state agencies that, as a
result of certain alleged deficiencies, the agency was assessing a fine and/or
taking steps to decertify the facility from participation in the Medicare and
Medicaid programs. In all but one case during fiscal 1997, such cited
deficiencies were remedied before any facilities were decertified, the Company
successfully appealed the appropriateness of the cited deficiency and such cited
deficiencies were rescinded or the Company successfully negotiated an amicable
resolution of any such decertification action and the facility remained
certified for participation in the Medicare and/or Medicaid programs.
Unfortunately, however, one of the Company's specialty hospitals was decertified
for participation in the Medicare program. In October 1997, the facility was
recertified for participation in the Medicare program. None of the Company's
facilities has had its license revoked.
The SSA and DHHS regulations provide for exclusion of providers and related
persons from participation in the Medicare and Medicaid programs if they have
been convicted of a criminal offense related to the delivery of an item or
service under either of these programs or if they have been convicted, under
state or federal law, of a criminal offense relating to neglect or abuse of
residents in connection with the delivery of a health care item or service.
Furthermore, individuals or entities and their affiliates may be excluded from
the Medicaid and Medicare programs under certain circumstances including
conviction relating to fraud, license revocation or suspension, or filing claims
for excessive charges or unnecessary services or failure to furnish services of
adequate quality. Penalties for violation include imprisonment for up to five
years, a fine of up to $25,000, or both. In addition, Executive Order 12549
prohibits any corporation or facility from participating in federal contracts if
it or its principals have been disbarred, suspended or are ineligible, or have
been voluntarily excluded, from participating in federal contracts.
Fraud and Abuse, Referral and Relationship Prohibitions
Additionally, the federal Medicare/Medicaid Anti-Fraud and Abuse Amendments
to the SSA (the "Anti-Kickback Law") make it a criminal felony offense to
knowingly and willfully offer, pay, solicit or receive remuneration in order to
induce business for which reimbursement is provided under all government health
programs, including the Medicare and Medicaid programs, with the exception of
the Federal Employees Health Benefits Program. In addition to criminal
penalties, including fines up to $25,000 and five years imprisonment per
offense, violations of the Anti-Kickback Law or related federal laws can lead to
civil monetary penalties and exclusion from the Medicare and Medicaid programs
from which the Company receives substantial revenues. The Anti-Kickback Law has
been broadly interpreted to make remuneration of any kind, including many types
of business and financial arrangements among providers, such as joint ventures,
space and equipment rentals, management and personal services contracts, and
certain investment arrangements, potentially illegal if any purpose of the
remuneration or financial arrangement is to induce a referral.
DHHS has promulgated regulations which describe certain arrangements that
will be deemed to not constitute violations of the Anti-Kickback Law (the "Safe
Harbors"). The Safe Harbors described in the regulations are narrow and do not
cover a wide range of economic relationships that many hospitals, physicians and
other health care providers consider to be legitimate business arrangements not
prohib-
20
<PAGE>
ited by the statute. The regulations do not purport to describe comprehensively
all lawful relationships between health care providers and referral sources and
clearly provide that arrangements that do not qualify for Safe Harbor protection
are not automatically deemed to violate the Anti-Kickback Law. Thus, hospitals
and other health care providers having arrangements or relationships that do not
fall within a Safe Harbor may not be required to alter them in order to ensure
compliance with the Anti-Kickback Law. Failure to qualify for a Safe Harbor may,
however, subject a particular arrangement or relationship to increased
regulatory scrutiny. In 1993, the DHHS published proposed regulations for
comment in the Federal Register establishing additional Safe Harbors.
Additionally, in 1995, the DHHS published a proposed rule aimed at clarifying
the existing Safe Harbors. As of August 27, 1997, these regulations had not been
adopted in final form. The Company cannot predict the final form that these
regulations and rules will take or their effect, if any, on the Company's
business. In addition to the Anti-Kickback Law, Section 1877 of the Social
Security Act (known as the "Stark Law") imposes restrictions on financial
relationships between physicians and certain entities. The Stark Law provides
that if a physician (or a family member of a physician) has a financial
relationship with an entity that furnishes certain designated health services,
the physician may not refer a Medicare or Medicaid patient to the entity unless
an exception to the financial relationship exists. Designated health services
include certain services furnished by the Company, such as inpatient and
outpatient hospital services, physical therapy, occupational therapy, and home
health. The types of financial relationships that can trigger the referral
prohibition are broad and include ownership or investment interests, as well as
compensation arrangements. Penalties for violating the law are severe, including
denial of payment for services furnished pursuant to prohibited referrals, civil
monetary penalties, of $15,000 for each item claimed and exclusion from the
Medicare and Medicaid programs.
The Stark II Law contemplates the promulgation of regulations interpreting
the statutory language. On August 14, 1995, final regulations were published
interpreting the original provisions of the Stark Law that became effective
January 1, 1992. These provisions relate to entities that furnish clinical
laboratory services and are often referred to as "Stark I." As of August 27,
1997, regulations interpreting the restrictions as applied to the additional
designated health services (such as hospital services) had not been published.
Nevertheless, it is the position of the HCFA that the expanded provisions, which
are referred to as "Stark II," became effective as of January 1, 1995, the
statutory effective date. The Company cannot predict the form that such
regulations will take or the effect that such regulations, and the
interpretations thereof, will have on the Company.
The Company believes that its business practices and contractual
arrangements generally satisfy the Anti-Kickback and Stark Law requirements and
proscriptions. Both the Anti-Kickback and Stark Laws are broadly drafted,
however, and their application is often uncertain. Since the inquiry under both
laws is highly factual, it is not possible to predict how they may be applied to
certain arrangements between the Company and other health care providers.
Although the Company believes that its operations and practices are in
compliance with the Anti-Kickback and Stark Laws, there can be no assurance that
enforcement authorities will not assert that the Company, or one of its
facilities, or certain transactions into which they have entered, has violated
or is violating such Anti-Kickback or Stark Law, or that if any such assertions
were made, that the Company would prevail, or whether any sanction imposed would
have a material adverse effect on the operations of the Company. The Company
intends to monitor regulations under, and interpretations of, the Stark II bill
to determine whether any modifications to its operations will be necessary as a
result of such final regulations or statute interpretations. Even the assertion
of a violation of the Anti-Kickback Law, Stark Law or similar laws could have a
material adverse effect upon the Company.
In addition, from time to time, legislation is introduced or regulations
are proposed at the federal and state levels that would further affect or
restrict relationships and compensation or financial arrangements among health
care providers. The Company cannot predict whether any proposed legislation or
other legislation or regulations applicable to the Company will be adopted, the
final form that any such legislation or regulations might take, or the effect
that any such legislation or regulations might have on the Company.
In addition to laws addressing referral relationships, several federal
laws impose criminal and civil sanctions for fraudulent and abusive billing
practices. The federal False Claims Act imposes sanctions,
21
<PAGE>
consisting of monetary penalties of up to $10,000 for each claim and treble
damages, on entities and persons who knowingly present or cause to be presented
a false or fraudulent claim for payment to the United States. Section 1128B(a)
of the Social Security Act prohibits the knowingly and willful making of a false
statement or representation of a material fact in relation to the submission of
a claim for payment under all government health programs (including the Medicare
and Medicaid programs) other than the Federal Employee Health Benefits Program.
Violations of this provision constitute felony offenses punishable by fines and
imprisonment. The recently enacted Health Insurance Portability and
Accountability Act of 1996 ("HIPAA") created several new federal health care
offenses, establishing criminal penalties for fraud, theft, embezzlement, and
the making of false statements in relation to health care benefits programs
(which includes private, as well as government programs).
A joint federal/state initiative, Operation Restore Trust, was created in
1995 to apply to nursing homes, home health agencies, and suppliers of medical
equipment to these providers in the five states of New York, Florida,
California, Illinois and Texas. The program was subsequently expanded to
hospices in those states as well. The program is designed to focus audit and law
enforcement efforts on geographic areas and provider types receiving large
concentrations of Medicare and Medicaid funds. According to DHHS statistics, the
targeted states account for nearly 40% of all Medicare and Medicaid
beneficiaries. Under Operation Restore Trust, the office of Inspector General
("OIG") and HCFA have undertaken a variety of activities to address fraud and
abuse by nursing homes, home health providers and medical equipment suppliers.
These activities will include financial audits, creation of a Fraud and Waste
Report Hotline, and increased investigations and enforcement activity.
On May 20, 1997, the DHHS announced that Operation Restore Trust is being
expanded during the next two years to include twelve additional states (Arizona,
Colorado, Georgia, Louisiana, Massachusetts, Missouri, New Jersey, Ohio,
Pennsylvania, Tennessee, Virginia, and Washington), as well as several other
types of health care services. Over the longer term, Operation Restore Trust
investigative techniques will be used in all 50 states, and will be appled
throughout the Medicare and Medicaid programs.
The Balanced Budget Act also includes numerous health care fraud and abuse
provisions, including: new exclusion authority for the transfer of ownership or
control interest in an entity to an immediate family or household member in
anticipation of, or following, a conviction, assessment, or exclusion; increased
mandatory exclusion periods for multiple health fraud convictions, including
permanent exclusion for those convicted of three health care-related crimes;
authority for the DHHS to refuse to enter into Medicare agreements with
convicted felons; new civil money penalties for contracting with an excluded
provider or violating the Medicare or Medicaid anti-kickback statute; new surety
bond and information disclosure requirements for certain providers and
suppliers; and an explanation of the mandatory and permissive exclusions added
by HIPAA to any federal health care program (other than the Federal Employees
Health Benefits Program).
If any of the Company's financial practices failed to comply with the
foregoing fraud and antiremuneration or fraud and abuse laws, the Company could
be materially adversely affected. See "Item 3. Legal Proceedings - OIG/DOJ
Investigation Involving Certain Medicare Part B and Related Co-Insurance
Billings." The Company believes that its operations and practices comply with
these laws and regulations. The Company, however, is unable to predict the
effect of future administrative or judicial interpretations of these laws, or
whether other legislation or regulations on the federal or state level in any of
these areas will be adopted, what form such legislation or regulations may take,
or their impact on the Company.
State Requirements
All states in which the Company operates, other than California, Colorado,
Texas, New Mexico, Ohio and Kansas, have adopted Certificate of Need or similar
laws that generally require that a state agency approve certain acquisitions and
determine that a need exists prior to the addition of beds or services, the
implementation of other changes, or the incurrence of certain capital
expenditures. State approvals are generally issued for a specified maximum
expenditure and require implementation of the proposal within a specified period
of time. Failure to obtain the necessary state approval can result in
22
<PAGE>
the inability to provide the service, to operate the facility, to complete the
acquisition, addition or other change, and can also result in the imposition of
sanctions or adverse action on the facility's license and adverse reimbursement
action.
INSURANCE
The Company maintains a variety of insurance coverages including
malpractice, public liability, fire and property damage and destruction and
directors' and officers' liability insurance. Each of these coverages has
differing levels of self-insurance retention (deductible) limitations. The
Company's self-insured retention with respect to malpractice and public
liability insurance is $1.0 million per occurrence per policy year and $11.0
million in the aggregate with a subaggregate of $3.0 million with respect to
long-term care operations. In addition, the Company maintains umbrella
malpractice and public liability insurance coverage of $50.0 million per
occurrence and in the aggregate.
The Company maintains property damage and destruction insurance coverage in
amounts the Company deems adequate and customary in its industry with no
material self-insured retention in respect of these policies.
The Company is largely self-insured with respect to the health insurance
benefits made available to its employees. The Company is also self-insured with
respect to its workers' compensation coverage in Nevada, New Mexico, Ohio,
Oklahoma, Kansas and Montana. In Texas, the Company is a non-subscriber to the
State's workers' compensation pool. The Company believes that it has adequate
resources to cover any self-insured claims, and the Company maintains excess
liability coverage to protect it against unusual claims in these areas.
Effective as of April 3, 1996, the Company maintains director's and
officer's liability insurance coverage in the aggregate amount of $25.0 million,
consisting of three successive layers of $10.0 million, $10.0 million and $5.0
million, respectively. The initial layer of coverage has a $0.5 million
self-insured retention on all matters, excluding those arising out of actions of
regulatory entities, which has a $2.0 million self-insured retention. These
policies specifically exclude all acts, events or occurrences arising or
occurring prior to April 3, 1996. In addition, the Company maintains director's
and officer's liability coverage specific to CMS and its subsidiaries in the
amount of $10.0 million for claims resulting from wrongful acts occurring from
December 31, 1993 to July 10, 1995 and reported during the policy period of July
10, 1995 to July 10, 2001. In connection with certain of the litigation matters
described in "Item 3. Legal Proceedings - Stockholder Litigation" and "-
Stockholder Derivative Actions," the Company has notified the carrier of the
pendency of these matters and is seeking coverage for its advancement of defense
costs on behalf of certain of the former CMS directors. The Company believes
that the insurance coverage it maintains in this regard is adequate and
customary.
23
<PAGE>
DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------ ----- -----------------------------------------------------------
<S> <C> <C>
Neal M. Elliott ............ 57 Pesident, Chief Executive Officer and Chairman of the
Board
Charles H. Gonzales ......... 41 Senior Vice President of Subsidiary Operations and Di-
rector
Ernest A. Schofield ......... 39 Senior Vice President, Treasurer, Chief Financial Officer
and Director
Anthony Misitano ............ 42 Senior Vice President, Acute Rehabilitation Hospital Di-
vision
Joseph P. Turmes ............ - Senior Vice President of Operations
Scot Sauder ............... 41 Vice President of Legal Affairs, Secretary and General
Counsel
Frank M. McCord ............ 67 Director
Raymond N. Noveck ......... 54 Director
Charles K. Bradford ......... 63 Director
Maria Pappas ............... 48 Director
Ronald N. Riner, M.D. ...... 48 Director
</TABLE>
Neal M. Elliott, the Company's President, Chief Executive Officer and
Chairman of the Board, has served in those capacities since July 1986. Mr.
Elliott, a certified public accountant, worked for Price Waterhouse & Co. prior
to joining The Hillhaven Corporation ("Hillhaven") as Controller in 1969. In
1970, Mr. Elliott became Vice President of Finance for Hillhaven and served as
such until 1983. From 1983 to 1986, Mr. Elliott served as President of the
long-term care group of National Medical Enterprises, Inc., a health care
company then affiliated with Hillhaven. Mr. Elliott is a director of LTC
Properties, Inc., a real estate investment trust which invests in health care
related real estate.
Charles H. Gonzales, the Company's Senior Vice President of Subsidiary
Operations, has served in such position since January 1992. He became a director
of the Company in January 1992. From September 1986 to January 1992, Mr.
Gonzales, a certified public accountant, served as Senior Vice President of
Government Programs for the Company. From June 1984 to September 1986, Mr.
Gonzales was National Director of Reimbursement for Hillhaven.
Ernest A. Schofield, the Company's Senior Vice President, Treasurer, and
Chief Financial Officer, has been with the Company since July 1987. He became a
director of the Company in July 1996. From July 1987 to April 1988, he served as
a reimbursement analyst for the Company, from April 1988 to May 1989, he served
as Assistant Controller, from May 1989 to November 1990, he served as Vice
President and Controller of the Company, and from November 1990 to August 1994
he served as Vice President of Finance. He assumed his present position in
September 1994. Prior to joining the Company, Mr. Schofield, a certified public
accountant, held various positions in public accounting with Fox & Company and
as a partner with Olivas & Company (certified public accounting firms).
Anthony Misitano, the Company's Senior Vice President, Acute Rehabilitation
Hospital Division, has served in such capacity since August 1996. Mr. Misitano
is also the President and Chief Executive Officer of Continental Medical
Systems, Inc. Prior thereto, Mr. Misitano served as an officer of Continental
Medical Systems, Inc. holding a variety of positions since 1988 including,
without limitation, Executive Vice President of the CMS Hospital Group and
President of the Central Division of Continental Medical Systems, Inc. In this
connection, Mr. Misitano was responsible for overseeing the entire operation of
the Company's Hospital Group including inpatient, outpatient and home health
services.
24
<PAGE>
Joseph P. Turmes, the Company's Senior Vice President of Operations has
served in such position since June 1997. Mr. Turmes joined Horizon/CMS in
October 1995 as its Vice President of Operations - Long-Term Care Division
Western Region. In January 1997, Mr. Turmes became Horizon/CMS's Vice President
of Operations - Long-Term Care Division. Mr. Turmes has had over 25 years of
experience in the health care industry including over 20 years in the long-term
care industry. Among other things, Mr. Turmes was previously employed by The
Hillhaven Corporation in such positions as nursing facility administrator,
district director, director of operations, and regional vice president of
operations. He also served as vice president of operations and chief operating
officer for the Franciscan Health Systems, a not-for-profit company engaged in
the long-term acute care business. Mr Turmes has also provided consulting
services to long-term care providers.
Scot Sauder, the Company's Vice President of Legal Affairs, Secretary and
General Counsel, has been with the Company since September 1993. From September
1993 to September 1994, he served as General Counsel to the Company. From
September 1994 through July 1995, he served as Secretary and General Counsel to
the Company. Prior to joining the Company, Mr. Sauder, an attorney licensed to
practice in Texas and certain federal courts, was a director of Geary, Glast &
Middleton, P.C., and Smith & Underwood, P.C. (law firms).
Frank M. McCord is the Chairman and Chief Executive Officer of Cascade
Savings Bank in Everett, Washington, a position he has held since March 1990.
From 1987 until that date, Mr. McCord served such bank as a member of the board
of directors and the executive, loan and audit committees. From 1956 to 1986,
Mr. McCord, a certified public accountant, held various positions with KPMG Peat
Marwick. Mr. McCord became a partner with KPMG Peat Marwick in 1965 and served
as the managing partner of its Seattle, Washington office until 1986. He became
a director of the Company in October 1986.
Raymond N. Noveck, a certified public accountant, has served as the
President of Strategic Systems, Inc., a provider of audiotex health and medical
information since January 1990. He became a director of the Company in July
1987. From July 1989 through December 1989, Mr. Noveck was Senior Vice President
of Kimberly Quality Care, a provider of home health care, temporary nursing
personnel and related medical services. Prior to that, he was Executive Vice
President of Lifetime Corporation, a home health care company, from June 1987
through July 1989.
Charles K. Bradford, a certified public accountant, has served since 1993
as the Vice President and Regional Manager for Cain Brothers, a private
investment banking and financial advisory firm that serves the health care
industry. He became a director of the Company in July 1996. Prior to joining
Cain Brothers, he served as National, and then, International Director of the
health care practice of Arthur Andersen LLP. Mr. Bradford is a member of several
health care associations and has served on the Health Care Committee of the
American Institute of Certified Public Accountants, the American Hospital
Association Council on Finance and the Hospital Financial Management Association
Principles and Practices Board. Mr. Bradford is the co-author of a book
published by the American Hospital Association entitled Monitoring the
Hospital's Financial Health.
Maria Pappas, a Ph.D. in Counseling and Psychology and an attorney, serves
as a Cook County Commissioner in the State of Illinois. Ms. Pappas is currently
the chair of the Law Enforcement Committee of the Cook County Commissioners. She
became a director of the Company in July 1996. Prior to becoming a Commissioner
in November 1990, Ms. Pappas held teaching positions as a professor of
Counseling and Psychology at Loyola and DePaul Universities, respectively, and
at educational centers in Israel, Holland, Greece, Switzerland, England and
Austria. She has also served as a member of the Illinois Supreme Court Special
Committee on the Administration of Justice.
Ronald N. Riner, M.D., a physician specializing in cardio vascular disease,
serves as the President of The Riner Group, Inc. in St. Louis, a professional
advisory and consulting company providing services to the medical, business,
investment and scientific communities on issues concerning health care
management, clinical practice management, risk management, strategic planning,
clinical trials and medical device development. He has served in this capacity
since 1981. He became a director of the Company in July 1996. Dr. Riner has
served as Vice President of Medical Affairs at the Daughters of Charity National
Health System in St. Louis, Missouri.
25
<PAGE>
ITEM 2. PROPERTIES
The Physical properties owned, leased, or managed by the Company are
described in item 1. Business - of this form 10-K.
ITEM 3. LEGAL PROCEEDINGS
DOJ INVESTIGATION IN RESPECT OF CONTINENTAL MEDICAL SYSTEMS, INC.
As previously disclosed by both CMS and the Company, in late fall 1994, CMS
learned of the Department of Justice ("DOJ") investigations being handled by the
United States Attorney's offices in Harrisburg, Pennsylvania and Sacramento,
California. In this connection, representatives of the DOJ visited or contacted
operating facilities and office locations of CMS for the purpose of interviewing
certain of CMS's employees and reviewing certain documents.
In July 1996, the Company was informed that both the civil and criminal
divisions of the United States Attorney's office in Sacramento, California are
closing their investigation in this regard and they would not commence any civil
or criminal action or proceeding against the Company in respect of this
investigation. The Company was also informed that both the criminal and civil
divisions of the United States Attorney's office in Harrisburg, Pennsylvania
were closing their investigation in this regard and they would not commence any
civil or criminal action or proceeding against the Company in respect of this
investigation.
Tenet Healthcare Corporation and Related Litigation
As previously disclosed, Horizon/CMS filed a lawsuit on March 7, 1996
against Tenet Healthcare Corporation ("Tenet") in the United States District
Court for the District of Nevada. The lawsuit arose out of an agreement entered
into between Horizon/CMS and Tenet in connection with Horizon/CMS's attempted
acquisition of The Hillhaven Corporation ("Hillhaven") in January 1995. In the
lawsuit, Horizon/CMS alleges that Tenet failed to honor its commitment to pay
Horizon/CMS approximately $14.5 million pursuant to the agreement. Tenet has
contended that the amount owing to Horizon/CMS under the agreement is
approximately $5.1 million. During fiscal 1996, Horizon/CMS recognized as a
receivable approximately $13.0 million of the approximately $14.5 million
Horizon/CMS contends it is owed under the agreement. On May 13, 1997,
Horizon/CMS sought leave of the court to amend its complaint against Tenet to
assert, among other things, that Tenet tortiously interfered with Horizon/ CMS's
HERE IT ISassert, among other things, that Tenet tortiously interfered with
Horizon/ CMS' contractual relationship with its investment bankers, Donaldson,
Lufkin & Jenrette Securities Corporation ("DLJ"). In this connection,
Horizon/CMS seeks actual damages against Tenet in the approximate amount of
$14.5 million plus pre-judgment interest and punitive damages.
On May 13, 1997, Horizon/CMS filed a lawsuit against DLJ in the United
States District Court for the Central District of California. This lawsuit
arises out of the events and circumstances involved in the lawsuit against
Tenet. Specifically, this lawsuit alleges that DLJ, which served as investment
banker to Horizon/CMS in connection with Horizon/CMS's attempted acquisition of
Hillhaven, breached its fiduciary duty to Horizon/CMS, engaged in professional
negligence and tortiously interfered with Horizon/ CMS's contract with Tenet by
advising Tenet not to pay the $14.5 million Horizon/CMS contends is owing under
the agreement. In this connection, Horizon/CMS seeks actual damages against DLJ
in the approximate amount of $14.5 million and punitive damages. On June 27,
1997, pursuant to an agreement reached with DLJ and its counsel, Horizon/CMS
filed a new lawsuit against DLJ in the United States District Court for the
District of Nevada. This lawsuit is identical in all respects to the lawsuit
filed in the United States District Court for the Central District of
California. Pursuant to the agreement with DLJ and its counsel, DLJ has agreed
that it will not contest either jurisdiction or venue in Nevada. In addition, on
June 27, 1997, Horizon/CMS moved to consolidate the two Nevada matters.
Horizon/CMS has agreed to dismiss the litigation pending in California upon
consolidation of the two Nevada matters. Upon consolidation, Horizon/CMS will
seek an aggregate of $14.5 million in actual damages plus prejudgment interest
and punitive damages against Tenet, DLJ or both. Horizon is vigorously
prosecuting, this litigation matter; no assurance can be given, however, that
Horizon will ultimately prevail.
26
<PAGE>
OIG/DOJ Investigation Involving Certain Medicare Part B and Related
Co-Insurance Billings
Horizon/CMS announced on March 15, 1996 that certain Medicare Part B and
related co-insurance billings previously submitted by Horizon/CMS were being
investigated by the OIG and the DOJ. On December 31, 1996, Horizon/CMS announced
that it had reached a settlement with the DOJ and OIG that concluded their
investigation of these billings. Horizon/CMS also announced that it had received
a letter from the United States Attorney's office conducting such investigation
indicating that the United States declined any criminal prosecution of
Horizon/CMS or any of its employees with respect to these billings. Under the
settlement, Horizon/CMS paid approximately $5.8 million to the United States as
a complete and final resolution of such matters. In addition, pursuant to the
terms of the settlement, Horizon/CMS is implementing a corporate-wide Medicare
Part B compliance program that includes the appointment of a subcommittee to
Horizon/CMS's Corporate Compliance Committee reporting directly to the
Chairman's office and to Horizon/CMS's Board of Directors, ongoing orientation
and training sessions for current and new employees, training evaluation and
annual audits to assess accuracy, validity and reliability of billings.
Securities and Exchange Commission ("SEC") and New York Stock Exchange ("NYSE")
Investigations
The Division of Enforcement of the SEC is conducting a private
investigation with respect to trading in the securities of Horizon/CMS and CMS.
In connection with that investigation, Horizon/CMS has produced certain
documents and Neal M. Elliott, Chairman of the Board, President and Chief
Executive Officer of Horizon/CMS, and certain other present and former officers
of Horizon/CMS have given testimony to the SEC. Horizon/CMS has also been
informed that certain of its division office employees and an individual,
affiliates of whom have limited business relationships with Horizon/CMS, have
responded to subpoenas from the SEC. Mr. Elliott has also produced certain
documents in response to a subpoena from the SEC. In addition, Horizon/CMS and
Mr. Elliott have responded or are responding to separate subpoenas from the SEC
pertaining to trading in Horizon/CMS's common stock and Horizon/CMS's March 1,
1996 press release announcing a revision in Horizon/CMS's third quarter earnings
estimate; Horizon/CMS's March 7, 1996 press release announcing the filing of a
lawsuit against Tenet; the March 12, 1996 press release announcing that the
merger with Pacific Rehab could not be effected by April 1, 1996; Horizon/CMS's
March 15, 1996 press release announcing the existence of a federal investigation
into certain of Horizon/ CMS's Medicare Part B billings; Horizon/CMS's February
19, 1997 announcement that HEALTHSOUTH would acquire Horizon/CMS; and any
discussions of proposed business combinations between Horizon/CMS and Medical
Innovations, and Horizon/CMS and certain other companies. The investigation is
ongoing, and neither Horizon/CMS nor Mr. Elliott possesses all the facts with
respect to the matters under investigation. Although neither Horizon/CMS nor Mr.
Elliott has been advised by the SEC that the SEC has concluded that any of
Horizon/CMS, Mr. Elliott or any other current or former officer or director of
Horizon/CMS has been involved in any violation of the federal securities laws,
there can be no assurance as to the outcome of the investigation or the time of
its conclusion. Both Horizon/CMS and Mr. Elliott intend to continue cooperating
fully with the SEC in connection with the investigation.
In March 1995, the NYSE informed Horizon/CMS that it had initiated a review
of trading in Hillhaven common stock prior to the announcement of Horizon/CMS's
proposed acquisition of Hillhaven. In April 1995, the NYSE extended the review
of trading to include all dealings with CMS. In April 3, 1996, the NYSE notified
Horizon/CMS that it had initiated a review of trading in its common stock
preceding Horizon/CMS's March 1, 1996 press release described above. On February
20, 1997, the NYSE notified Horizon/CMS that it was reviewing trading in
Horizon/CMS's securities prior to the February 18, 1997 announcement that
HEALTHSOUTH would acquire Horizon/CMS. Horizon/CMS is cooperating with the NYSE
in its reviews and, to Horizon/CMS's knowledge, the reviews are ongoing.
Michigan Attorney General Investigation Into Long-Term Care Facility In
Michigan
Horizon/CMS learned in September 1996 that the Attorney General of the
State of Michigan is investigating one of its skilled nursing facilities. The
facility, in Howell, Michigan, has been owned and operated by Horizon/CMS since
February 1994. The Attorney General seized a number of patient,
27
<PAGE>
financial and accounting records that were located at this facility. By order of
a circuit judge in the county in which the facility is located, the Attorney
General was ordered to return patient records to the facility for copying. The
investigation appears to involve allegations arising out of a licensing survey
conducted in April 1996. Horizon/CMS has advised the Michigan Attorney General
that it is willing to cooperate in this investigation. Horizon/CMS cannot now
predict when the investigation will be completed; the ultimate outcome of the
investigation; or the effect thereof on Horizon/CMS's financial condition or
results of operations. If adversely determined, this investigation could result
in the imposition of civil and criminal fines or sanctions against Horizon/CMS,
which could have a material adverse impact on Horizon/CMS's financial condition
and its results of operations.
Stockholder Litigation
On March 28, 1996, Horizon/CMS was served with a lawsuit filed on March 21,
1996 in New Mexico state district court in Albuquerque, New Mexico, by a former
stockholder of CMS, Ronald Gottesman v. Horizon/CMS Healthcare Corporation, No.
CV-96-02894, Second Judicial District Court, County of Bernalillo, State of New
Mexico. This lawsuit, which among other things seeks class certification,
alleges violations of federal and New Mexico state securities laws arising from
what the plaintiff contends are materially misleading statements by Horizon/CMS
in its June 6, 1995 joint proxy statement/prospectus (the "CMS Prospectus"). The
plaintiff alleges that Horizon/CMS failed to disclose in the CMS Prospectus
those problems in Horizon/CMS's Medicare Part B billings Horizon/CMS described
in its related March 15, 1996 announcement. In this action, the plaintiff seeks
damages in an unspecified amount, plus costs and attorneys' fees. On August 22,
1997, the Company and the plaintiff entered into a stipulation whereby the
Plaintiff agreed to dismiss the litigation upon final approval of the proposed
settlement described below.
Since April 5, 1996, Horizon/CMS has been served with several complaints by
current or former stockholders of Horizon/CMS on behalf of all persons who
purchased Horizon/CMS Common Stock between June 6, 1995 and March 15, 1996. Each
of these lawsuits was filed in the United States District Court for the District
of New Mexico, in Albuquerque, New Mexico. In July 1996, the Court entered its
order consolidating these lawsuits into a single action styled In re Horizon/CMS
Healthcare Corporation Securities Litigation, Case No. CIV 96-0442-BB. On
September 30, 1996, the consolidated putative class plaintiffs filed their
consolidated complaint. In this complaint, the plaintiffs allege violations of
federal and New Mexico state securities laws. Among such violations, the
plaintiffs alleged that Horizon/CMS, certain of its current and former directors
and certain former directors of CMS, disseminated materially misleading
statements or omitted disclosing material facts about Horizon/CMS and its
operations. In December 1996, Horizon/CMS and the individual defendants filed
their motions to dismiss this consolidated lawsuit.
On February 20, 1997, Horizon/CMS announced that it had reached an
agreement in principle to settle the claims against it and certain of its
current and former directors in the consolidated class action lawsuit. Under the
proposed settlement, Horizon/CMS agreed to pay a minimum amount of $17.0 million
to resolve all claims against Horizon/CMS and its current and former directors,
excluding those claims arising against the former directors of CMS for conduct
occurring prior to the merger between CMS and Horizon. Under the settlement, the
maximum amount payable by Horizon/CMS is $20.0 million to resolve completely and
finally all claims in the litigation, including any amounts related to claims
against former directors of CMS. In agreeing to settle the litigation, none of
the defendants concedes or admits any of the plaintiffs' claims or allegations.
The settlement is subject to court approval.
On April 7, 1997, Horizon/CMS paid the $17.0 million, in trust, to the
plaintiffs' lead counsel. Also in April, 1997, Horizon/CMS paid $2.25 million to
CMS's directors' and officers' liability insurance carrier in exchange for the
carrier's assumption of the remaining risk contingency. On June 16, 1997, the
Court preliminarily approved the proposed settlement and set a final hearing to
approve the proposed settlement in September 1997. The parties are currently
proceeding to consummate the settlement in accordance with the rules governing
these proceedings.
28
<PAGE>
On August 19, 1997, the plaintiffs and the individual defendants announced
to the Court that they had reached a settlement of the claims excluded by the
Company's prior settlement. This proposed settlement calls for the claims to
settle by a payment of $4 million. This entire amount will be paid by CMS's
directors' and officers' liability insurance carrier. The effect of this
settlement is to discharge the Company of its $3 million guarantee described
above. Accordingly, subject to Court approval, the Company's $17 million payment
will represent the Company's total liability to the plaintiffs in this matter.
Stockholder Derivative Actions
Commencing in April and continuing into May 1996, Horizon/CMS was served
with nine complaints alleging a class action derivative action brought by
stockholders of Horizon/CMS for and on behalf of Horizon/CMS in the Court of
Chancery of New Castle County, Delaware, against Neal M. Elliott, Klemett L.
Belt, Jr., Rocco A. Ortenzio, Robert A. Ortenzio, Russell L. Carson, Bryan C.
Cressey, Charles H. Gonzales, Michael A. Jeffries, Gerard M. Martin, Frank M.
McCord, Raymond M. Noveck, Barry M. Portnoy and LeRoy S. Zimmerman. The nine
lawsuits have been consolidated into one action styled In re Horizon/CMS
Healthcare Corporation Shareholders Litigation. The plaintiffs allege, among
other things, that Horizon/CMS's current and former directors breached their
fiduciary duties to Horizon/CMS and the stockholders as a result of (i) the
purported failure to supervise adequately and the purported knowing
mismanagement of the operations of Horizon/CMS, and the (ii) purported misuse of
inside information in connection with the sale of Horizon/CMS's Common Stock by
certain of the current and former directors in January and February 1996. To
that end, the plaintiffs seek an accounting from the directors for profits to
themselves and damages suffered by Horizon/CMS as a result of the transaction
complained of in the complaint and attorneys' fees and costs. On June 21, 1996,
the individual defendants filed a motion with the Chancery Court seeking to
dismiss this matter because, among other things, the plaintiffs failed to make a
demand on the board of directors prior to commencing this litigation.
Horizon/CMS cannot now predict the outcome or the effect of this litigation or
the length of time it will take to resolve this litigation.
In April 1996, Horizon/CMS was served with a complaint in a stockholder's
derivative lawsuit styled Lind v. Rocco A. Ortenzio, Neal M. Elliott, Klemett
L. Belt, Jr., Robert A. Ortenzio, Russell L. Carson, Bryan C. Cressey, Charles
H. Gonzales, Michael A. Jeffries, Gerard M. Martin, Frank M. McCord, Raymond N.
Noveck, Barry M. Portnoy, LeRoy S. Zimmerman and Horizon/CMS Healthcare
Corporation, No. CIV 96-0538-BB, pending in the United States District Court
for the District of New Mexico. The plaintiff alleges, among other things, that
Horizon/CMS's current and former directors breached their fiduciary duties to
Horizon/CMS and the stockholders as a result of (i) the purported failure to
supervise adequately and the purported knowing mismanagement of the operations
of Horizon/CMS, and the (ii) purported misuse of inside information in
connection with the sale of Horizon/CMS's Common Stock by certain of the
current and former directors in January and February 1996. To that end, the
plaintiff seeks an accounting from the directors for profits to themselves and
damages suffered by Horizon/CMS as a result of the transaction complained of in
the complaint and attorneys' fees and costs. Horizon/CMS filed a motion seeking
a stay of this case pending the outcome of the motion to dismiss in the
Delaware derivative lawsuits or, in the alternative, to dismiss this case for
those same reasons. Horizon/CMS cannot now predict the outcome or the effect of
this litigation or the length of time it will take to resolve this litigation.
Lawsuit by Former Shareholders of Communi-Care, Inc. and Pro Rehab, Inc.
On May 28, 1997, CMS was served with a lawsuit styled Kenneth Hubbard and
Lynn Hubbard v. Rocco Ortenzio, Robert A. Ortenzio and Continental Medical
Systems, Inc., No. 3:97 CV294MCK, filed in the United States District Court for
the Western District of North Carolina, Charlotte Division by the former
shareholders of Communi-Care, Inc. and Pro Rehab, Inc. (now known as RehabWorks)
seeking damages arising out of certain "earnout" provisions of the definitive
purchase agreements under which CMS purchased the outstanding stock of
Communi-Care, Inc., and Pro Rehab, Inc. from such shareholders. The plaintiffs
allege that the manner in which CMS and the other defendants operated the
companies after their acquisition breached their fiduciary duties to the
plaintiffs, constituted fraud, gross negligence and bad faith and a breach of
their employment agreements with the companies. As a result
29
<PAGE>
of such alleged conduct, the plaintiffs assert that they are entitled to damages
in an amount in excess of $27.0 million from CMS and the other defendants.
Horizon/CMS believes based upon the advice of Eaves, Bardacke & Baugh, P.A.,
counsel to Horizon/CMS in this matter, the assertions of these plaintiffs to be
without factual or legal merit and, as a result, intends to contest such claims
vigorously. Because this litigation has just been commenced, Horizon/CMS cannot
now predict the outcome of such litigation, the length of time it will take to
resolve such litigation or the effect of any such resolution on Horizon/CMS's
financial condition or results of operations.
RehabOne Litigation
In March 1997, Horizon/CMS was served with a lawsuit filed in the United
States District Court for the Middle District of Pennsylvania, styled RehabOne,
Inc. v. Horizon/CMS Healthcare Corporation, Continental Medical Systems, Inc.,
David Nation and Robert Ortenzio, No. CV-97-0292. In this lawsuit, the plaintiff
alleges violations of federal and state securities laws, fraud, and negligent
misrepresentation by Horizon/CMS and certain former officers of CMS in
connection with the issuance of a warrant to purchase 500,000 shares of
Horizon/CMS Common Stock (the "Warrant"). The Warrant was issued to the
plaintiff by Horizon/CMS in connection with the settlement of certain prior
litigation between the plaintiff and CMS. The plaintiff's complaint does not
state the amount of damages sought. Horizon/CMS disputes the factual and legal
assertions of the plaintiff in this litigation and intends to contest the
plaintiff's claims vigorously. Horizon/CMS has moved to dismiss the complaint
and that motion is pending. Because this litigation has just commenced,
Horizon/CMS cannot predict the length of time it will take to resolve the
litigation, the outcome of the litigation or the effect of any such outcome on
Horizon/ CMS's financial condition or results of operations.
EEOC Litigation
In March 1997, the Equal Employment Opportunity Commission (the "EEOC")
filed a complaint against Horizon/CMS alleging that Horizon/CMS has engaged in
unlawful employment practices in respect of Horizon/CMS's employment policies
related to pregnancies.Specifically, the EEOC asserts that Horizon/CMS's alleged
refusal to provide pregnant employees with light-duty assignments to accommodate
their temporary disabilities caused by pregnancy violates Sections 701(k) and
703(a) of Title VII, 42 U.S.C. (section) 2000e-(k) and 2000e-2(a). In this
lawsuit, the EEOC seeks, among other things, permanently to enjoin Horizon/CMS's
employment practices in this regard. Horizon/CMS disputes the factual and legal
assertions of the EEOC in this litigation and intends to contest the EEOC's
claims vigorously. Because this litigation has just commenced, Horizon/CMS
cannot predict the length of time it will take to resolve the litigation, the
outcome of the litigation or the effect of any such outcome on Horizon/ CMS's
financial condition or results of operations.
North Louisiana Rehabilitation Hospital Medicare Billing Investigation
In August 1996, the United States Attorney for the Western District of
Louisiana, without actually initiating litigation, apprised Horizon/CMS of
alleged civil liability under the federal False Claims Act for what the
government believes were false or fraudulent Medicare and other federal program
claims submitted by Horizon/CMS's North Louisiana Rehabilitation Hospital
("NLRH") during the period from 1989 through 1992, including certain claims
submitted by a physician who was a member of the medical staff and under
contract to NLRH during the period. Specifically, the government alleges that
NLRH facilitated the submission of false claims under Part B of the Medicare
program by the physician and that NLRH itself submitted false claims under Part
A of the Medicare program for services that were not medically necessary. In
August 1996, the U.S. Attorney identified allegedly improper Part A and Part B
billings, together with penalty provisions under the False Claims Act, ranging
in the aggregate from approximately $1.7 million to $2.2 million. The government
does not dispute that the Medicare Part A services were rendered, only whether
they were medically necessary. Horizon/CMS has vigorously contested the
allegation that any cases of disputed medical necessity in this matter
constitute false or fraudulent claims under the civil False Claims Act.
Moreover, Horizon/CMS denies that NLRH facilitated the submission of false
claims under Medicare Part B.
30
<PAGE>
In late April 1997, Horizon/CMS received administrative subpoenas relating
to the matter and has since then produced extensive materials with respect
thereto. Without conceding liability for either the Medicare Part A or Part B
claims, in May 1997, Horizon commenced preliminary settlement discussions with
the government. In preparation for settlement meetings held in late June and
mid-July 1997, Horizon/CMS and the government developed and then refined their
respective analyses of any losses the government may have incurred in this
regard. Following the July 1997 meeting, the government proposed to Horizon/CMS
that the matter be settled by Horizon/CMS paying the government $4.9 million
with respect to alleged Medicare Part A overpayments and that Horizon/CMS and
certain individual physicians pay the government $820,000 with respect to
Medicare Part B claims for physician services. In late July, Horizon/CMS
responded by offering to settle the matter for $3.7 million for alleged Medicare
Part A overpayments and $445,000 for alleged Medicare Part B claims for which
Horizon/CMS potentially could bear any responsibility. Horizon/CMS anticipates
that settlement discussions will continue and, at this time, is optimistic that
the matter can be resolved without litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
31
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is listed on the NYSE under the symbol "HHC."
The following table sets forth, for the periods indicated, the high and low sale
price per share for the Company's Common Stock, as reported on the NYSE
composite tape.
HIGH LOW
-------- -------
FISCAL YEAR ENDED MAY 31, 1997:
First Quarter ........................... $137/8 $ 95/8
Second Quarter ........................... 133/8 101/8
Third Quarter ........................... 171/4 101/4
Fourth Quarter ........................... 181/4 141/2
FISCAL YEAR ENDED MAY 31, 1996:
First Quarter ........................... $233/4 $171/8
Second Quarter ........................... 24 173/4
Third Quarter ........................... 28 215/8
Fourth Quarter ........................... 191/2 121/8
There were approximately 2,787 holders of record of the Company's Common
Stock as of August 25, 1997.
The Company has not paid or declared any dividends on its Common Stock
since its inception and anticipates that future earnings will be retained to
finance the continuing development of its business. The payment of any future
dividends will be at the discretion of the Company's board of directors and will
depend upon, among other things, future earnings, the success of the Company's
business activities, regulatory and capital requirements, the general financial
condition of the Company and general business conditions. The Company's credit
facility restricts the payment of dividends. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations Liquidity and Capital
Resources" included in Item 7 of this Form 10-K.
32
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following selected income statement and balance sheet data for the
periods ended May 31, 1993 through May 31, 1997 have been derived from the
Company's consolidated financial statements. The information set forth below is
qualified by reference to and should be read in conjunction with the
consolidated financial statements and related notes thereto.
<TABLE>
<CAPTION>
YEAR ENDED MAY 31,
-------------------------
1997 1996
------------ ------------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
<S> <C> <C>
CONSOLIDATED STATEMENTS OF OPERATIONS DATA(1):
Total operating revenues(2) .................................... $1,799,824 $1,756,534
---------- ----------
COSTS AND EXPENSES:
Cost of services ............................................. 1,513,981 1,438,985
Facility leases ............................................. 85,878 84,234
Depreciation and amortization ................................. 64,628 57,883
Interest expense ............................................. 53,539 47,318
Special charge(3) ............................................. 97,305 80,540
---------- ----------
Total costs and expenses .................................... 1,815,331 1,708,960
---------- ----------
Earnings (loss) before minority interests, income taxes, cumu-
lative effect of accounting change and extraordinary item (15,507) 47,574
Minority interests ............................................. (7,375) (7,228)
---------- ----------
Earnings (loss) before income taxes, cumulative effect of ac-
counting change and extraordinary item ........................ (22,882) 40,346
Income taxes ................................................... (821) 31,672
---------- ----------
Earnings (loss) before cumulative effect of accounting change
and extraordinary item ....................................... (22,061) 8,674
Cumulative effect of accounting change, net of tax ............ - -
---------- ----------
Earnings (loss) before extraordinary item ..................... (22,061) 8,674
Extraordinary item, net of tax(4) .............................. (13,858) (31,328)
---------- ----------
Net earnings (loss) .......................................... $ (35,919) $ (22,654)
========== ==========
EARNINGS (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE:
Earnings (loss) before cumulative effect of accounting change
and extraordinary item ....................................... $ (0.42) $ 0.16
Cumulative effect of accounting change, net of tax ............ - -
---------- ----------
Earnings (loss) before extraordinary item ..................... (0.42) 0.16
Extraordinary item, net of tax ................................. (0.27) (0.60)
---------- ----------
Net earnings (loss) per share ................................. $ (0.69) $ (0.44)
========== ==========
Earnings (Loss) Per Common Share - Assuming Full Dilu-
tion:
Earnings (loss) before cumulative effect of accounting change
and extraordinary item ....................................... $ (0.42) $ 0.16
Cumulative effect of accounting change, net of tax ............ - -
---------- ----------
Earnings (loss) before extraordinary item ..................... (0.42) 0.16
Extraordinary item, net of tax ................................. (0.27) (0.60)
---------- ----------
Net earnings (loss) per share ................................. $ (0.69) $ (0.44)
========== ==========
Weighted average shares outstanding (in thousands):
Primary ...................................................... 52,269 52,048
========== ==========
Fully diluted ................................................ 52,472 52,200
========== ==========
<PAGE>
<CAPTION>
1995 1994 1993
------------ ------------ --------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
CONSOLIDATED STATEMENTS OF OPERATIONS DATA(1):
Total operating revenues(2) .................................... $1,622,658 $1,381,380 $1,136,358
---------- ---------- ----------
COSTS AND EXPENSES:
Cost of services ............................................. 1,343,533 1,159,270 935,186
Facility leases ............................................. 81,590 68,832 64,461
Depreciation and amortization ................................. 56,618 48,249 33,915
Interest expense ............................................. 53,045 44,396 26,999
Special charge(3) ............................................. 36,922 74,834 17,154
---------- ---------- ----------
Total costs and expenses .................................... 1,571,708 1,395,581 1,077,715
---------- ---------- ----------
Earnings (loss) before minority interests, income taxes, cumu-
lative effect of accounting change and extraordinary item 50,950 (14,201) 58,643
Minority interests ............................................. (5,245) (4,664) (6,787)
---------- ---------- ----------
Earnings (loss) before income taxes, cumulative effect of ac-
counting change and extraordinary item ........................ 45,705 (18,865) 51,856
Income taxes ................................................... 22,348 1,430 21,520
---------- ---------- ----------
Earnings (loss) before cumulative effect of accounting change
and extraordinary item ....................................... 23,357 (20,295) 30,336
Cumulative effect of accounting change, net of tax ............ - - (3,204)
---------- ---------- ----------
Earnings (loss) before extraordinary item ..................... 23,357 (20,295) 27,132
Extraordinary item, net of tax(4) .............................. 2,571 734 -
---------- ---------- ----------
Net earnings (loss) .......................................... $ 25,928 $ (19,561) $ 27,132
========== ========== ==========
EARNINGS (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE:
Earnings (loss) before cumulative effect of accounting change
and extraordinary item ....................................... $ 0.49 $ (0.55) $ 0.94
Cumulative effect of accounting change, net of tax ............ - - (0.10)
---------- ---------- ----------
Earnings (loss) before extraordinary item ..................... 0.49 (0.55) 0.84
Extraordinary item, net of tax ................................. 0.05 0.02 -
---------- ---------- ----------
Net earnings (loss) per share ................................. $ 0.54 $ (0.53) $ 0.84
========== ========== ==========
Earnings (Loss) Per Common Share - Assuming Full Dilu-
tion:
Earnings (loss) before cumulative effect of accounting change
and extraordinary item ....................................... $ 0.49 $ (0.55) $ 0.89
Cumulative effect of accounting change, net of tax ............ - - (0.09)
---------- ---------- ----------
Earnings (loss) before extraordinary item ..................... 0.49 (0.55) 0.80
Extraordinary item, net of tax ................................. 0.05 0.02 -
---------- ---------- ----------
Net earnings (loss) per share ................................. $ 0.54 $ (0.53) $ 0.80
========== ========== ==========
Weighted average shares outstanding (in thousands):
Primary ...................................................... 47,850 37,078 32,248
========== ========== ==========
Fully diluted ................................................ 47,857 40,051 36,941
========== ========== ==========
</TABLE>
33
<PAGE>
<TABLE>
<CAPTION>
MAY 31,
-------------------------------------------------------------
1997 1996 1995 1994 1993
------------ ------------ ------------ ------------ ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Consolidated Balance Sheet Data:
Working capital ........................... $ 289,737 $ 342,226 $ 282,221 $ 232,158 $227,199
Total assets .............................. 1,606,381 1,512,751 1,402,813 1,151,695 926,398
Long-term debt, excluding current portion . 732,657 645,639 532,688 461,331 459,062
Total stockholders' equity ............... 620,489 651,348 650,892 463,135 305,892
</TABLE>
- ----------
(1) The Company completed the following material business acquisitions using the
purchase method of accounting:
In December 1996, the Company completed the acquisition of all of the
outstanding shares of Pacific Rehab., a provider of outpatient rehabilitation
services in 66 outpatient clinics. Under the terms of the merger agreement,
Pacific Rehab stockholders received $6.50 for each share in cash of Pacific
Rehab common stock and Pacific Rehab became an indirect wholly owned
subsidiary of the Company. The purchase price was approximately $54,000 in
cash. In addition, the Company assumed approximately $22,300 in debt.
In November 1996, the Company completed the merger of an indirect wholly owned
subsidiary of the Company with The Rehab Group, Inc. ("Rehab Group") and Rehab
Group became an indirect wholly owned subsidiary of the Company. The purchase
price, including transaction costs, was approximately $23,300 in cash. In
addition, the Company assumed approximately $2,900 in debt. Rehab Group
operates 26 outpatient medical rehabilitation clinics in Tennessee, Virginia,
Georgia, Alabama, Arkansas and Mississippi.
In July 1996, the Company completed the merger of a wholly owned subsidiary of
the Company with Medical Innovations and Medical Innovations became a wholly
owned subsidiary of the Company. Under the merger agreement, the Company paid
$1.85 in cash for each share of Medical Innovations common stock. The purchase
price, including transaction costs, was approximately $32,700 in cash. In
addition, the Company assumed approximately $11,000 in debt. Medical
Innovations provides services primarily in Texas and Nevada. These services
include specialized home care, home medical equipment, home medical and
intravenous therapies, as well as comprehensive home health care management
services under contractual arrangements with hospitals and other providers.
Also in July 1996, the Company acquired American Rehabilitation
Network, Inc. ("ARN") for approximately $7,800 in cash. ARN operates nine
outpatient rehabilitation centers in Michigan.
In July 1994, the Company acquired peopleCARE. Consideration given for the
acquisition included the issuance of approximately 449,000 shares of the
Company's Common Stock, valued at approximately $10,000, assumption of capital
lease obligations of approximately $48,600 and cash payment of approximately
$56,000.
In February 1994, the Company acquired Greenery in consideration for the
issuance of approximately 2.0 million shares of the Company's common stock,
valued at approximately $48,000 and the assumption of approximately $58,000 in
debt.
(2) Includes $18.2 million of revenues related to the estimated reimbursement
benefit of debt retirement costs, net of a $7.0 million pre-tax charge to
increase third-party settlement receivable reserves recorded during fiscal
1996.
(3) Special charges represent the following items by period: (i) fiscal 1997 -
$7,150 related to the approval by management of the Company of restructuring
measures relating to the Company's rehabilitation hospital corporate office
located in Mechanicsburg, Pennsylvania and certain contract rehabilitation
therapy operations, $4,000 related to the settlement of the investigation by
the OIG and the DOJ of certain of the Company's Medicare Part B and related
co-insurance billings, $19,800 resulting primarily from the settlement of
the claims against the Company and certain of its current and former
directors in the consolidated class action lawsuit filed in New Mexico
Federal District Court in April 1996, $6,450 related to the estimated costs
related to monitoring of, responding to and defense and/or settlement costs
associated with the North Louisiana Rehabilitation Hospital billing
investigation, and various other threatened or pending litigation currently
in process, $6,705 related to the estimated impairment of a non competition
agreement recorded in connection with a previous acquisition and $53,200
related to the termination of certain agreements between its wholly-owned
subsidiary, HFM and the HEA Group and to restructure and forgive certain
indebtedness of the HEA Group; (ii) fiscal 1996 - $62,640 related to costs
incurred in completing the merger with CMS and the approval by management of
restructuring measures related to efforts to combine the previously separate
companies, $11,900 related to a decision by management prior to the CMS
merger to dispose of selected long-term care facilities and a $6,000 accrual
for costs related to pending litigation and investigations; (iii) fiscal
1995 - reflects the effect of a revision in the Company's estimate of
contract therapy receivables from third party payors of $18,377, costs of
$13,500 incurred in connection with the settlement of pending litigation and
related contract terminations and costs of $5,045 related to restructuring
actions taken at contract therapy companies; (iv) fiscal 1994 - related to
the impairment of selected rehabilitation hospital division assets of
$50,244, the costs associated with the consolidation of contract therapy
companies and losses related to the termination of certain relationships in
the contract therapy business of approximately $22,842 and the costs related
to the reduction of corporate office work force and other restructuring
costs of $1,748; (v) fiscal 1993 - reflects the writedown of certain
rehabilitation facility development costs and merger expenses incurred in
connection with an acquisition accounted for as a pooling of interests and
expenses of subsequently integrating the acquired companies' operations.
34
<PAGE>
(4) Extraordinary items represent the following items by period: (i) fiscal 1997
- reflects a $13,858, net of tax, loss related to the disposition of certain
assets following the CMS merger, (ii) fiscal 1996 - reflects a $22,075, net
of tax, loss recorded in connection with the tender of the Company's senior
subordinated notes and a $9,253, net of tax, charge related to a decision by
management subsequent to the CMS merger to revise and expand the group of
facilities previously identified as held for sale prior to the CMS merger;
(iii) fiscal 1995 - reflects gains recognized related to open market
purchases of the Company's subordinated debt and convertible subordinated
notes at a discount; and (iv) fiscal 1994 reflects gains recognized related
to open market purchases of the Company's convertible subordinated notes at
a discount.
35
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
The following table sets forth certain statement of operations data
expressed as a percentage of total operating revenues:
<TABLE>
<CAPTION>
YEAR ENDED MAY 31,
------------------------------------
1997 1996 1995
--------- --------- ------------
<S> <C> <C> <C>
Total operating revenues ....................................... 100.0% 100.0% 100.0%
-------- -------- ----------
Cost of services ................................................ 84.1 81.9 82.8
Facility leases ................................................ 4.8 4.8 5.0
Depreciation and amortization .................................... 3.6 3.3 3.5
Interest expense ................................................ 3.0 2.7 3.3
Special charge ................................................... 5.4 4.6 2.3
-------- -------- ------
Earnings (loss) before minority interests, income taxes and ex-
traordinary item ................................................ (0.9) 2.7 3.1
Minority interests ............................................. (0.4) (0.4) (0.3)
-------- -------- ------
Earnings (loss) before income taxes and extraordinary item ...... (1.3) 2.3 2.8
Income taxes ................................................... (0.1) 1.8 1.4
-------- -------- ------
Earnings (loss) before extraordinary item ........................ (1.2) 0.5 1.4
Extraordinary item, net of tax ................................. (0.8) (1.8) 0.2
-------- -------- ------
Net earnings (loss) ............................................. (2.0)% (1.3)% 1.6%
======== ======== ==========
</TABLE>
The following table sets forth a summary of the Company's total operating
revenues by type of service and the percentage of total operating revenues that
each such service represented for each period indicated:
<TABLE>
<CAPTION>
YEAR ENDED MAY 31,
---------------------------------------------------------------------
1997 1996 1995
--------------------- --------------------- ---------------------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
Long-term care services .................. $ 403 22.4% $ 384 21.8% $ 340 21.0%
Specialty health care services: .........
Acute and outpatient rehabilitation ...... 545 30.3 546 31.1 497 30.6
Contract rehabilitation therapy ......... 379 21.1 392 22.3 395 24.3
Other(1) ................................. 444 24.7 405 23.1 376 23.2
Other operating revenues(2) ............... 29 1.5 30 1.7 15 0.9
------- ------ ------- ------ ------- ------
Total operating revenues .................. $1,800 100.0% $1,757 100.0% $1,623 100.0%
======= ====== ======= ====== ======= ======
</TABLE>
- ----------
(1) Includes revenues derived from subacute care, institutional pharmacy
operations, Alzheimer's care, noninvasive medical diagnostic testing
services, home health care services, physicians services, home respiratory,
and infusion supplies and services, hospice care, assisted living care and
clinical laboratory services.
(2) Includes revenues derived from management fees, interest income, rental
income and other miscellaneous revenues, including $9.3 million, net of
direct expenses, resulting from arrangements related to an unsuccessful
merger effort recorded during fiscal 1996. With respect to the latter, see
"Item 3. Litigation - Litigation against Tenet Healthcare Corporation" in
Part I of this Form 10-K.
36
<PAGE>
YEAR ENDED MAY 31, 1997 COMPARED TO YEAR ENDED MAY 31, 1996
REVENUES
Total operating revenues increased approximately $43.3 million, or 2.4% for
the year ended May 31, 1997 as compared to the prior fiscal year. The increase
in total operating revenues for the fiscal 1997 period is primarily attributable
to acquisitions of specialty health care operations and internal growth of
long-term care and institutional pharmacy operations. These increases were
offset by the disposition of certain acute rehabilitation and subacute care
facilities and a general decline in acute rehabilitation and subacute revenues.
Specialty health care acquisitions caused an approximate $95.7 million
increase in revenues during fiscal 1997 as compared with fiscal 1996.
Approximately $46.1 million of this increase was the result of the acquisition
of Medical Innovations in July 1996. An additional approximate $49.6 million of
the increase resulted from various acquisitions of outpatient rehabilitation
clinics including the acquisitions of ARN in July 1996, the Rehab Group in
November 1996 and Pacific Rehab in December 1996.
During fiscal year 1997, internal growth in operations resulted in
increases in revenues of approximately $12.0 million and $17.2 million in
long-term care and institutional pharmacy operations, respectively, as compared
with fiscal 1996. The increase in long-term care revenues resulted primarily
from a 4.0% increase in Medicaid rates offset somewhat by a decline in census.
Growth in long-term care revenues due to acquisitions was offset by declines
resulting from dispositions. The increase in institutional pharmacy revenues
resulted largely from the continued expansion of pharmacy programs into the
Company's facilities.
Acute rehabilitation and subacute revenues declined approximately $36.8
million during fiscal 1997 as compared with fiscal 1996 as a result of the sale
of the Company's interests in five acute rehabilitation hospitals located in
California and Tennessee. A $5.8 million decline in subacute revenues resulted
from the sale of long-term and subacute facilities providing subacute services
in California and Maryland.
An approximate $19.7 million decline in acute rehabilitation and subacute
revenues is attributable to cost containment measures implemented in the acute
rehabilitation hospitals. Because the Medicare program provides for cost-based
reimbursement, the reduction in operating costs has resulted in a reduction in
operating revenues. Subacute revenues also declined approximately $8.1 million
due to the decertification from the Medicare program of a specialty hospital for
the five month period ended October 1996.
Finally, an approximate $11.2 million decline results from recording in
fiscal 1996 of $18.2 million of revenue resulting from the estimated Medicare
reimbursement for costs incurred by the Company in a tender for certain of CMS's
senior subordinated notes offset by a $7.0 million reduction of revenue recorded
to increase third-party settlement receivable reserves.
COSTS AND EXPENSES
Cost of services increased approximately $75.0 Million, or 5.0% For fiscal
year 1997 as compared with fiscal 1996. The increase in cost of services is
primarily attributable to the growth in long-term care and specialty health care
operations. As a percentage of total operating revenues, cost of services
increased to 84.1% from 81.9% for the year ended May 31, 1997 as compared with
the corresponding period in 1996. The increase is due to a change in the mix of
margins among the Company's various divisions, a change in the mix among payor
sources with lower margin Medicaid revenues providing a larger share of total
operating revenues and, to a lesser extent, a general increase in corporate
costs during fiscal year 1997.
Facility lease expense increased $1.6 million, or 2.0% for fiscal year 1997
as compared with fiscal 1996. The increase in facility lease expense is
attributable to the increase in the number of leased facilities operated in
fiscal 1997 as well as the effects of routine lease escalators currently in
place. As a percentage of total operating revenues, facility lease expense
remained constant at 4.8% for the year ended May 31, 1997 and the year ended May
31, 1996.
Depreciation and amortization increased $6.7 million, or 10.4% for the year
ended May 31, 1997, compared to the corresponding period in fiscal 1996. As a
percentage of total operating revenues, depreciation and amortization increased
to 3.6% from 3.3% for fiscal year 1997, compared to fiscal 1996. The increase in
depreciation and amortization is attributable to the growth in the number of
facilities owned in fiscal 1997 as well as the impact of capital expenditures
and amortization of goodwill associated with fiscal 1997 acquisitions.
37
<PAGE>
Interest expense increased $6.2 million, or 13.1% for the year ended May
31, 1997, compared to the corresponding period in fiscal 1996. As a percentage
of total operating revenues, interest expense increased to 3.0% during year
ended May 31, 1997 from 2.7% for the corresponding period in fiscal 1996. The
increase in interest expense is primarily attributable to the increase in the
indebtedness outstanding under the Credit Facility and other long-term debt
during the period as a result of acquisitions and payments related to special
charges, as well as a general increase in the composite rate on the Company's
Credit Facility. See "Liquidity and Capital Resources - Credit Facility."
The Company recorded special charges totaling $7.2 million, $4.0 million,
$19.8 million and $66.4 million during the first, second, third and fourth
quarters of fiscal 1997, respectively. The first quarter charge resulted from
the approval by management of the Company of restructuring measures relating to
the Company's rehabilitation hospital corporate office located in Mechanicsburg,
Pennsylvania and certain contract rehabilitation therapy operations. These
measures included the transfer of all corporate-related functions performed in
Mechanicsburg to the Company's corporate office in Albuquerque, New Mexico and
the further consolidation of the contract rehabilitation therapy division's
administrative and management organization. The second quarter charge resulted
from the settlement of the investigation by the OIG and the DOJ of certain of
the Company's Medicare Part B and related co-insurance billings. See "Item 1.
Legal Proceedings - OIG/DOJ Investigation Involving Certain Medicare Part B and
Related Co-Insurance Billings" in Part II of this Form 10-K. The third quarter
charge resulted primarily from the settlement of the claims against the Company
and certain of its current and former directors in the consolidated class action
lawsuit filed in New Mexico Federal District Court in April 1996. See "Item 1.
Legal Proceedings Stockholder Litigation" in Part II of this Report. The fourth
quarter charge resulted from the accrual of estimated costs related to the
monitoring of, responding to and defense and/or settlement of pending or
threatened litigation, the estimated impairment of the value associated with a
noncompetition agreement recorded in connection with a previous acquisition and
costs associated with the termination of certain agreements to manage 126
long-term care facilities between its wholly-owned subsidiary, HFM, and the HEA
Group and to restructure and forgive certain indebtedness of the HEA Group. See
Note 7 of the Notes to Consolidated Financial Statements for a more complete
discussion of these charges.
Extraordinary Item
The extraordinary items recorded during fiscal year 1997 result from the
disposition of assets. Accounting Principles Board Opinion No. 16 ("APB 16"),
"Business Combinations," requires that profit or loss resulting from the
disposal of assets within two years after a pooling of interests business
combination should be classified as an extraordinary item, net of taxes. All
dispositions occurring during fiscal 1997 were completed within two years of the
CMS merger that was accounted for as a pooling of interests.
During the second quarter of fiscal 1997, the Company disposed of certain
assets and operations of a non-invasive medical diagnostic company providing
hospital-based and mobile ultrasound and related diagnostic services. The
Company also disposed of a medical office automation operation company providing
medical and financial systems. During the third quarter of fiscal 1997, the
Company disposed of a long-term care facility located in Wisconsin and two
subacute care facilities located in Maryland and California. The Company also
disposed of its interest in four rehabilitation hospitals, eleven hospital based
or freestanding outpatient rehabilitation clinics and nine congregate care
facilities located in California. During the fourth quarter of fiscal 1997, the
Company disposed of one long-term care facility located in Ohio and its interest
in one rehabilitation hospital located Tennessee. See Note 16 of the Notes to
Consolidated Financial Statements for a more complete discussion of these
extraordinary items.
YEAR ENDED MAY 31, 1996 COMPARED TO YEAR ENDED MAY 31, 1995
REVENUES
Total operating revenues increased approximately $133.9 million, or 8.3%
for the year ended May 31, 1996, compared to the prior fiscal year. The increase
in total operating revenues for the period was due in large part to numerous
acquisitions in the long-term care, outpatient rehabilitation and other
specialty health care areas, increases in the rates realized in the long-term
and subacute care operations and in-
38
<PAGE>
creases in occupancy at both the rehabilitation hospital operations and the
long-term care operations. The increase is also attributable, in part, to
non-recurring revenue recorded by the Company of approximately $18.2 million
during the second quarter of fiscal 1996 representing the estimated
reimbursement benefit for costs associated with the bond tender offer expensed
during the period. See Note 5 of the Notes to Consolidated Financial Statements.
During the second quarter of fiscal 1996 the Company also recorded in total
operating revenues $9.3 million, net of direct expenses, resulting from
arrangements related to an unsuccessful merger effort which is the subject of
pending litigation. See "Litigation Against Tenet Healthcare Corporation" in
Item 3. of Part I of this Form 10-K. These increases were offset, in part, by a
$7.0 million charge to increase third party settlement receivable reserves.
During the year ended May 31, 1996, the Company completed numerous
acquisitions at a total cost of approximately $62.0 million. Almost 50% of this
total was expended in connection with the acquisitions of outpatient
rehabilitation clinic operations. Long-term and subacute care acquisitions
comprised approximately 30% of the total. The balance was expended on its
acquisition of various specialty medical services operations. Total operating
revenues recorded during fiscal 1996 subsequent to these acquisitions totaled
approximately $25.0 million.
Revenue increased by approximately $23.2 million during fiscal 1996 due to
an approximate 3.6% increase in average rates realized in long-term and subacute
operations as compared with the prior year. This increase was caused by a
general increase in rates among all payor types and was offset somewhat by a
shift towards a less favorable payor mix.
Revenues in fiscal 1996 increased by $55.5 million in the long-term and
subacute care operations as a result of an increase in average occupancy of 2%
to 90% from 88% in fiscal 1995. Revenues increased by $12.2 million in the
rehabilitation hospital operations as a result of an increase in average
occupancy of 2% to 72% in fiscal 1996 from 70% in fiscal 1995.
COSTS AND EXPENSES
Cost of services increased approximately $95.5 million, or 7.1% for fiscal
year 1996 as compared with fiscal 1995. The increase in cost of services is
primarily attributable to the growth in long-term care and specialty health care
operations. As a percentage of total operating revenues, cost of services
declined to 81.9% from 82.8% for the year ended May 31, 1996, compared to the
corresponding period in 1995, due largely to increased revenues from higher
margin businesses and the achievement of certain operating efficiencies
following the CMS merger.
Facility lease expense increased $2.6 million, or 3.2% for fiscal year 1996
as compared with fiscal 1995. The increase in facility lease expense is
attributable to the increase in the number of leased facilities operated in
fiscal 1996 as well as the effects of routine lease escalators currently in
place. As a percentage of total operating revenues, facility lease expense
declined to 4.8% from 5.0% for the year ended May 31, 1996, compared to the
corresponding period in fiscal 1995.
Depreciation and amortization increased $1.3 million, or 2.2% for the year
ended May 31, 1996, compared to the corresponding period in fiscal 1995. As a
percentage of total operating revenues, depreciation and amortization declined
to 3.3% from 3.5% for fiscal year 1996, compared to fiscal 1995. The increase in
depreciation and amortization is attributable to the growth in the number of
facilities owned in fiscal 1996 as well as the impact of capital expenditures.
Interest expense declined $5.7 million, or 10.8% for the year ended May 31,
1996, compared to the corresponding period in fiscal 1995. The decline in
interest expense is primarily attributable to the retirement of substantially
all of the senior subordinated notes of CMS, utilizing proceeds from the
Company's Credit Facility which bears interest at a substantially lower rate.
The decrease in interest expense due to interest rates was offset somewhat by an
increase in the average amount of debt outstanding.
The Company recorded special charges totaling $63.5 million and $17.0
million during the first and fourth quarters of fiscal 1996, respectively. The
first quarter charge resulted primarily from costs incurred in completing the
merger with CMS, the approval by management of restructuring measures related to
efforts to combine the previously separate companies and a decision by
management prior to the CMS merger to
39
<PAGE>
dispose of selected long-term care facilities. The fourth quarter charge
reflected the accrual of estimated legal and other costs related to monitoring
and responding to the various legal and investigative matters affecting the
Company and the impairment of selected long-lived assets to fair market value.
See Note 7 of the Notes to Consolidated Financial Statements for a more complete
discussion of these charges.
EXTRAORDINARY ITEM
The extraordinary item recorded during fiscal 1996 results from the
extinguishment of debt and management's decision to dispose of certain assets
following the CMS merger.
On September 26, 1995, the Company completed a tender offer and consent
solicitation for two issues of publicly held senior subordinated notes of CMS.
The Company purchased $118.7 million in principal amount of 10 3/8% senior
subordinated notes due 2003 at 109.25% plus a consent fee of 1.05% and $137.5
million in principal amount of 10 7/8% senior subordinated notes due 2002 at
109.0% plus a consent fee of 0.75%. The Company paid $289.5 million to retire
the senior subordinated Notes, including principal, premiums, accrued interest,
consent fees and other related costs. As a result of the tender, the Company
recorded an extraordinary charge related to the loss on the retirement of the
senior subordinated notes, including the write-off of related deferred discount,
swap cancellation and financing costs, of approximately $22.1 million, net of
tax, in the second quarter of fiscal 1996.
As a result of discussions occurring during the fourth quarter of fiscal
1996, management significantly revised and expanded the group of facilities
originally identified for disposal in the first quarter of fiscal 1996.
Management also obtained board of director approval to pursue such a sale.
Subsequent to year end, the Company reached agreement regarding the sales price
of these assets. The difference between the proposed sales price or estimated
fair value of the properties and the recorded basis of the assets to be sold is
approximately $21.3 million. As a result, a $9.4 million charge was recorded in
the fourth quarter to increase the $11.9 million first quarter asset disposal
reserve to $21.3 million. Because management's decision with respect to the
fourth quarter revision and expansion of the group of facilities to be disposed
of occurred subsequent to the acquisition of CMS, the resulting charge was
classified as an extraordinary item, net of taxes, in accordance with APB 16.
LIQUIDITY AND CAPITAL RESOURCES
Cash Uses
The net cash used in the Company's investing activities increased from
$133.7 million for the year ended May 31, 1996 to $162.2 million for the year
ended May 31, 1997. The primary uses of cash in investing activities were cash
acquisitions and internal construction and capital expenditures for property and
equipment. The Company used cash rather than its Common Stock to effect
acquisitions during the year ended May 31, 1997. Under existing circumstances,
the Company expects it will continue to rely on cash as a currency to effect
future acquisitions. Cash required for internal construction and capital
expenditures for property and equipment increased during the year ended May 31,
1997 as compared with fiscal 1996 as a result of expenditures required to
complete construction on an office building to house corporate operations. As of
May 31, 1997, the Company has future plans or commitments to fund construction
totaling approximately $18.5 million.
During the fiscal years ended May 31, 1996 and 1997, the Company was
engaged in an program of expansion through the acquisition of other businesses
and facilities and the construction and improvement of facilities owned by the
Company. During those years, this expansion program required funds: (i) to
acquire assets and to expand and improve existing and newly acquired facilities;
(ii) to discharge funded indebtedness assumed or otherwise acquired in
connection with the acquisitions of facilities and properties; and (iii) to
finance the increase in patient and other accounts receivable resulting from
acquisitions. The funds necessary to meet these requirements have been provided
principally by the Company's operating and financing activities and, to a lesser
extent, during fiscal 1997 from sales of property and equipment.
The Company's expansion program has been curtailed since February 1997 as a
result of the covenants contained in the Plan and Agreement of Merger between
the Company and HEALTHSOUTH described under "Business - Proposed Merger of
Horizon/CMS with HEALTHSOUTH Corporation"
40
<PAGE>
in Item 1. of Part I of this Annual Report. If for any reason the Merger is not
consummated, any reinstatement of the Company's expansion program will be
dependent upon decisions with respect thereto by the management and board of
directors of the Company predicated on numerous factors, including the market
price of the Company's Common Stock, the Company's ability to refinance its
outstanding indebtedness under its Credit Agreement and the Company's
alternative sources of cash.
Cash Sources
At May 31, 1997, the Company's working capital was $289.7 million and
included cash and cash equivalents of $44.3 million as compared with $342.2
million in working capital and $33.2 million in cash and cash equivalents at May
31, 1996. During the year ended May 31, 1997, the Company's operating activities
provided $73.8 million of net cash. During the years ended May 31, 1996 and
1995, the Company's operating activities provided $33.9 million and $10.6
million of net cash, respectively. In connection with the special charges
recorded by the Company during fiscal years 1997, 1996 and 1995, the Company
made cash payments totaling $37.8 million, $35.2 million and $13.8 million,
during each of those years, respectively.
At May 31, 1997, the available credit under the Company's Credit Facility
(as defined below) was $111.4 million. To the extent that the Company's
operations and expansion program require cash expenditures in excess of the
amounts available to it under the Credit Facility, management of the Company
believes that the Company can obtain the necessary funds through other financing
activities, including the issuance and sale of debt and through the sale of
property and equipment.
CREDIT FACILITY
The Company is the borrower under a credit agreement dated as of September
26, 1995 (The "Credit Facility") with NationsBank of Texas, N.A., as Agent, and
the lenders named therein. The aggregate revolving credit commitment under the
Credit Facility is $750 million, of which the Company had borrowed $604.0
million and had outstanding letters of credit of $34.6 million at May 31, 1997.
Borrowings under the Credit Facility bear interest, payable monthly, at a rate
equal to either, as selected by the Company, the Alternate Base Rate (as therein
defined) of the Agent in effect from time to time, or the Adjusted London
Inter-Bank Offer Rate plus 0.625% to 1.50% per annum, depending on the
maintenance of specified financial ratios. The applicable interest rates at May
31, 1997 were 8.5% and 7.06% - 7.38% on the Alternate Base Rate and Adjusted
London Inter-Bank Offer Rate advances, respectively. In addition, borrowings
thereunder mature in September 2000 and are secured by a pledge of the capital
stock of substantially all subsidiaries of the Company. Under the terms of the
Credit Facility, the Company is required to maintain certain financial ratios
and is restricted in the payment of dividends to an amount which shall not
exceed 20% of the Company's net earnings for the prior fiscal year.
The lenders' obligations to make additional loans pursuant to the Credit
Facility are subject to the satisfaction of certain conditions, including that
(i) the Company is not in violation of any law, rule or regulation of any
governmental authority where such violation could be reasonably expected to
result in a Material Adverse Effect (as defined in the Credit Agreement, which
definition includes a material adverse effect on the financial condition or
results of operations of the Company) and (ii) that there are no suits pending
as to which there is a reasonable possibility of an adverse determination and
which, if adversely determined, could be reasonably expected to result in a
Material Adverse Effect.
FORWARD-LOOKING STATEMENTS
The matters discussed in this form 10-K contain forward-looking statements
that involve risks and uncertainties. Although the Company believes that its
expectations are based on reasonable assumptions, it can give no assurance that
the anticipated results will occur. Important factors that could cause actual
results to differ materially from those in the forward-looking statements
include conditions in the capital markets, including the interest rate
environment and stock market levels and activity, the regulatory environment in
which the Company operates and the enactment by Congress of health care reform
measures.
41
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
(A) Consolidated Financial Statements of the Company:
(i) Report of Independent Public Accountants - Arthur Andersen LLP
Report of Independent Auditors - Ernst & Young LLP
(ii) Consolidated Balance Sheets
(iii) Consolidated Statements of Operations
(iv) Consolidated Statements of Stockholders' Equity
(v) Consolidated Statements of Cash Flows
(vi) Notes to Consolidated Financial Statements
42
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders
of Horizon/CMS Healthcare Corporation:
We have audited the accompanying consolidated balance sheets of Horizon/CMS
Healthcare Corporation (formerly, Horizon Healthcare Corporation) (a Delaware
corporation) and subsidiaries as of May 31, 1997 and 1996, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended May 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 did not audit the financial statements and schedule of
Continental Medical Systems, Inc. and subsidiaries ("CMS"), a company acquired
during fiscal 1996 in a transaction accounted for as a pooling-of-interests, as
discussed in Notes 1 and 14. Such statements are included in the consolidated
financial statements of Horizon/CMS Healthcare Corporation and reflect total
operating revenues of 60.8 percent in 1995 of the related consolidated total.
Those statements were audited by other auditors whose report has been furnished
to us and our opinion, insofar as it relates to amounts included for CMS, is
based solely upon the report of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits 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 and the report of the other auditors provide a
reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors,
the financial statements referred to above present fairly, in all material
respects, the financial position of Horizon/CMS Healthcare Corporation and
subsidiaries as of May 31, 1997 and 1996, and the results of their operations
and their cash flows for each of the three years in the period ended May 31,
1997, in conformity with generally accepted accounting principles.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index of
financial statements is presented for purposes of complying with the Securities
and Exchange Commission's rules and is not part of the basic financial
statements. This schedule has been subjected to the auditing procedures applied
in the audit of the basic financial statements and, in our opinion, fairly
states in all material respects the financial data required to be set forth
therein in relation to the basic financial statements taken as a whole.
/s/ ARTHUR ANDERSEN LLP
----------------------------------------
ARTHUR ANDERSEN LLP
Albuquerque, New Mexico
August 27, 1997
43
<PAGE>
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders
of Horizon/CMS Healthcare Corporation
We have audited the consolidated statements of operations, stockholders'
equity, and cash flows of Continental Medical Systems, Inc. and subsidiaries
(the Company) for the year ended June 30, 1995 (not presented separately
herein). Our audits also included Schedule II of Continental Medical Systems,
Inc. (not presented separately herein). These financial statements and schedule
are the responsibility of the Company's management. Our responsibility is to
express an opinion on the financial statements and schedule based on our audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated results of operations
and cash flows of Continental Medical Systems, Inc. and subsidiaries for the
year ended June 30, 1995, in conformity with generally accepted accounting
principles. Also in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
present fairly in all material respects the information set forth therein.
/s/ ERNST & YOUNG LLP
----------------------------------------
ERNST & YOUNG LLP
Harrisburg, Pennsylvania
August 3, 1995, except for Note 6
and Note 19 for which the date is
September 26, 1995; Note 14 for
which the date is September 12, 1995;
and Note 20 for which the date is
September 27, 1995
44
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
CONSOLIDATED BALANCE SHEETS
MAY 31, 1997 AND 1996
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996
------------ --------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ................................................ $ 44,287 $ 33,233
Patient care accounts receivable, net of allowance for doubtful accounts of
$50,242 in 1997 and $43,097 in 1996....................................... 334,153 335,833
Estimated third party settlements .......................................... 34,092 53,900
Prepaid and other assets ................................................... 74,559 76,801
Deferred income taxes ...................................................... 14,925 21,287
---------- ----------
Total current assets ................................................... 502,016 521,054
PROPERTY AND EQUIPMENT, net ................................................ 626,670 635,556
GOODWILL, net ............................................................... 319,555 185,187
OTHER INTANGIBLE ASSETS, net ................................................ 30,728 40,453
NOTES RECEIVABLE, excluding current portion ................................. 59,393 73,017
DEFERRED INCOME TAXES ...................................................... 10,491 3,166
OTHER ASSETS ............................................................... 57,528 54,318
---------- ----------
Total assets ............................................................ $1,606,381 $1,512,751
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt .......................................... $ 9,882 $ 7,360
Accounts payable ......................................................... 21,086 24,724
Accrued expenses and other liabilities .................................... 181,311 146,744
---------- ----------
Total current liabilities ............................................. 212,279 178,828
LONG-TERM DEBT, excluding current portion ................................. 732,657 645,639
OTHER LIABILITIES ......................................................... 21,403 20,764
---------- ----------
Total liabilities ...................................................... 966,339 845,231
MINORITY INTERESTS ......................................................... 19,553 16,172
COMMITMENTS AND CONTINGENCIES .............................................
STOCKHOLDERS' EQUITY:
Common stock of $.001 par value, authorized 150,000,000 shares, 52,840,552
and 52,581,762 shares issued with 52,200,541 and 51,941,751
shares outstanding at May 31, 1997 and 1996, respectively ............... 53 53
Additional paid-in capital ................................................ 594,576 589,516
Retained earnings ......................................................... 34,565 70,484
Treasury stock ............................................................ (8,705) (8,705)
---------- ----------
Total stockholders' equity ............................................. 620,489 651,348
---------- ----------
Total liabilities and stockholders' equity .............................. $1,606,381 $1,512,751
========== ==========
</TABLE>
The accompanying notes are an integral part of these balance sheets.
45
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------ --------------
<S> <C> <C> <C>
TOTAL OPERATING REVENUES ........................... $1,799,824 $1,756,534 $1,622,658
---------- ---------- ----------
COSTS AND EXPENSES:
Cost of services .................................... 1,513,981 1,438,985 1,343,533
Facility leases .................................... 85,878 84,234 81,590
Depreciation and amortization ..................... 64,628 57,883 56,618
Interest expense .................................... 53,539 47,318 53,045
Special charge .................................... 97,305 80,540 36,922
---------- ---------- ----------
Total costs and expenses ........................ 1,815,331 1,708,960 1,571,708
---------- ---------- ----------
Earnings (loss) before minority interests, income
taxes and extraordinary item ..................... (15,507) 47,574 50,950
Minority interests ................................. (7,375) (7,228) (5,245)
---------- ---------- ----------
Earnings (loss) before income taxes and extraordinary
item ............................................. (22,882) 40,346 45,705
Income taxes ....................................... (821) 31,672 22,348
---------- ---------- ----------
Earnings (loss) before extraordinary item ............ (22,061) 8,674 23,357
Extraordinary item, net of tax ..................... (13,858) (31,328) 2,571
---------- ---------- ----------
Net earnings (loss) ................................. $ (35,919) $ (22,654) $ 25,928
========== ========== ==========
Earnings (loss) per common and common equivalent share:
Earnings (loss) before extraordinary item ......... $ (0.42) $ 0.16 $ 0.49
Extraordinary item, net of tax ..................... (0.27) (0.60) 0.05
---------- ---------- ----------
Net earnings (loss) ................................. $ (0.69) $ (0.44) $ 0.54
========== ========== ==========
Weighted average number of shares outstanding ...... 52,269 52,048 47,850
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these statements.
46
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
--------------------- PAID-IN RETAINED TREASURY
SHARES AMOUNT CAPITAL EARNINGS STOCK TOTAL
------------ -------- ----------- ----------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Balance at May 31, 1994 .................. 43,440,558 $43 $393,209 $ 70,623 $ (740) $ 463,135
Common stock offering, net of $6,487 of
issue costs .............................. 4,915,457 5 119,608 - - 119,613
Common stock issued in connection with
acquisitions .............................. 1,847,899 2 39,334 759 - 40,095
Exercise of stock purchase warrants, op-
tions and issuance of shares under the
employee stock purchase plan ............ 475,193 1 7,017 - - 7,018
Treasury stock acquired in payment for
stockholder's note ........................ - - - - (4,847) (4,847)
Distribution to subsidiary stockholder ... - - - (50) - (50)
Net earnings .............................. - - - 25,928 - 25,928
----------- ---- --------- --------- -------- ---------
Balance at May 31, 1995 .................. 50,679,107 51 559,168 97,260 (5,587) 650,892
Exercise of stock purchase warrants, op-
tions and issuance of shares under the
employee stock purchase plan ............ 1,476,637 1 21,182 - (3,118) 18,066
Effect of pooling of interests restatement - - - (4,122) - (4,122)
Common stock issued in connection with
acquisitions .............................. 426,018 1 9,166 - - 9,166
Net loss ................................. - - - (22,654) - (22,654)
----------- ---- --------- --------- -------- ---------
Balance at May 31, 1996 .................. 52,581,762 53 589,516 70,484 (8,705) $ 651,348
Exercise of stock purchase warrants, op-
tions and issuance of shares under the
employee stock purchase plan ............ 258,790 - 5,060 - - 5,060
Net loss ................................. - - - (35,919) - (35,919)
----------- ---- --------- --------- -------- ---------
Balance at May 31, 1997 .................. 52,840,552 $53 $594,576 $ 34,565 $ (8,705) $ 620,489
=========== ==== ========= ========= ======== =========
</TABLE>
The accompanying notes are an integral part of these statements.
47
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
------------- ------------- ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings (loss) ......................................................... $ (35,919) $ (22,654) $ 25,928
Adjustments:
Depreciation and amortization ................................................ 64,628 57,883 56,618
Provision for doubtful accounts ............................................. 27,552 27,735 23,584
Other ........................................................................ 5,112 (11,356) (25,404)
Special charge ............................................................... 97,305 80,540 36,922
Extraordinary item ......................................................... 13,430 47,462 (4,172)
Increase (decrease) in cash from changes in assets and liabilities, excluding
effects of acquisitions and dispositions:
Patient care accounts receivable and estimated third party settlements ...... (25,721) (78,059) (30,491)
Prepaid and other assets ................................................... (8,789) (18,694) (22,800)
Deferred income taxes ...................................................... 1,501 (9,288) 168
Accounts payable and accrued expenses ....................................... (65,549) (42,018) (24,062)
Other liabilities ............................................................ 238 2,388 (25,666)
---------- ---------- ----------
Total adjustments ............................................................ 109,707 56,593 (15,303)
---------- ---------- ----------
Net cash provided by operating activities .................................... 73,788 33,939 10,625
---------- ---------- ----------
Cash flows from investing activities:
Payments pursuant to acquisition agreements, net of cash acquired ............ (159,748) (50,080) (117,359)
Cash proceeds from sale of property and equipment ........................... 78,385 - 22,718
Other intangible assets ...................................................... (3,747) (14,072) (863)
Acquisition of property and equipment ....................................... (72,235) (48,506) (52,622)
Notes receivable ............................................................ (4,801) (22,509) 2,215
Other investing activities ................................................... (50) 1,469 (12,688)
---------- ---------- ----------
Net cash used in investing activities ....................................... (162,196) (133,698) (158,599)
---------- ---------- ----------
Cash flows from financing activities:
Long-term debt borrowings ................................................... 711,667 925,343 211,484
Long-term debt repayments ................................................... (643,826) (813,296) (196,906)
Deferred financing costs ................................................... - (1,700) (3,104)
Repurchase of convertible subordinated notes ................................. - - (3,812)
Issuance of common stock ................................................... 5,060 18,394 124,217
Bank Overdraft ............................................................... 30,000 - -
Distributions to minority interests .......................................... (3,439) (2,476) (4,975)
Other financing activities ................................................... - (30,636) 360
---------- ---------- ----------
Net cash provided by financing activities .................................... 99,462 95,629 127,264
---------- ---------- ----------
Net increase (decrease) in cash and cash equivalents ........................ 11,054 (4,130) (20,710)
Cash and cash equivalents, beginning of year ................................. 33,233 40,674 61,384
Effect of pooling of interests restatement .................................... - (3,311) -
---------- ---------- ----------
Cash and cash equivalents, end of year ....................................... $ 44,287 $ 33,233 $ 40,674
========== ========== ==========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest .................................................................. $ 52,804 $ 56,260 $ 54,351
========== ========== ==========
Income taxes, net ......................................................... $ 15,985 $ (4,953) $ 19,236
========== ========== ==========
Noncash investing and financing activities:
Net assets acquired in exchange for common stock ........................... $ - $ 1,444 $ 22,030
========== ========== ==========
Assumption of long-term debt in connection with acquisitions ............... $ 26,115 $ 2,232 $ 19,900
========== ========== ==========
Assumption of obligations under capital lease in connection with acquisi-
tions ..................................................................... $ - $ - $ 48,600
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
48
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
Horizon/CMS Healthcare Corporation and its subsidiaries (collectively, the
"Company" or "Horizon/CMS") is a leading provider of post-acute and long-term
health care services. The Company's long-term care facilities provide skilled
nursing care and basic patient services with respect to daily living and general
medical needs. The Company also provides comprehensive medical rehabilitation
programs and services in each of the rehabilitation industry's three principal
sectors - inpatient rehabilitation care, outpatient rehabilitation care and
contract therapy. The Company also provides other specialty health care services
to its long-term care, subacute, specialty hospital and rehabilitation
facilities and outside parties. Such specialty health care services include
licensed specialty hospital services and subacute units, institutional pharmacy
services, physician placement services, Alzheimer's care, non-invasive medical
diagnostic testing services, home respiratory care services, clinical laboratory
services, home health care and management and managed care services to
physicians and other providers. Substantially all of these services are within
the post-acute health care market and, accordingly, the Company operates within
a single industry segment.
In connection with the merger of a wholly owned subsidiary of the Company
with Continental Medical Systems, Inc. ("CMS") in July 1995, the Company changed
its name to Horizon/CMS Healthcare Corporation. As discussed in Note 14, the
accompanying financial statements have been restated to include the accounts and
operations of CMS for all periods prior to the merger. These restated financial
statements include the stockholders equity of CMS as of June 30, 1995 and the
results of operations of CMS for the year ended June 30, 1995.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and those entities that are controlled by the Company and in which it owns more
than 50% of the equity. All significant intercompany accounts and transactions
have been eliminated in consolidation.
Investments in affiliates, which are included in other assets in the
accompanying consolidated balance sheets, in which the Company owns 50% or less
but more than 20% of the equity and limited partnerships are carried on the
equity basis which approximates the Company's equity in underlying net book
value. Other investments are stated at cost.
49
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED )
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
Operating Revenues
The Company derives net patient care revenues principally from public
funding through the Medicaid and Medicare programs, private pay patients and
non-affiliated long-term care facilities. For fiscal years 1997, 1996 and 1995,
the Company derived 34%, 33% and 28% of its revenues from Medicare. For fiscal
years 1997, 1996 and 1995, the Company derived 19%, 18% and 17% of its revenues
from Medicaid. Under the Medicare program and some state Medicaid programs, the
Company's long-term care facilities are paid interim amounts designed to
approximate the facilities' reimbursable costs. Such interim amounts due from
third party payors and amounts due from other payor sources are recorded as
patient care accounts receivable. With respect to these programs for which
interim payments are subject to retroactive cost adjustment, actual costs
incurred are reported through cost reports by each facility annually. Throughout
the annual cost reporting period, the Company records, for each of several
hundred Medicare and Medicaid certified providers operated by the Company, the
estimated difference between interim payments received and the expected actual
costs as estimated third party settlements. The cost reports are subject to
examinations and retroactive adjustments, which may result in upward or downward
adjustment from initially submitted reimbursable costs. The Company generally
expects final settlement on annual cost reports to occur approximately 24 months
following the end of an annual cost reporting period. Tentative partial
settlement may occur as soon as six months following the cost reporting period.
Differences between amounts originally accrued as estimated third-party
settlements, subsequent revisions of estimates, and the amounts ultimately
received or paid are recorded in operations in the year of final settlement and
disclosed if material. Most of the Company's Medicaid payments are prospective
and no retroactive adjustment is made to such payments.
Estimated settlements reflect expected amounts receivable from third
parties offset by expected amounts payable to third parties. The Company's total
net settlement position is anticipated to vary from period to period due to
several factors including: the significant number of individual providers for
which settlements must be estimated, the fact that several cost reporting
periods remain open for each provider at any given time, the numerous cost
reporting periods of the Company's various providers, the interrelationship
between continually changing interim rates and estimated settlements, the
unpredictable timing of tentative and final settlements and the offset of
estimated payables and receivables.
While settlement adjustments are common upon third-party intermediary cost
report examination, the Company is currently unaware of any matters that may
result in a retroactive cost report adjustment that would be material to the
Company's financial condition or results of operations.
There have been and the Company expects that there will continue to be a
number of proposals to limit Medicare and Medicaid reimbursement. The Company
cannot predict at this time whether any of these proposals will be adopted or,
if adopted and implemented, what effect such proposals would have on the
Company.
The Company has also entered into payment agreements with certain
commercial insurance carriers, health maintenance organizations, and other payor
sources. The basis for payment under these arrangements include prospectively
determined amounts for each unit of service.
Cash Equivalents
For purposes of the accompanying consolidated statements of cash flows, the
Company considers its highly liquid investments purchased with original
maturities of three months or less to be cash equivalents.
50
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
Depreciation
Property and equipment is stated at the lower of cost or net realizable
value. Depreciation is recorded using the straight-line method over the
estimated useful lives of the assets (buildings - 30 to 40 years; equipment - 3
to 20 years). Maintenance and repairs are charged to expense as incurred. Major
renewals or improvements are capitalized.
Goodwill and Other Intangible Assets Resulting from Business Combinations
In connection with acquisitions accounted for using the purchase method,
the purchase price is allocated to the estimated fair value of the tangible and
identifiable intangible net assets as of the effective date of the acquisition,
with any excess cost allocated to goodwill.
Identifiable intangible assets are identified and measured under the
provisions of Accounting Principles Board Opinion No. 16, "Business
Combinations." Historically, the nature and circumstances surrounding the
Company's acquisitions have resulted in the identification and recognition of
certain identifiable intangible assets including: favorable lease purchase
costs, noncompetition agreements, contract rights, sign-on bonuses and trade
name costs. These intangible assets are amortized over the respective estimated
useful lives (one to ten years).
The Company believes that the excess cost over net assets of acquired
companies (goodwill) generally has an unlimited useful life and, therefore, an
amortization period of 15 to 40 years has been assigned. In determining that the
life of goodwill is unlimited, the Company considered the following factors: (i)
the concentrations that exist in the Company's selected markets and the fact
that acquisitions frequently serve as a platform for the integration of other
services provided by the Company; (ii) the long-term and specialty health care
industry, which is positively impacted by aging trends and the continued
pressure to transfer patients from high cost, acute care settings to long-term
and specialty health care settings; (iii) the increasing acceptance by the
medical establishment of long-term and specialty health care as a better
alternative to acute care hospital based treatment; and (iv) the nature of the
services provided by the Company, which will be continuously needed in the
future and are not subject to obsolescence.
The Company reviews the realizability of the carrying amount of goodwill
whenever events or circumstances occur that indicate the recorded costs may not
be recoverable. Principal factors considered by the Company in this review
include changes in market share and competitive conditions, technological and
regulatory changes (including reimbursement), demand trends and earnings trends
of the acquired companies. If such a review, which is performed no less
frequently than quarterly, indicates that the undiscounted future cash flows
from operations of the acquired business are less than the recorded asset, its
carrying amount will be reduced to its estimated fair value. In the absence of
an active market for the asset, fair value will be estimated using accepted
valuation techniques, including discounted cash flow analysis.
Income Taxes
The Company files a consolidated federal income tax return for all 80% or
more owned subsidiaries. Separate returns are filed for all subsidiaries owned
less than 80%. The Company accounts for income taxes under the provisions of
Statement of Financial Accounting Standards No. 109 ("SFAS 109"), "Accounting
for Income Taxes." SFAS 109 requires the recognition of deferred tax liabilities
and assets for the expected future tax consequences of temporary differences
between the carrying amounts and the tax basis of assets and liabilities.
51
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
Self Insurance
The Company maintains malpractice insurance with a level of self-insurance
retention (deductible) limitation. The Company's self-insured retention with
respect to malpractice and public liability insurance is $1.0 million per
occurrence per policy year and $11.0 million in the aggregate with a
subaggregate of $3.0 million with respect to long-term care operations. In
addition, the Company maintains umbrella malpractice and public liability
insurance coverage of $50.0 million per occurrence and in the aggregate.
Workers' compensation coverage is effected through deductible insurance policies
and qualified self insurance plans which vary by the states in which the Company
operates. Provisions for estimated settlements are provided in the period of the
related coverage and are determined on a case by case basis plus an amount for
incurred but not reported claims. Differences between the amounts accrued and
subsequent settlements are recorded in operations in the period of settlement.
The Company is largely self-insured with respect to health insurance
benefits made available to its employees. Provisions for estimated claim
payments are provided in the period of the related coverage and are determined
based upon historical development experience and include amount for incurred but
not reported claims.
Earnings Per Share
The Financial Accounting Standards Board recently issued Statement of
Financial Accounting Standard No. 128 ("SFAS 128"), "Earnings Per Share". This
new standard supersedes Accounting Principles Board Opinion No. 15 ("APB 15"),
"Earnings Per Share", which the Company currently applies in the accompanying
financial statements. SFAS 128 eliminates several requirements of APB 15 and
simplifies earnings per share calculations. The effect of adopting SFAS 128,
which is effective beginning the third quarter of fiscal year 1998, is to change
fiscal 1995 primary net earnings per share from $0.54 per share to $0.55 per
share. The adoption will have no effect on the other measures of either primary
or fully diluted net earnings (loss) per share during the three year period
ended May 31, 1997.
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 reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
In the case of all known contingencies, Horizon/CMS accrues a charge for a
loss when it is probable and the amount is reasonably estimable. Accruals for
loss contingencies include estimates of legal fees and other related costs to be
incurred in connection with the known contingency. As facts concerning
contingencies becomes known, Horizon/CMS reassesses its position and adjusts
recorded reserves, as necessary.
52
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(2) NOTES RECEIVABLE
Notes receivable consist of the following:
<TABLE>
<CAPTION>
1997 1996
--------- --------
<S> <C> <C>
Variable rate note receivable based on lesser of 8% or LIBOR + 2.25% (8.0%
at May 31, 1997), full recourse; interest payable semi-annually; principal pay-
able December 2008; unsecured ................................................... $10,653 $10,653
7% note receivable; payable in monthly installments of $60 including interest;
due April 2004; secured by real property ....................................... 9,451 9,567
8% note receivable; payable in monthly installments of $125 including interest;
due June 15, 2002; secured ...................................................... 7,546 -
Variable rate note receivable (7.0% at May 31, 1997); interest payable monthly;
principal payable $3,000 in August 2002 and $3,000 in August 2004; secured
by real property ............................................................... 6,000 6,000
7% note receivable, payable in monthly installments of $27 including interest;
due January 2016; secured by real property .................................... 3,384 3,496
Other notes receivable bearing interest at 6% to 12%; due at varying dates
through fiscal 2036 ............................................................ 26,988 25,851
Variable rate note receivable (7.3% at May 31, 1996) payable in variable
monthly installments including interest; due December 2005 ..................... - $21,650
-------- --------
Notes receivable ............................................................... 64,022 77,217
Less current portion, included in prepaid and other assets ..................... 4,629 4,200
-------- --------
Notes receivable, excluding current portion .................................... $59,393 $73,017
======== ========
</TABLE>
(3) PROPERTY AND EQUIPMENT
Property and equipment owned and held under capital lease is stated at cost
and consists of the following:
<TABLE>
<CAPTION>
1997 1996
---------- ---------
<S> <C> <C>
Land ....................................... $ 66,375 $ 70,672
Buildings .................................... 499,094 503,868
Equipment .................................... 204,302 189,332
--------- ---------
769,771 763,872
Less accumulated depreciation and amortization. 143,101 128,316
--------- ---------
Property and equipment, net .................. $626,670 $635,556
========= =========
</TABLE>
53
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(4) ACCRUED EXPENSES AND OTHER LIABILITIES
Accrued expenses and other current liabilities are comprised of the
following:
<TABLE>
<CAPTION>
1997 1996
---------- ---------
<S> <C> <C>
Salaries, wages and benefits ............... $ 45,968 $ 46,872
Accrued insurance ........................... 30,006 23,957
Accruals for special charges (Note 7) ...... 15,702 17,453
Accrued property and payroll taxes ......... 15,669 13,565
Accrued income taxes ........................ - 13,414
Accrued interest ........................... 7,631 6,896
Bank overdraft .............................. 30,000 -
Other ....................................... 36,335 24,587
--------- ---------
$181,311 $146,744
========= =========
</TABLE>
(5) LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
1997 1996
---------- ------------
<S> <C> <C>
Revolving credit drawn on credit agreement; interest due monthly; principal
due in fiscal 2001 ............................................................ $604,000 $508,622
107/8% senior subordinated notes; due in fiscal 2002 ........................... 8,562 8,562
103/8% senior subordinated notes; due in fiscal 2003 ........................... 65 65
Convertible subordinated debenture; interest at 83/4%; due in fiscal 2015 ...... 20,400 20,400
Convertible subordinated debenture; interest at 61/2%; due in fiscal 2012 ...... 5,680 5,680
Convertible subordinated debenture; interest at 73/4%; due in fiscal 2012 ...... 2,000 2,000
Obligations under capital leases and other long-term debt bearing interest rang-
ing from 5.0% to 14.0%; due at varying dates through fiscal 2017; secured by
related land, buildings and equipment ....................................... 101,832 107,670
-------- --------
Long-term debt ............................................................... 742,539 652,999
Less current portion ......................................................... (9,882) (7,360)
-------- --------
Long-term debt, excluding current portion .................................... $732,657 $645,639
======== ========
</TABLE>
54
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(5) LONG-TERM DEBT - (CONTINUED)
At May 31, 1995, the Company was party to a $250,000 revolving credit loan
agreement with the Boatmen's National Bank of St. Louis, as agent for a group of
banks (the "Boatmen's Facility"). The Boatmen's Facility was drawn in the amount
of $104,750 at May 31, 1995. This facility bore interest at either the Adjusted
Corporate Base Rate plus up to .25% or at the Adjusted London Interbank Offer
Rate ("LIBOR") rate plus 0.5 to 1.25% both as defined in the credit agreement.
Prior to the CMS merger, at May 31, 1995, the Company was also party to a
credit facility with Citibank, N.A., as agent for a group of banks (the
"Citibank Facility"). At May 31, 1995, $34,000 had been drawn on this facility.
The Citibank Facility provided up to $235,000 in a revolving line of credit for
a revolving loan period through December 31, 1996 and the subsequent conversion
of the revolving loan into a term loan. At the Company's option, the interest
rate on any loan under the Citibank Facility was based on the LIBOR rate or a
base rate as specified in the agreement as adjusted for a margin.
In July 1995, in connection with the merger with CMS, the Company and CMS
entered into a new facility with NationsBank of Texas, N.A., as agent for a
group of banks, (the "NationsBank Facility") that replaced the Boatmen's and
Citibank Facilities and combined the amount available for borrowing at $485,000.
The aggregate principal amount was divided between the Company and CMS in the
amounts of $250,000 and $235,000, respectively.
Under the NationsBank Facility, interest is computed at a rate equal to
either, as selected by the Company, the Alternate Base Rate or the Adjusted
LIBOR rate (as such terms are defined therein) plus 0.625% to 1.50% per annum,
depending on the maintenance of specified financial ratios. The Alternate Base
rate is equal to the greater of the prime rate or the federal funds effective
rate plus .5%. The weighted average interest rate on amounts outstanding under
the NationsBank Facility was 7.4% at May 31, 1997. The NationsBank Facility
matures in September 2000. The credit agreement underlying the NationsBank
Facility, among other things, (a) requires the Company to maintain certain
financial ratios, (b) restricts the Company's ability to enter into capital
leases beyond certain specified amounts, (c) prohibits transactions with
affiliates not at arm's length, (d) allows the Company to make only permitted
investments, (e) restricts certain indebtedness, liens, dispositions of property
and issuances of securities and (f) prohibits a change in control or a
fundamental change in the business of the Company except under certain limited
circumstances. The NationsBank Facility also restricts the payment of dividends
by the Company to an amount which shall not exceed 20% of the Company's net
income for the prior fiscal year, and any such payment is subject to continued
compliance by the Company with the financial ratio covenants contained in the
credit agreement. Substantially all of the subsidiaries of the Company have
guaranteed the obligations of the Company under the NationsBank Facility. This
facility further provides that certain limited events or occurrences that would
or could reasonably be expected to have a material adverse effect on the
Company's ability to repay the loans or to perform its obligations under the
loan documents will constitute an event of default under this facility.
Simultaneous with the tender offer for the 103/8% and 107/8% senior
subordinated notes discussed below, in September 1995 the NationsBank Facility
was amended and restated to increase the facility from $485,000 to $750,000, of
which $70,000 is available in the form of letters of credit, and to remove the
division between the Company and CMS. At May 31, 1997, $111,400 was available to
be drawn under this facility.
55
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(5) LONG-TERM DEBT - (CONTINUED)
THE COMPANY UTILIZES AN INTEREST RATE COLLAR AGREEMENT, CONSISTING OF THE
COMBINATION OF AN INTEREST rate cap and an interest rate floor in a single
transaction, to reduce the impact of increases in interest rates on its floating
rate debt without any initial investment by the Company. The Company entered
into this $200 million notional amount collar agreement following the expansion
of the NationsBank Facility in October 1995. The Company utilizes the collar as
an interest rate hedge on its floating rate, LIBOR based credit facility and
does not intend the instrument to be speculative in nature. The agreement has a
term of two years and expires in October 1997. The collar agreement entitles the
Company to receive from the counterparty the amount, if any, by which average
LIBOR interest payments on the notional amount exceed 8.0% per annum. The collar
agreement requires that the Company pay to the counterparty the amount, if any,
by which average LIBOR interest payments on the notional amount is less than
4.57% per annum. The fair value of the collar agreement is estimated based on
quotes from market makers of these instruments and represents the estimated
amount that the Company would expect to receive or pay if the agreement was
terminated. The fair value of the collar on May 31, 1997 would require that no
payment be made by the Company or the counterparty to terminate the agreement.
On August 17, 1992, the Company issued 107/8% senior subordinated notes due
2002 ("107/8% Notes") in the amount of $200,000 in a public offering in which
the Company received net proceeds of $192,500. The 107/8% Notes were priced at
99.25%, to yield 11% annually to maturity. On March 16, 1993 the Company issued
its 103/8% senior subordinated notes due 2003 ("103/8% Notes") in the amount of
$150,000 in a private placement in which the Company received net proceeds of
$144,586. The 103/8% Notes were priced at 99.22% to yield 101/2% annually to
maturity. During fiscal 1995, the Company purchased $85,206 principal amount of
its 107/8% and 103/8% Notes, at a discount in a series of open market
transactions. In September 1995, the Company completed a tender offer and
consent solicitation for $256,167 principal amount of its 107/8% Notes and
103/8% Notes.
In order to reduce the impact of changes in interest rates on its long-term
debt, the Company, during fiscal 1994 and 1993, entered into four, seven year
interest rate swap agreements with notional amounts of $25,000 each which were
scheduled to mature in 1999 and 2000 and which provided for receipt of yields of
between 5.16% and 6.65% and payment of six month LIBOR yield. On September 12,
1995, these interest rate swap agreements were terminated at a cost of $3,540 in
connection with the tender offer for the senior subordinated notes discussed
above.
In connection with the merger of Greenery Rehabilitation Group, Inc.
("Greenery") into the Company in February 1994, the Company assumed the
obligations under Greenery's 61/2% convertible subordinated notes and 83/4%
convertible senior subordinated notes, par value of $26,631 and $28,150,
respectively, at February 11, 1994. These obligations were recorded at their
fair market value under purchase accounting, resulting in a discount on the
61/2% convertible subordinated notes of $2,663.
The 61/2% convertible subordinated notes are due June 2011, and are
convertible into common stock of the Company at a price of $69.32 per share.
These notes may be redeemed in whole or in part at par, plus accrued interest.
Commencing June 15, 1996, the Company is obligated to retire 5% of the issue
amount annually to maturity.
56
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(5) LONG-TERM DEBT - (CONTINUED)
The 8% convertible senior subordinated notes are due 2015 and are
convertible into common stock of the Company at a price of $54.00 per share. The
Company may redeem the notes, in whole or in part at 106.125% of par, plus
accrued interest, declining annually to par on April 1, 2000. Commencing April
1, 2000, the Company is required to retire 5% of the original issue amount
annually to maturity. The notes are senior to the 61/2% debentures, but will be
subordinated to any future senior indebtedness.
During fiscal 1995, the Company repurchased $4,800 of its 61/2% convertible
subordinated notes and $506 of its 83/4% convertible senior subordinated notes.
The approximate aggregate maturities of long-term debt are as follows:
Year ending May 31,
1998 .............................. $ 9,882
1999 .............................. 2,804
2000 .............................. 2,626
2001 .............................. 615,212
2002 .............................. 11,082
Thereafter ........................ 100,933
---------
$742,539
=========
(6) LEASE COMMITMENTS
The Company has noncancelable operating leases primarily for facilities and
equipment. Certain leases provide for purchase and renewal options of from 5 to
15 years, contingent rentals primarily based on operating revenues and the
escalation of lease payments coincident with increases in certain economic
indexes. Contingent rent expense for the years ended May 31, 1997, 1996 and 1995
was approximately $5,562, $6,501 and $6,346, respectively.
Future minimum payments under noncancelable operating leases are as
follows:
Year ending May 31,
1998 ............................ $ 85,495
1999 ............................ 69,033
2000 ............................ 53,770
2001 ............................ 45,180
2002 ............................ 38,404
Thereafter ...................... 114,850
---------
$406,732
=========
The Company is contingently liable for annual lease payments of
approximately $1,188 for leases on facilities sold. The leases expire at varying
dates through fiscal 1999. In addition, the Company is contingently liable for
annual lease payments of $6,836 for leases on managed facilities.
The leases expire at varying dates through fiscal 2007.
57
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(6) LEASE COMMITMENTS - (CONTINUED)
The Company leases its corporate office space located in Albuquerque, NM
from a limited liability company, of which certain of the Company officers,
directors and family members are members. The lease is classified as an
operating lease. The Company made lease payments of $873, $782 and $589 under
this lease during fiscal 1997, 1996 and 1995, respectively. The lease expires on
July 31, 2001.
The Company leases seven facilities, under operating leases, from various
limited partnerships and/or limited liability companies of which a director of
the Company is a passive investor. The Company made lease payments of $3,557
under these leases during fiscal 1997.
(7) SPECIAL CHARGE
The Company has recorded as special charges during the past three fiscal
years the effects of various non-routine items. Following is a discussion of the
amounts, material components and activities related to these charges.
FISCAL YEAR 1997
The Company recorded special charges totaling approximately $7,200, $4,000,
$19,800 and $66,300 during the first, second, third and fourth quarters of
fiscal 1997, respectively. The first quarter fiscal 1997 charge resulted from
the approval by management of the Company of restructuring measures relating to
the Company's rehabilitation hospital corporate office located in Mechanicsburg,
Pennsylvania and certain contract rehabilitation therapy operations. These
measures included the transfer of all corporate-related functions performed in
Mechanicsburg to the Company's corporate office in Albuquerque, New Mexico and
the further consolidation of the contract rehabilitation therapy division's
administrative and management organization. The first quarter charge was
comprised of the following:
(i) Approximately $5,300 of the charge related to involuntary termination
benefits paid to an estimated 130 employees impacted by the restructuring of the
rehabilitation hospital corporate office. Management approved and committed the
Company to the employee terminations and communicated the termination benefits
payable to the employees during the first quarter of fiscal 1997. The completion
of these terminations occurred during the third quarter of fiscal 1997.
(ii) Approximately $1,500 of the charge related to lease exit costs
primarily for office space that was vacated as a result of the restructuring.
The remaining approximate $400 balance of the first quarter of fiscal 1997
special charge is comprised of impairment charges related to excess assets that
were sold as a result of the restructuring. This charge adjusted the carrying
amount of those assets to their estimated fair values.
The $4,000 second quarter fiscal 1997 charge related to the settlement of
the investigation by the Office of the Inspector General ("OIG") and the
Department of Justice ("DOJ") of certain of the Company's Medicare Part B and
related co-insurance billings.
The $19,800 third quarter fiscal 1997 charge resulted primarily from the
settlement of the claims against the Company and certain of its current and
former directors in the consolidated class action lawsuit filed in New Mexico
Federal District Court in April 1996. See Note 15, Legal Proceedings, for a more
complete discussion of pending and threatened litigation.
58
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(7) SPECIAL CHARGE - (CONTINUED)
The $66,300 fourth quarter fiscal 1997 charge is comprised of three
components as follows:
(i) The Company recorded an approximate $6,400 charge related to threatened
or pending litigation. Approximately $4,600 of the charge is related to the
North Louisiana Rehabilitation Hospital Medicare billing investigation and was
recorded based upon management's estimate of the likely legal and expert
consulting costs to be incurred and the estimate of the likely payment that will
be made in settlement of this matter. The approximate $1,800 balance of this
charge is for estimated costs related to monitoring of, responding to and
defense costs associated with various other threatened and pending litigation
including the Communi-Care, Inc. and Pro Rehab, Inc. litigation, the Tenet
litigation and various other matters. See Note 15, Legal Proceedings, for a more
complete discussion of pending and threatened litigation.
(ii) The Company recorded an approximate $6.700 charge as management
established a reserve for the potential impairment of the estimated value of a
noncompete agreement with the former principal of an organization Horizon/CMS
acquired.
During the fourth quarter of fiscal year 1997, the Company became aware of
actions by the former principal that it believes to be in violation of the
noncompete agreement. The Company has subsequently filed a lawsuit in which it
seeks to enforce the covenant not to compete or to recover amounts paid by the
Company for the noncompete agreement. While the outcome of the pending
litigation may cause management to reevaluate the need for an impairment reserve
related to the noncompete agreement or may result in the recovery, as
contemplated in the agreement in the event of certain violations, of amounts
paid by the Company for the noncompete agreement, the Company does not consider
the likelihood of these potential outcomes sufficient to obviate the need to
record a reserve at this time.
(iii) In addition, the Company recorded an approximate $53,200 charge in
connection with the termination of certain agreements (the "Management
Agreements") between its wholly-owned subsidiary, Horizon Facilities Management,
Inc. (HFM), and Texas Health Enterprises, Inc. and certain of its affiliates
(collectively, the "HEA Group") and to restructure and forgive certain
indebtedness of the HEA Group. The HEA Group operates 126 nursing facilities in
Texas, Oklahoma and Michigan. Under the Management Agreements that were
originally effective January 1, 1996, HFM has provided management and
administrative services for such facilities and has provided a line of credit
facility (the "HEA Group Credit Facility") for the benefit of such facilities.
In addition, certain other subsidiaries of Horizon/CMS have provided ancillary
medical, institutional pharmacy and therapy services to the HEA Group facilities
(the "Ancillary Services").
59
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(7) SPECIAL CHARGE - (CONTINUED)
In March 1997, Horizon/CMS and a third party negotiated, subject to the
consent of the HEA Group, a sale of the stock of HFM and all of the trade debt
owing by the HEA Group to Horizon/CMS and its subsidiaries. At that time,
amounts owed by the HEA Group to Horizon/CMS for management fees, ancillary
services, and interest on advances made pursuant to the HEA Group Credit
Facility were significantly in arrears. The HEA Group, when consulted in April
1997, refused to consent to such a sale and asserted monetary claims, allegedly
of substantial value, against Horizon/CMS for the manner in which the
indebtedness under the HEA Group Credit Facility was administered and the manner
in which HFM provided management and administrative services to the HEA Group
facilities. Horizon/ CMS disputed the claims made by the HEA Group. By the end
of April 1997, amounts owed by the HEA Group to Horizon/CMS, including principal
under the HEA Group Credit Facility of approximately $26,300, aggregated
approximately $61,300. After considering (i) the amounts owed by the HEA Group
to Horizon/CMS and its subsidiaries, (ii) the monetary and operational resources
required to provide continuing management services to HEA Group facilities in
light of the increasing uncertainties surrounding the ongoing operations of the
HEA Group facilities, (iii) the ability of the HEA Group facilities to repay the
amounts owing to Horizon/CMS and its subsidiaries, (iv) the ability of Horizon/
CMS and its subsidiaries to pursue the legal remedies available to them under
the Management Agreements and the HEA Group Credit Facility and to realize on
the same, (v) the merits of the claims asserted by the HEA Group, (vi) the
effect of the foregoing on the patients residing in the HEA Group facilities,
(vii) Horizon/CMS's strategic objectives, and (viii) the pending merger
transaction with HEALTHSOUTH Corporation, Horizon/CMS determined in May 1997
that it was in the best business interest of Horizon/CMS to terminate the
Management Agreements, to restructure certain trade indebtedness of the HEA
Group to Horizon/CMS and its subsidiaries, and to release the HEA Group from
liability for amounts owing under the Management Agreements and the HEA Group
Credit Facility. Although no claims have been formally asserted by the HEA
Group, the agreement with the HEA Group includes a release of any potential
claims the HEA Group may have relating to services provided by HFM pursuant to
the Management Agreements.
Effective upon the termination of the Management Agreements, the relevant
HEA Group entities assumed direct responsibility for all management functions at
the HEA Group facilities. Pursuant to the agreement between the parties,
approximately $17,000 in aggregate indebtedness for ancillary services owed to
Horizon/CMS and its subsidiaries was converted to a secured promissory note (the
"Trade Note"). Payments on the Trade Note are based upon a 30-year amortization
schedule with the outstanding principal balance and all accrued and unpaid
interest being due and payable in five years. The Trade Note accrues interest at
8.0% per annum with repayment being secured by leasehold mortgages on 18 of the
HEA Group facilities and a mortgage on one owned HEA Group facility.
As a result of the termination of the Management Agreements, Horizon/CMS
recorded during the fourth quarter of fiscal year 1997 a $53,200 million charge.
The charge is comprised of (i) $40,200 resulting from the release of liability
with respect to principal and interest under the Credit Facility and prior
management fees payable, (ii) $9,500 resulting from the adjustment to fair value
of the Trade Note and (iii) $3,500 related to restructuring measures undertaken
in connection with closure of the divisional office established to provide
management services to the HEA Group facilities.
60
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(7) SPECIAL CHARGE - (CONTINUED)
The components of the fiscal year 1997 special charge are as follows:
<TABLE>
<CAPTION>
IMPAIRMENT AND LEASE
NONCANCELLABLE TERMINATION EXIT AND
COMMITMENTS LEGAL BENEFITS OTHER TOTAL
---------------- ------------ ------------- --------- ------------
<S> <C> <C> <C> <C> <C>
Fiscal Year 1997 Special Charge ...... $ 58,835 $ 30,250 $ 6,052 $2,168 $ 97,305
Fiscal Year 1997 Activity:
Payments ........................... - (23,800) (4,084) (536) (28,420)
Asset Impairment ..................... (58,835) - - - (58,835)
--------- --------- -------- ------ ---------
Balance May 31, 1997 .................. $ - $ 6,450 $ 1,968 $1,632 $ 10,050
========= ========= ======== ====== =========
</TABLE>
At May 31, 1997, the number of employees terminated in connection with the
fiscal 1997 restructuring charge totaled 130.
Fiscal Year 1996
The Company recorded special charges totaling $63,540 and $17,000 during
the first and fourth quarters of fiscal 1996, respectively. The first quarter
fiscal 1996 charge resulted primarily from costs incurred in completing the
merger with CMS, the approval by management of restructuring measures related to
efforts to combine the previously separate companies and a decision by
management to dispose of selected facilities. Specifically, the first quarter
charge was comprised of the following components:
(i) Approximately $11,900 of the charge related to an impairment adjustment
resulting from the planned disposition of assets and leasehold improvements at
eight long-term care facilities. The charge represented the amount by which the
carrying amount of the properties intended for sale at that time exceeded the
estimated fair value of the properties. As discussed in Note 16, the charge was
later revised upward based upon management's decision in the fourth quarter of
fiscal 1996 to revise and to expand significantly the group of facilities to be
disposed of.
(ii) The Company recorded an approximate $14,200 impairment of assets as a
result of the planned elimination or consolidation of operations in the effort
to combine the Company and CMS. In connection therewith, contract respiratory
therapy, corporate and physician placement operations were consolidated and
restructured. The consolidation and elimination of certain contract respiratory
company operations resulted in a $5,700 charge, comprised of a $4,900 fair value
adjustment to the carrying cost of related long-lived assets and an $800
adjustment to receivables and inventory which were negatively impacted by the
Company's decision to restructure the operations. The consolidation of corporate
operations resulted in the retirement of existing credit facilities and the
negotiation of an expanded consolidated credit agreement, which resulted in the
write-off of $2,600 of existing credit facility deferred financing costs.
Consolidation of corporate operations also resulted in a write-off of excess or
duplicative computer system development investment of approximately $950. In
evaluating the existing operations of the combined companies, the Company also
determined to cease operations and/or dispose of assets at a rehabilitation
clinic in California and a long-term care property in Ohio. The adjustment to
fair value of the carrying cost of the related long-lived assets was
approximately $3,400. Various other restructuring measures caused the balance of
the charge. Substantially all of the actions which comprise this total were
completed during fiscal 1996.
61
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(7) SPECIAL CHARGE - (CONTINUED)
(iii) Approximately $20,600 of the charge resulted from involuntary
termination benefits paid and payable to an estimated 340 employees impacted by
the merger with CMS. Affected personnel were employed primarily within the
Company's corporate offices and contract therapy businesses.
During the first quarter of fiscal 1996, management approved and committed
the Company to the employee terminations and communicated the termination
benefits payable to the employees. Of the $20,600 total, approximately $9,250
was paid to the former chairman and chief executive officer of CMS pursuant to
agreements in place prior to discussions with the Company related to the merger
with CMS.
(iv) Other costs related to the CMS merger or costs associated with
activities that were not continued by the combined company totaled approximately
$16,840. Included in this total are $7,000 of transaction costs incurred in
consummating the CMS merger, $2,200 of lease exit costs and $7,640 resulting
from other merger related activities.
The $17,000 fourth quarter charge is comprised of two components as
follows:
(i) The Company recorded an approximate $6,000 charge for the estimated
costs related to monitoring of, responding to and defense costs associated with
the OIG/DOJ, SEC and NYSE investigations, shareholder and Tenet litigation, and
various other litigation and investigations currently in process. This charge
did not reflect any estimate for settlement of the OIG/DOJ, shareholder or any
of the other matters discussed. See Note 15, Legal Proceedings for a more
complete discussion of pending and threatened litigation.
(ii) An approximate $11,000 charge was recorded to reduce the carrying
value of selected long-lived assets to estimated fair value. The assets written
down are comprised largely of three operations experiencing poor financial
performance and for which management has become concerned with respect to future
prospects. The subsidiary companies affected include a medical software
operation, a stand-alone outpatient rehabilitation therapy clinic and sleep
diagnostic operations. Fair value was based on estimated future cash flows to be
generated by the operations discounted at a market rate.
The components of the fiscal year 1996 special charge are as follows:
<TABLE>
<CAPTION>
IMPAIRMENT AND LEASE
NONCANCELLABLE TERMINATION EXIT AND TRANSACTION
COMMITMENTS LEGAL BENEFITS OTHER COSTS TOTAL
---------------- ----------- ------------- ------------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Fiscal Year 1996 Special Charge ...... $ 37,144 $ 6,000 $ 20,566 $ 10,133 $ 6,697 $ 80,540
Fiscal Year 1996 Activity:
Payments ........................... - - (18,989) (6,318) (6,506) (31,813)
Adjustments ........................ - - 113 (9) (191) (87)
Asset Impairment ..................... (37,144) - - - - (37,144)
--------- -------- --------- --------- -------- ---------
Balance May 31, 1996 .................. - 6,000 1,690 3,806 - 11,496
Fiscal Year 1997 Activity:
Payments ........................... - (4,215) (2,240) (2,839) - (9,294)
Adjustments ........................ - (250) 550 (395) - (95)
--------- -------- --------- --------- -------- ---------
Balance May 31, 1997 .................. $ - $ 1,535 $ - $ 572 $ - $ 2,107
========= ======== ========= ========= ======== =========
</TABLE>
62
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(7) SPECIAL CHARGE - (CONTINUED)
At May 31, 1997, the number of employees terminated in connection with the
fiscal 1996 restructuring charge totaled 340.
Fiscal Year 1995
The Company recorded a $36,922 special charge during the fiscal year ended
May 31, 1995. The special charge was comprised of the following:
(i) Approximately $18,377 reflects the effect of a revision in the
Company's estimate of receivables from a third party at its contract therapy
division.
(ii) A charge of approximately $5,045 was recorded for estimated costs of
eliminating management and staff positions, office lease terminations and
certain other costs of the changes implemented during fiscal 1995 in the
contract therapy division.
(iii) An approximate $13,500 charge was recorded as a result of the
settlement of certain pending litigation and termination of a number of
contracts with the other party to the litigation. As consideration for the
settlement, contract terminations and related releases, the Company paid cash
and delivered a warrant to purchase the Company's common stock. As a result, the
Company accrued in fiscal 1995 $12,800 of expenses and wrote down $700 of
receivables to record the effects of the arrangement.
The components of the fiscal year 1995 special charge are as follows:
<TABLE>
<CAPTION>
IMPAIRMENT AND LEASE
NONCANCELLABLE TERMINATION EXIT AND TRANSACTION
COMMITMENTS LEGAL BENEFITS OTHER COSTS TOTAL
---------------- ------------ ------------- ---------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Fiscal Year 1995 Special Charge ...... $ 19,077 $ 12,800 $ 2,158 $ 2,687 $ 200 $ 36,922
Fiscal Year 1995 Activity:
Payments ........................... - (12,800) (498) (462) - (13,760)
Asset Impairment ..................... (19,077) - - - - (19,077)
--------- --------- -------- -------- ------ ---------
Balance May 31, 1995 .................. - - 1,660 2,225 200 4,085
Fiscal Year 1996 Activity:
Payments ........................... - - (1,593) (1,625) (183) (3,401)
--------- --------- -------- -------- ------ ---------
Balance May 31, 1996 .................. - - 67 600 17 684
Fiscal Year 1997 Activity:
Payments ........................... - - - (114) - (114)
--------- --------- -------- -------- ------ ---------
Balance May 31, 1997 .................. $ - $ - $ 67 $ 486 $ 17 $ 570
========= ========= ======== ======== ====== =========
</TABLE>
At May 31, 1997, the number of employees terminated in connection with the
fiscal 1995 restructuring charge totaled 200.
The remaining balance of special charges recorded prior to fiscal year 1995
is approximately $3,000 and is recorded within accrued expenses in the
accompanying balance sheet.
63
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(8) INCOME TAXES
The provision (benefit) for income taxes on earnings (loss) before
extraordinary items consists of the following:
1997 1996 1995
---------- ---------- --------
Current:
Federal ...... $(1,619) $32,785 $ 5,801
State ......... 1,566 8,314 3,686
-------- -------- --------
(53) 41,099 9,487
-------- -------- --------
Deferred:
Federal ...... (753) (8,646) 10,594
State ......... (15) (781) 2,267
-------- -------- --------
(768) (9,427) 12,861
-------- -------- --------
Total ......... $ (821) $31,672 $22,348
======== ======== ========
The differences between the total tax expense recorded on earnings (loss)
before income taxes and before extraordinary item and the income tax expense
using the statutory federal income tax rate (35 percent) were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---------- --------- -----------
<S> <C> <C> <C>
Computed tax expense (benefit) at statutory rate .................. $(8,009) $14,121 $15,997
State income tax expense, net of federal income tax benefit ...... 754 5,629 4,597
Amortization of goodwill .......................................... 1,794 1,295 1,245
Change in valuation allowance .................................... - (579) (800)
Goodwill write-offs, merger costs and other special charges ...... 4,029 10,234 850
Other ............................................................ 611 972 459
-------- ------- -------
Total income tax expense (benefit) .............................. $ (821) $31,672 $22,348
======== ======= =======
</TABLE>
64
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(8) INCOME TAXES - (CONTINUED)
The components of the net deferred tax assets and liabilities are as
follows:
<TABLE>
<CAPTION>
1997 1996
------------ -----------
<S> <C> <C>
Components of the deferred tax asset: ........................
Reserves for special charges .............................. $ 33,171 $ 25,216
Basis difference in accounts receivable ..................... 587 13,902
Accrued payroll and related benefits ........................ 6,887 6,197
Other accrued liabilities ................................. 11,887 13,020
Tax carryforward items .................................... 4,565 4,702
Deferred lease credit ....................................... 1,736 2,065
Other ...................................................... 4,720 3,163
--------- ---------
Total deferred tax asset .................................... 63,553 68,265
Valuation allowance .......................................... (3,250) (2,250)
--------- ---------
Net deferred tax asset ....................................... 60,303 66,015
--------- ---------
Components of the deferred tax liability: .....................
Buildings and equipment, related basis differences, deferred
gain and depreciation .................................... (29,180) (34,704)
Difference between reporting income/loss from partnership in-
vestments for financial and income tax reporting (1,767) (1,971)
Other ...................................................... (3,940) (4,887)
--------- ---------
Total deferred tax liability ................................. (34,887) (41,562)
--------- ---------
Excess deferred assets over liabilities ..................... $ 25,416 $ 24,453
========= =========
</TABLE>
As a result of business combinations during the years ended May 31, 1997
and 1996, net deferred income tax assets of $1,062 and $567, respectively,
including related valuation allowances of $0 and $1,179, respectively, were
recorded.
The valuation allowance is the result of federal separate return loss
carryforward limitations and states with no or limited loss carryover
provisions. The valuation allowance increased by $1,000 during fiscal 1997
primarily as a result of current year losses which significantly reduce the
Company's ability to utilize certain preacquisition losses and credits. This
reduced tax benefit has been recorded as a reduction in goodwill.
The Company has regular tax net operating loss carryforwards of
approximately $8,500 of which approximately $5,500 is subject to separate return
year limitations and expire in years 2007 through 2010. The $3,000 balance will
expire in 2012. In addition, the Company also has an estimated alternative
minimum tax credit carryforward of $1,300 which is available for utilization
indefinitely.
65
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(9) CAPITAL STOCK
Common Stock
During fiscal 1996, former executive officers tendered approximately
137,000 shares of the Company's common stock to the Company in payment of the
exercise price and related withholding taxes on the exercise of approximately
209,000 shares. This transaction was accounted for as a stock for stock exercise
and the resulting tender of shares of common stock have been recorded as
treasury stock in the accompanying balance sheet.
In November and December 1994, the Company completed the sale of 5,558,790
shares of its common stock, including the sale of 643,333 shares held by certain
stockholders. The Company's net proceeds of approximately $119,600 were used to
repay outstanding debt under the revolving credit loan agreement and to fund
acquisitions.
Preferred Stock
There are 500,000 shares of authorized but unissued shares of $.001
preferred stock. On September 12, 1994, the board of directors of the Company
declared a dividend of one preferred share purchase right (a "Right") for each
outstanding share of the Company's common stock held of record on September 22,
1994, and approved the further issuance of Rights with respect to all shares of
the Company's common stock that are subsequently issued. Each Right entitles the
registered holder to purchase from the Company one one-thousandth of a share of
series A junior participating preferred stock, par value $.001 per share of the
Company, at a price of $110 per one one-thousandth of a share, subject to
adjustment. Until the occurrence of certain events, the Rights are not
exercisable, will be evidenced by the certificates for the Company's common
stock and will not be transferable apart from the Company's common stock.
Stock Purchase Warrants
The Company had 500,000 stock purchase warrants outstanding at May 31,
1997, for the purchase of common shares. These warrants are priced at $26.00 per
share.
Stock Benefit Plans
In August 1995, the Board approved the 1995 Stock Incentive Plan (the "1995
Plan"). The 1995 Plan provides for discretionary granting of (i) "incentive
stock options" as defined in Section 422 of the Internal Revenue Code of 1986,
as amended, (ii) stock options that do not constitute incentive stock options
("non-statutory stock options"), and (iii) shares of the Company's common stock,
which are subject to forfeiture under the circumstances specified by the
administrative committee of the 1995 Plan at the time of award of such shares
("restricted stock"). All of the employees of the Company (including an employee
who may also be a director of the Company) are eligible to participate in the
1995 Plan.
All options granted under the 1995 Plan carry a term as specified by the
administrative committee at the date of the grant (but no more than 10 years in
the case of incentive stock options). The effect of an employee's termination of
employment by reason of death, retirement, disability or otherwise will be
specified in the option contract that evidences each option grant. The option
price will be determined by the administrative committee and (i) in the case of
the incentive stock options, will be no less than the fair market value of the
shares on the date that the option is granted, and (ii) in the case of
non-statutoryHERE IT ISshares on the date that the option is granted, and (ii)
in the case of non-statutor stock options, will be no less than 50% of the fair
market value of the shares on the date the option is granted. All options
granted may be exercised in accordance with the option contract as provided for
by the administrative committee.
66
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(9) CAPITAL STOCK - (CONTINUED)
In connection with the compensation committee's approval of the 1995 Plan,
the board of directors also approved the termination of the existing employee
stock option plan which provides for issuance of stock options to employees. No
additional awards will be made thereunder on or after the date of approval of
the 1995 Plan.
During fiscal 1995, the Company had a nonqualified employee stock option
plan and a directors' stock option plan that provided the Company the ability to
grant to employees and outside directors the option to purchase shares of common
stock of the Company at the market value of the stock at the option grant date.
All options granted under the previous employee plan and directors' plan
expire 10 years after grant, are non-transferable and are exercisable only
during or immediately following the period the individual is employed by the
Company or is a current member of the board of directors, subject to certain
exceptions for death or disability. One-third of each option is exercisable on
each of the first, second and third anniversary dates following the date of
grant.
The Company, through CMS, also had options outstanding pursuant to the
following stock compensation plans at May 31, 1997: the 1986 stock option plan,
the 1989 non-qualified stock option agreement, the 1989 non-employee directors'
stock option plan, the 1992 CEO stock option plan, the 1993 non-qualified stock
option plan, and the 1994 stock option plan. Under these plans, options become
exercisable in four to seven annual installments commencing on the first
anniversary of the date of grant, and expire between October 1995 and August
2003, five to ten years from the date of grant.
During fiscal 1997, the board of directors of the Company approved a
repricing of all options granted by the Company during calendar year 1995 (the
"Calendar Year 1995 Options"). The Calendar Year 1995 Options, which were
originally granted at exercise prices ranging form $17.875 to $28.00 per common
share, were exchanged on a one-for-one basis for approximately 2.0 million
options granted under the 1995 Plan and are exercisable at $17.50 per share. The
1995 Plan terms are substantially similar to those plans terms pursuant to which
the Calendar Year 1995 Options were originally issued. The vesting schedules of
the original Calendar Year 1995 Options were not affected by the exchange and
repricing of opitions.
The Company applies Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" ("APB 25") and related interpretations in
accounting for its stock option plan. Accordingly, no compensation cost has been
recognized in the statement of operations in connection with the grant of
exercise of options as the exercise price of granted options has historically
been equal to or less than the market price for the Company's stock on date of
grant.
67
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(9) CAPITAL STOCK - (CONTINUED)
The following information is a summary of the stock option activity under
the plans:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED MAY 31,
-------------------------------------------------
1997 1996 1995
--------------- --------------- -------------
<S> <C> <C> <C>
Options outstanding at beginning of year ...... 4,947,243 6,221,774 4,916,079
Granted ....................................... 1,050,100 2,198,265 1,934,116
Options exercised: ...........................
1997 ($1.38 to $16.38) ........................ (203,677) - -
1996 ($1.38 to $25.50) ........................ - (1,366,557) -
1995 ($1.38 to $20.75) ........................ - - (338,881)
Canceled and other adjustments ............... (1,167,270) (2,106,239) (289,540)
------------ ------------ ------------
Options outstanding at end of year ............ 4,626,396 4,947,243 6,221,774
============ ============ ============
Options exercisable at end of year ............ 2,137,913 1,885,420 2,596,947
============ ============ ============
Option price range ........................... $1.38-$33.82 $1.38-$40.47 $1.38-$28.75
============ ============ ============
</TABLE>
The Company administers a stock purchase plan for the benefit of employees.
The Employee Stock Purchase Plan ("ESP Plan"), which was effective until June
30, 1996, allowed substantially all full-time employees to contribute up to five
percent of their compensation for the quarterly purchase of the Company's common
stock at 85 percent of market value at the date of purchase. The board of
directors of the Company terminated the ESP Plan effective as of June 30, 1996.
In its place, the Company adopted the Horizon/CMS 1996 Employee Stock Purchase
Plan ("1996 ESP Plan"). The 1996 ESP Plan allows substantially all full-time
employees to contribute up to five percent of their compensation, on a payroll
withholding basis, for the semi-annual purchase of the Company's common stock at
85 percent of the lower of (i) the closing trading price at the beginning of the
semi-annual period, or (ii) the closing trading price at the end of the
semi-annual period.
Under the plans, the Company sold 52,533 shares and 25,307 shares to
employees in fiscal 1997 and 1996, respectively. Pro forma compensation cost has
been calculated for the estimated fair value of the employees' purchase rights.
The estimated fair value of those purchase rights granted in fiscal 1997 and
1996 was $7.33 and $5.33, respectively.
For purposes of the following pro forma disclosure, the fair value of each
option granted in fiscal 1997 and 1996 is estimated on the date of the grant
using the Black-Scholes option pricing model with the following weighted average
assumptions:
1997 1996
-------- ----------
Risk free interest rate ...... 6.438% 6.390%
Option life .................. 1 Year 1 Year
Volatility .................. 48.8% 48.8%
Dividends ..................... - -
68
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(9) CAPITAL STOCK - (CONTINUED)
Had compensation cost for the Company's fiscal 1997 and 1996 stock-based
compensation plans been determined consistent with Statement of Financial
Accounting Standard No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123"), which establishes fair value as the measurement basis for stock-based
awards, the Company's net loss and net loss per common share for fiscal 1997 and
1996 would approximate the pro forma amounts below (in thousands, except per
share data):
AS REPORTED PRO FORMA
------------------------- --------------------------
1997 1996 1997 1996
----------- ----------- ----------- ------------
Net loss ............ $(35,919) $(22,654) $(40,958) $ (29,913)
========= ========= ========= =========
Net loss per share ... $ (0.69) $ (0.44) $ (0.78) $ (0.57)
========= ========= ========= =========
In connection with the Greenery acquisition, the Company issued a five year
option to purchase 125,000 shares of the Company's common stock at $17 per
share. This option was exercised during 1995 and the shares, along with
approximately 50,000 shares of additional common stock, were converted to
treasury stock in consideration for reduction of amounts due to the Company
under the terms of a note receivable.
The total number of shares allocated, granted and outstanding pursuant to
the Company's employee and directors' stock option plans and employee stock
purchase plan together with other shares issued or allocated for issuance to
employees and directors pursuant to option, incentive or similar plans, may not
exceed 10 percent of the total number of shares authorized for issuance at the
time of the allocation or grant.
(10) EMPLOYEE BENEFITS
The Company has a deferred compensation plan for a select group of
management and/or highly compensated employees. This plan allows eligible
employees to defer portions of their current compensation up to 10%. The Company
then matches up to 4% of the employee's compensation. Employee contributions are
vested immediately. Employer contributions vest on a graduated basis, with full
vesting achieved at the end of five years. The Company contributed approximately
$216, $238 and $261 to these plans for the years ended May 31, 1997, 1996 and
1995, respectively.
The Company also has 401(k) savings plans available to substantially all
employees who have been with the Company for more than six months. Employees may
defer up to 15% of their salary subject to the maximum permitted by law. The
Company matches a portion of the employee's contribution, which may be
discretionary, depending upon the plan. Employee contributions are vested
immediately. Employer contributions vest on a graduated basis, with full vesting
achieved at the end of five or seven years, depending upon the plan or upon
termination of the plan by the Company. The Company contributed approximately
$1,464, $2,286 and $1,890 to these plans for the years ended May 31, 1997, 1996
and 1995, respectively.
In addition, the Company has a profit-sharing plan to which it may make
contributions at its discretion. The Company has not made any contributions to
this plan. The Company may terminate any of the above plans at any time.
69
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(11) FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the Company's financial instruments at May 31,
are as follows:
<TABLE>
<CAPTION>
1997 1996
---------------------- ------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
---------- --------- ---------- -----------
<S> <C> <C> <C> <C>
Notes receivable .................................... 64,022 63,973 $ 77,217 $ 77,717
Investments in marketable equity securities and other
short-term investments ........................... 1,008 1,008 1,425 1,425
Long-term debt .................................... 694,269 693,906 591,601 593,593
Interest rate hedges .............................. - - - (106)
</TABLE>
The fair value of notes receivable was estimated by discounting the future
cash flows using current rates available to similar borrowers under similar
circumstances. The fair value of marketable equity securities and other
short-term investments is based on quoted market prices. It is not practicable
to estimate the fair value of the Company's other investments, which include
certain equity investments, because of the lack of a quoted market price and the
inability to estimate fair value without incurring excessive costs. The fair
value of the Company's long-term debt, excluding capital leases, was estimated
based on the quoted market prices for the same or similar issues or on the
current rates offered to the Company for debt of the same remaining maturities.
The fair value of interest rate hedges are the estimated amounts that the
Company would be required to pay to terminate the agreements, taking into
account current interest rates.
The market value of the outstanding convertible subordinated notes at May
31, 1997 of $21,253 included in the long-term debt amount above is a function of
both the conversion feature and the underlying debt instrument. It is
impracticable to allocate the market value between these two components;
however, the market value is not representative of the amounts that would be
currently required to retire the debt obligation.
(12) ACQUISITIONS
During fiscal 1997, 1996 and 1995, the Company completed certain
acquisitions of long-term care facilities and providers of specialty health care
services. The acquisitions, with the exception of the CMS merger, have been
accounted for under the purchase method of accounting.
In December 1996, the Company completed the acquisition of all of the
outstanding shares of Pacific Rehabilitation & Sports Medicine, Inc. ("Pacific
Rehab"), a provider of outpatient rehabilitation services in 66 outpatient
clinics. Under the terms of the merger agreement, Pacific Rehab stockholders
received $6.50 in cash for each share of Pacific Rehab common stock and Pacific
Rehab became an indirect wholly owned subsidiary of the Company. The purchase
price was approximately $54,000 in cash. In addition, the Company assumed
approximately $22,600 in debt. The total amount of goodwill recorded in
connection with this acquisition approximated $78,500. Total annual revenues of
Pacific Rehab for its fiscal year ended December 31, 1995 were approximately
$35,100.
In November 1996, the Company completed the merger of an indirect wholly
owned subsidiary of the Company with The Rehab Group, Inc. ("Rehab Group") and
Rehab Group became an indirect wholly owned subsidiary of the Company. The
purchase price, including transaction costs, was approximately $23,300 in cash.
In addition, the Company assumed approximately $2,900 in debt. The total amount
of goodwill recorded in connection with this acquisition approximated $18,800.
Rehab Group operates 26 outpatient medical rehabilitation clinics in Tennessee,
Virginia, Georgia, Alabama, Arkansas and Mississippi and generated total annual
revenues of approximately $17,800 for its fiscal year ended September 30, 1996.
70
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(12) ACQUISITIONS - (CONTINUED)
In July 1996, the Company completed the merger of a wholly owned subsidiary
of the Company with Medical Innovations, Inc. ("Medical Innovations") and
Medical Innovations became a wholly owned subsidiary of the Company. Under the
merger agreement, the Company paid $1.85 in cash for each share of Medical
Innovations common stock. The purchase price, including transaction costs, was
approximately $32,700 in cash. In addition, the Company assumed approximately
$11,000 in debt. The total amount of goodwill recorded in connection with this
acquisition approximated $36,800. Medical Innovations provides services
primarily in Texas and Nevada. These services include specialized home care,
home medical equipment, home medical and intravenous therapies, as well as
comprehensive home health care management services under contractual
arrangements with hospitals and other providers. Total annual revenues of
Medical Innovations for its fiscal year ended December 31, 1995 were
approximately $69.400.
Also in July 1996, the Company acquired American Rehabilitation Network,
Inc. ("ARN") for approximately $7,800 in cash. The total goodwill recorded in
connection with this acquisition approximated $6,600. ARN operates nine
outpatient rehabilitation centers in Michigan and generated total annual
revenues of approximately $7,200 for its fiscal year ended December 31, 1995.
In July 1995, the Company completed the CMS merger (see Note 14 for
information regarding this merger). In connection with this acquisition the
Company issued approximately 20.9 million shares of common stock, valued at
approximately $394,900. The merger was accounted for as a pooling of interests.
In July 1994, the Company acquired peopleCARE Heritage Group, a 13 facility
long-term care company located in Texas. Consideration given for the acquisition
included the issuance of approximately 449,000 shares of the Company's common
stock, valued at approximately $10,000, assumption of capital lease obligations
of approximately $48,600 for six facilities, and cash payment of approximately
$56,000 for fee simple title to seven facilities.
During fiscal 1997, 1996 and 1995, the Company made various other
acquisitions which individually and in the aggregate were insignificant.
(13) COMMITMENTS AND CONTINGENCIES
Letters of Credit
The Company was contingently liable for letters of credit aggregating
$34,600 and $37,900 at May 31, 1997 and 1996, respectively. The letters of
credit, which reduce the availability under the Company's credit agreement, were
used in lieu of lease deposits for facilities operated by the Company and for
deposits under various workers' compensation programs.
Employment and Consulting Agreements
Under an annual employment agreement with one executive officer, the
Company is committed to pay a minimum annual salary totaling $650. In addition,
the employment agreement provides for annual retirement benefits and disability
benefits equal to a maximum of 50 percent of base salary. The disability
benefits terminate upon retirement or age 65. Further, an annual death benefit
is payable to the surviving spouse or minor children equal to 50 percent of the
retirement benefit at the time of the officer's death. Amounts recorded for the
annual retirement and disability benefits have been included in other accrued
liabilities in the accompanying consolidated financial statements.
71
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(13) COMMITMENTS AND CONTINGENCIES - (CONTINUED)
Life Insurance Premiums
The Company funds life insurance premiums for certain current and former
executive officers. As of May 31, 1997, such advances totaled approximately
$1,273 and are reflected in other assets in the accompanying consolidated
financial statements. The Company is neither the beneficiary nor the owner of
the policies. These advances will be repaid to the Company by the officers'
estates upon the earlier of cancellation of the policies or death of the
officers.
Purchase Commitments
Under the terms of one of the Company's facility lease agreements, the
Company has the option to purchase the facility and the lessor has the option to
require the Company to purchase the facility should the Company fail to exercise
the purchase option for $5,500 at the end of the lease term (August 1, 1998).
The Company has purchased usage of a Cessna/Citation III aircraft from AMI
Aviation II, L.L.C., a Delaware limited liability company ("AMI II"). The
Company's chief executive officer owns 99% of the membership interests of AMI
II. Under the aircraft usage agreement, the Company will purchase a minimum of
30 hours usage per month for $45 per month for a five year period, and will pay
certain amounts per hour for usage over 30 hours in a month plus a monthly
maintenance reserve. The Company believes that the amounts payable under this
agreement are comparable to those it would pay to other third party vendors of
similar aircraft services.
Other
In connection with the Greenery merger, the Company committed to manage
three Connecticut facilities for an affiliate of two former directors of the
Company. The Company is committed to manage these facilities through December,
1998 subject to the affiliate's right to terminate sooner at any time with 90
days notice.
As of May 31, 1997, the Company has future commitments to fund construction
totaling approximately $18,479. The substantial majority of this total is
comprised of amounts necessary to complete ongoing construction on an office
building to house corporate operations.
72
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(14) CMS MERGER
In July 1995, the stockholders of the Company and CMS approved the merger
of one of the Company's wholly-owned subsidiaries with CMS. Under the terms of
the merger agreement, CMS stockholders received .5397 of a share of the
Company's common stock for each outstanding share of CMS's common stock.
Accordingly, the Company issued approximately 20.9 million shares of common
stock, valued at approximately $393,900 based on the closing price of the
Company's common stock on July 10, 1995, for all the outstanding shares of CMS's
common stock. Additionally, outstanding options to acquire CMS's common stock
were converted to options to acquire 3.8 million shares of the Company's common
stock. The merger qualified as a tax-free reorganization and was accounted for
as a pooling of interests. Accordingly, the accompanying financial statements
have been restated to include the accounts and operations of CMS for all periods
prior to the merger.
The accompanying consolidated statements of operations for the year ended
May 31, 1995, include the results of operations of the Company for the year
ended May 31, 1995, and the results of operations of CMS for the year ended June
30, 1995. The accompanying income statement for the year ended May 31, 1996
includes the results of operations of the Company and CMS, prior to the merger,
for the period June 1, 1995 through June 30, 1995 and the combined Company,
subsequent to the merger, for the period July 1, 1995 through May 31, 1996. The
duplication of reporting CMS's June 1995 operating results of $4,100 in fiscal
year 1995 and in the fiscal year ended May 31, 1996, has been accounted for with
a charge to retained earnings. A similar adjustment has also been made in the
accompanying statement of cash flows for the fiscal year ended May 31, 1996.
Separate results of the Company and CMS for the two years in the period
ended May 31, 1996 are as follows:
1996 1995
------------ ------------
Total operating revenues:
The Company .................................... $ 59,065 $ 635,398
CMS ............................................. 83,684 987,260
The Company, subsequent to the CMS merger ...... 1,613,785 -
---------- ----------
$1,756,534 $1,622,658
========== ==========
Earnings (loss) before extraordinary item:
The Company .................................... $ 2,280 $ 28,238
CMS ............................................. 4,122 (4,881)
The Company, subsequent to the CMS merger ...... 2,272 -
---------- ----------
$ 8,674 $ 23,357
========== ==========
Net earnings (loss):
The Company .................................... $ 2,280 $ 28,851
CMS ............................................. 4,122 (2,923)
The Company, subsequent to the CMS merger ...... (29,056) -
---------- ----------
$ (22,654) $ 25,928
========== ==========
73
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(14) CMS MERGER - (CONTINUED)
As a result of the combination with CMS, the Company revised the accounting
policies and financial presentation of each of the previously separate
companies. These changes did not have a material effect on the operating results
or financial position of the Company. A reconciliation of total operating
revenues and net earnings of the Company as previously reported prior to the CMS
merger to the amounts presented above and included in the accompanying financial
statements is as follows:
1995
------------
Total operating revenues:
As previously reported ...... $636,412
Adjustments .................. (1,014)
--------
$635,398
========
Net earnings:
As previously reported ...... $ 29,580
Adjustments .................. (729)
--------
$ 28,851
========
(15) LEGAL PROCEEDINGS
DOJ Investigation in Respect of Continental Medical Systems, Inc.
As previously disclosed by both CMS and the Company, in late fall 1994, CMS
learned of the Department of Justice ("DOJ") investigations being handled by the
United States Attorney's offices in Harrisburg, Pennsylvania and Sacramento,
California. In this connection, representatives of the DOJ visited or contacted
operating facilities and office locations of CMS for the purpose of interviewing
certain of CMS's employees and reviewing certain documents.
In July 1996, the Company was informed that both the civil and criminal
divisions of the United States Attorney's office in Sacramento, California are
closing their investigation in this regard and they would not commence any civil
or criminal action or proceeding against the Company in respect of this
investigation. The Company was also informed that both the criminal and civil
divisions of the United States Attorney's office in Harrisburg, Pennsylvania
were closing their investigation in this regard and they would not commence any
civil or criminal action or proceeding against the Company in respect of this
investigation.
74
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(15) LEGAL PROCEEDINGS - (CONTINUED)
Tenet Healthcare Corporation and Related Litigation
As previously disclosed, Horizon/CMS filed a lawsuit on March 7, 1996
against Tenet Healthcare Corporation ("Tenet") in the United States District
Court for the District of Nevada. The lawsuit arose out of an agreement entered
into between Horizon/CMS and Tenet in connection with Horizon/CMS's attempted
acquisition of The Hillhaven Corporation ("Hillhaven") in January 1995. In the
lawsuit, Horizon/CMS alleges that Tenet failed to honor its commitment to pay
Horizon/CMS approximately $14.5 million pursuant to the agreement. Tenet has
contended that the amount owing to Horizon/CMS under the agreement is
approximately $5.1 million. During fiscal 1996, Horizon/CMS recognized as a
receivable approximately $13.0 million of the approximately $14.5 million
Horizon/CMS contends it is owed under the agreement. On May 13, 1997,
Horizon/CMS sought leave of the court to amend its complaint against Tenet to
assert, among other things, that Tenet tortiously interfered with Horizon/ CMS's
contractual relationship with its investment bankers, Donaldson, Lufkin &
Jenrette Securities Corporation ("DLJ"). In this connection, Horizon/CMS seeks
actual damages against Tenet in the approximate amount of $14.5 million plus
pre-judgment interest and punitive damages.
On May 13, 1997, Horizon/CMS filed a lawsuit against DLJ in the United
States District Court for the Central District of California. This lawsuit
arises out of the events and circumstances involved in the lawsuit against
Tenet. Specifically, this lawsuit alleges that DLJ, which served as investment
banker to Horizon/CMS in connection with Horizon/CMS's attempted acquisition of
Hillhaven, breached its fiduciary duty to Horizon/CMS, engaged in professional
negligence and tortiously interfered with Horizon/ CMS's contract with Tenet by
advising Tenet not to pay the $14.5 million Horizon/CMS contends is owing under
the agreement. In this connection, Horizon/CMS seeks actual damages against DLJ
in the approximate amount of $14.5 million and punitive damages. On June 27,
1997, pursuant to an agreement reached with DLJ and its counsel, Horizon/CMS
filed a new lawsuit against DLJ in the United States District Court for the
District of Nevada. This lawsuit is identical in all respects to the lawsuit
filed in the United States District Court for the Central District of
California. Pursuant to the agreement with DLJ and its counsel, DLJ has agreed
that it will not contest either jurisdiction or venue in Nevada. In addition, on
June 27, 1997, Horizon/CMS moved to consolidate the two Nevada matters.
Horizon/CMS has agreed to dismiss the litigation pending in California upon
consolidation of the two Nevada matters. Upon consolidation, Horizon/CMS will
seek an aggregate of $14.5 million in actual damages plus prejudgment interest
and punitive damages against Tenet, DLJ or both. Horizon is vigorously
prosecuting, this litigation matter; no assurance can be given, however, that
Horizon will ultimately prevail.
OIG/DOJ Investigation Involving Certain Medicare Part B and Related
Co-Insurance Billings
Horizon/CMS announced on March 15, 1996 that certain Medicare Part B and
related co-insurance billings previously submitted by Horizon/CMS were being
investigated by the OIG and the DOJ. On December 31, 1996, Horizon/CMS announced
that it had reached a settlement with the DOJ and OIG that concluded their
investigation of these billings. Horizon/CMS also announced that it had received
a letter from the United States Attorney's office conducting such investigation
indicating that the United States declined any criminal prosecution of
Horizon/CMS or any of its employees with respect to these billings. Under the
settlement, Horizon/CMS paid approximately $5.8 million to the United States as
a complete and final resolution of such matters. In addition, pursuant to the
terms of the settlement, Horizon/CMS is implementing a corporate-wide Medicare
Part B compliance program that includes the appointment of a subcommittee to
Horizon/CMS's Corporate Compliance Committee reporting directly to the
Chairman's office and to Horizon/CMS's Board of Directors, ongoing orientation
and training sessions for current and new employees, training evaluation and
annual audits to assess accuracy, validity and reliability of billings.
75
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(15) LEGAL PROCEEDINGS - (CONTINUED)
Securities and Exchange Commission ("SEC") and New York Stock Exchange ("NYSE")
Investigations
The Division of Enforcement of the SEC is conducting a private
investigation with respect to trading in the securities of Horizon/CMS and CMS.
In connection with that investigation, Horizon/CMS has produced certain
documents and Neal M. Elliott, Chairman of the Board, President and Chief
Executive Officer of Horizon/CMS, and certain other present and former officers
of Horizon/CMS have given testimony to the SEC. Horizon/CMS has also been
informed that certain of its division office employees and an individual,
affiliates of whom have limited business relationships with Horizon/CMS, have
responded to subpoenas from the SEC. Mr. Elliott has also produced certain
documents in response to a subpoena from the SEC. In addition, Horizon/CMS and
Mr. Elliott have responded or are responding to separate subpoenas from the SEC
pertaining to trading in Horizon/CMS's common stock and Horizon/CMS's March 1,
1996 press release announcing a revision in Horizon/CMS's third quarter earnings
estimate; Horizon/CMS's March 7, 1996 press release announcing the filing of a
lawsuit against Tenet; the March 12, 1996 press release announcing that the
merger with Pacific Rehab could not be effected by April 1, 1996; Horizon/CMS's
March 15, 1996 press release announcing the existence of a federal investigation
into certain of Horizon/ CMS's Medicare Part B billings; Horizon/CMS's February
19, 1997 announcement that HEALTHSOUTH would acquire Horizon/CMS; and any
discussions of proposed business combinations between Horizon/CMS and Medical
Innovations, Inc. and Horizon/ CMS and certain other companies. The
investigation is ongoing, and neither Horizon/CMS nor Mr. Elliott possesses all
the facts with respect to the matters under investigation. Although neither
Horizon/ CMS nor Mr. Elliott has been advised by the SEC that the SEC has
concluded that any of Horizon/ CMS, Mr. Elliott or any other current or former
officer or director of Horizon/CMS has been involved in any violation of the
federal securities laws, there can be no assurance as to the outcome of the
investigation or the time of its conclusion. Both Horizon/CMS and Mr. Elliott
intend to continue cooperating fully with the SEC in connection with the
investigation.
In March 1995, the NYSE informed Horizon/CMS that it had initiated a review
of trading in Hillhaven common stock prior to the announcement of Horizon/CMS's
proposed acquisition of Hillhaven. In April 1995, the NYSE extended the review
of trading to include all dealings with CMS. In April 3, 1996, the NYSE notified
Horizon/CMS that it had initiated a review of trading in its common stock
preceding Horizon/CMS's March 1, 1996 press release described above. On February
20, 1997, the NYSE notified Horizon/CMS that it was reviewing trading in
Horizon/CMS's securities prior to the February 18, 1997 announcement that
HEALTHSOUTH would acquire Horizon/CMS. Horizon/CMS is cooperating with the NYSE
in its reviews and, to Horizon/CMS's knowledge, the reviews are ongoing.
Michigan Attorney General Investigation Into Long-Term Care Facility In
Michigan
Horizon/CMS learned in September 1996 that the Attorney General of the
State of Michigan is investigating one of its skilled nursing facilities. The
facility, in Howell, Michigan, has been owned and operated by Horizon/CMS since
February 1994. The Attorney General seized a number of patient, financial and
accounting records that were located at this facility. By order of a circuit
judge in the county in which the facility is located, the Attorney General was
ordered to return patient records to the facility for copying. The investigation
appears to involve allegations arising out of a licensing survey conducted in
April 1996. Horizon/CMS has advised the Michigan Attorney General that it is
willing to cooperate in this investigation. Due to the preliminary nature of
this investigation, Horizon/CMS cannot now predict when the investigation will
be completed; the ultimate outcome of the investigation; or the effect thereof
on Horizon/CMS's financial condition or results of operations. If adversely
determined, this investigation could result in the imposition of civil and
criminal fines or sanctions against Horizon/ CMS, which could have a material
adverse impact on Horizon/CMS's financial condition and its results of
operations.
76
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(15) LEGAL PROCEEDINGS - (CONTINUED)
Stockholder Litigation
On March 28, 1996, Horizon/CMS was served with a lawsuit filed on March 21,
1996 in New Mexico state district court in Albuquerque, New Mexico, by a former
stockholder of CMS, Ronald Gottesman v. Horizon/CMS Healthcare Corporation, No.
CV-96-02894, Second Judicial District Court, County of Bernalillo, State of New
Mexico. This lawsuit, which among other things seeks class certification,
alleges violations of federal and New Mexico state securities laws arising from
what the plaintiff contends are materially misleading statements by Horizon/CMS
in its June 6, 1995 joint proxy statement/prospectus (the "CMS Prospectus"). The
plaintiff alleges that Horizon/CMS failed to disclose in the CMS Prospectus
those problems in Horizon/CMS's Medicare Part B billings Horizon/CMS described
in its related March 15, 1996 announcement. In this action, the plaintiff seeks
damages in an unspecified amount, plus costs and attorneys' fees. On August 22,
1997, the Company and the plaintiff entered into a stipulation whereby the
Plaintiff agreed to dismiss the litigation upon final approval of the proposed
settlement described below.
Since April 5, 1996, Horizon/CMS has been served with several complaints by
current or former stockholders of Horizon/CMS on behalf of all persons who
purchased Horizon/CMS Common Stock between June 6, 1995 and March 15, 1996. Each
of these lawsuits was filed in the United States District Court for the District
of New Mexico, in Albuquerque, New Mexico. In July 1996, the Court entered its
order consolidating these lawsuits into a single action styled In re Horizon/CMS
Healthcare Corporation Securities Litigation, Case No. CIV 96-0442-BB. On
September 30, 1996, the consolidated putative class plaintiffs filed their
consolidated complaint. In this complaint, the plaintiffs allege violations of
federal and New Mexico state securities laws. Among such violations, the
plaintiffs alleged that Horizon/CMS, certain of its current and former directors
and certain former directors of CMS, disseminated materially misleading
statements or omitted disclosing material facts about Horizon/CMS and its
operations. In December 1996, Horizon/CMS and the individual defendants filed
their motions to dismiss this consolidated lawsuit.
On February 20, 1997, Horizon/CMS announced that it had reached an
agreement in principle to settle the claims against it and certain of its
current and former directors in the consolidated class action lawsuit. Under the
proposed settlement, Horizon/CMS agreed to pay a minimum amount of $17.0 million
to resolve all claims against Horizon/CMS and its current and former directors,
excluding those claims arising against the former directors of CMS for conduct
occurring prior to the merger between CMS and Horizon. Under the settlement, the
maximum amount payable by Horizon/CMS is $20.0 million to resolve completely and
finally all claims in the litigation, including any amounts related to claims
against former directors of CMS. In agreeing to settle the litigation, none of
the defendants concedes or admits any of the plaintiffs' claims or allegations.
The settlement is subject to court approval.
On April 7, 1997, Horizon/CMS paid the $17.0 million, in trust, to the
plaintiffs' lead counsel. Also in April, 1997, Horizon/CMS paid $2.25 million to
CMS's directors' and officers' liability insurance carrier in exchange for the
carrier's assumption of the remaining risk contingency. On June 16, 1997, the
Court preliminarily approved the proposed settlement and set a final hearing to
approve the proposed settlement in September 1997. The parties are currently
proceeding to consummate the settlement in accordance with the rules governing
these proceedings.
77
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(15) LEGAL PROCEEDINGS - (CONTINUED)
On August 19, 1997, the plaintiffs and the individual defendants announced
to the Court that they had reached a settlement of the claims excluded by the
Company's prior settlement. This proposed settlement calls for the claims to
settle by a payment of $4 million. This entire amount will be paid by CMS's
directors' and officers' liability insurance carrier. The effect of this
settlement is to discharge the Company of its $3 million guarantee described
above. Accordingly, subject to Court approval, the Company's $17 million payment
will represent the Company's total liability to the plaintiffs in this matter.
Stockholder Derivative Actions
Commencing in April and continuing into May 1996, Horizon/CMS was served
with nine complaints alleging a class action derivative action brought by
stockholders of Horizon/CMS for and on behalf of Horizon/CMS in the Court of
Chancery of New Castle County, Delaware, against Neal M. Elliott, Klemett L.
Belt, Jr., Rocco A. Ortenzio, Robert A. Ortenzio, Russell L. Carson, Bryan C.
Cressey, Charles H. Gonzales, Michael A. Jeffries, Gerard M. Martin, Frank M.
McCord, Raymond M. Noveck, Barry M. Portnoy and LeRoy S. Zimmerman. The nine
lawsuits have been consolidated into one action styled In re Horizon/CMS
Healthcare Corporation Shareholders Litigation. The plaintiffs allege, among
other things, that Horizon/CMS's current and former directors breached their
fiduciary duties to Horizon/CMS and the stockholders as a result of (i) the
purported failure to supervise adequately and the purported knowing
mismanagement of the operations of Horizon/CMS, and the (ii) purported misuse of
inside information in connection with the sale of Horizon/CMS's common stock by
certain of the current and former directors in January and February 1996. To
that end, the plaintiffs seek an accounting from the directors for profits to
themselves and damages suffered by Horizon/CMS as a result of the transaction
complained of in the complaint and attorneys' fees and costs. On June 21, 1996,
the individual defendants filed a motion with the Chancery Court seeking to
dismiss this matter because, among other things, the plaintiffs failed to make a
demand on the board of directors prior to commencing this litigation.
Horizon/CMS cannot now predict the outcome or the effect of this litigation or
the length of time it will take to resolve this litigation.
In April 1996, Horizon/CMS was served with a complaint in a stockholder's
derivative lawsuit styled Lind v. Rocco A. Ortenzio, Neal M. Elliott, Klemett
L. Belt, Jr., Robert A. Ortenzio, Russell L. Carson, Bryan C. Cressey, Charles
H. Gonzales, Michael A. Jeffries, Gerard M. Martin, Frank M. McCord, Raymond N.
Noveck, Barry M. Portnoy, LeRoy S. Zimmerman and Horizon/CMS Healthcare
Corporation, No. CIV 96-0538-BB, pending in the United States District Court
for the District of New Mexico. The plaintiff alleges, among other things, that
Horizon/CMS's current and former directors breached their fiduciary duties to
Horizon/CMS and the stockholders as a result of (i) the purported failure to
supervise adequately and the purported knowing mismanagement of the operations
of Horizon/CMS, and the (ii) purported misuse of inside information in
connection with the sale of Horizon/CMS's common stock by certain of the
current and former directors in January and February 1996. To that end, the
plaintiff seeks an accounting from the directors for profits to themselves and
damages suffered by Horizon/CMS as a result of the transaction complained of in
the complaint and attorneys' fees and costs. Horizon/CMS filed a motion seeking
a stay of this case pending the outcome of the motion to dismiss in the
Delaware derivative lawsuits or, in the alternative, to dismiss this case for
those same reasons. Horizon/CMS cannot now predict the outcome or the effect of
this litigation or the length of time it will take to resolve this litigation.
78
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(15) LEGAL PROCEEDINGS - (CONTINUED)
Lawsuit by Former Shareholders of Communi-Care, Inc. and Pro Rehab, Inc.
On May 28, 1997, CMS was served with a lawsuit styled Kenneth Hubbard and
Lynn Hubbard v. Rocco Ortenzio, Robert A. Ortenzio and Continental Medical
Systems, Inc., No. 3:97 CV294MCK, filed in the United States District Court for
the Western District of North Carolina, Charlotte Division by the former
shareholders of Communi-Care, Inc. and Pro Rehab, Inc. (now known as RehabWorks)
seeking damages arising out of certain "earnout" provisions of the definitive
purchase agreements under which CMS purchased the outstanding stock of
Communi-Care, Inc., and Pro Rehab, Inc. from such shareholders. The plaintiffs
allege that the manner in which CMS and the other defendants operated the
companies after their acquisition breached their fiduciary duties to the
plaintiffs, constituted fraud, gross negligence and bad faith and a breach of
their employment agreements with the companies. As a result of such alleged
conduct, the plaintiffs assert that they are entitled to damages in an amount in
excess of $27.0 million from CMS and the other defendants. Horizon/CMS believes
based upon the advice of Eaves, Bardacke & Baugh, P.A., counsel to Horizon/CMS
in this matter, the assertions of these plaintiffs to be without factual or
legal merit and, as a result, intends to contest such claims vigorously. Because
this litigation has just been commenced, Horizon/CMS cannot now predict the
outcome of such litigation, the length of time it will take to resolve such
litigation or the effect of any such resolution on Horizon/CMS's financial
condition or results of operations.
RehabOne Litigation
In March 1997, Horizon/CMS was served with a lawsuit filed in the United
States District Court for the Middle District of Pennsylvania, styled RehabOne,
Inc. v. Horizon/CMS Healthcare Corporation, Continental Medical Systems, Inc.,
David Nation and Robert Ortenzio, No. CV-97-0292. In this lawsuit, the plaintiff
alleges violations of federal and state securities laws, fraud, and negligent
misrepresentation by Horizon/CMS and certain former officers of CMS in
connection with the issuance of a warrant to purchase 500,000 shares of
Horizon/CMS Common Stock (the "Warrant"). The Warrant was issued to the
plaintiff by Horizon/CMS in connection with the settlement of certain prior
litigation between the plaintiff and CMS. The plaintiff's complaint does not
state the amount of damages sought. Horizon/CMS disputes the factual and legal
assertions of the plaintiff in this litigation and intends to contest the
plaintiff's claims vigorously. Horizon/CMS has moved to dismiss the complaint
and that motion is pending. Because this litigation has just commenced,
Horizon/CMS cannot predict the length of time it will take to resolve the
litigation, the outcome of the litigation or the effect of any such outcome on
Horizon/ CMS's financial condition or results of operations.
EEOC Litigation
In March 1997, the Equal Employment Opportunity Commission (the "EEOC")
filed a complaint against Horizon/CMS alleging that Horizon/CMS has engaged in
unlawful employment practices in respect of Horizon/CMS's employment policies
related to pregnancies. Specifically, the EEOC asserts that Horizon/CMS's
alleged refusal to provide pregnant employees with light-duty assignments to
accommodate their temporary disabilities caused by pregnancy violates Sections
701(k) and 703(a) of Title VII, 42 U.S.C. (section) 2000e-(k) and 2000e-2(a). In
this lawsuit, the EEOC seeks, among other things, permanently to enjoin
Horizon/CMS's employment practices in this regard. Horizon/CMS disputes the
factual and legal assertions of the EEOC in this litigation and intends to
contest the EEOC's claims vigorously. Because this litigation has just
commenced, Horizon/CMS cannot predict the length of time it will take to resolve
the litigation, the outcome of the litigation or the effect of any such outcome
on Horizon/ CMS's financial condition or results of operations.
79
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(15) LEGAL PROCEEDINGS - (CONTINUED)
North Louisiana Rehabilitation Hospital Medicare Billing Investigation
In August 1996, the United States Attorney for the Western District of
Louisiana, without actually initiating litigation, apprised Horizon/CMS of
alleged civil liability under the federal False Claims Act for what the
government believes were false or fraudulent Medicare and other federal program
claims submitted by Horizon/CMS's North Louisiana Rehabilitation Hospital
("NLRH") during the period from 1989 through 1992, including certain claims
submitted by a physician who was a member of the medical staff and under
contract to NLRH during the period. Specifically, the government alleges that
NLRH facilitated the submission of false claims under Part B of the Medicare
program by the physician and that NLRH itself submitted false claims under Part
A of the Medicare program for services that were not medically necessary. In
August 1996, the U.S. Attorney identified allegedly improper Part A and Part B
billings, together with penalty provisions under the False Claims Act, ranging
in the aggregate from approximately $1.7 million to $2.2 million. The government
does not dispute that the Medicare Part A services were rendered, only whether
they were medically necessary. Horizon/CMS has vigorously contested the
allegation that any cases of disputed medical necessity in this matter
constitute false or fraudulent claims under the civil False Claims Act.
Moreover, Horizon/CMS denies that NLRH facilitated the submission of false
claims under Medicare Part B.
In late April 1997, Horizon/CMS received administrative subpoenas relating
to the matter and has since then produced extensive materials with respect
thereto. Without conceding liability for either the Medicare Part A or Part B
claims, in May 1997, Horizon commenced preliminary settlement discussions with
the government. In preparation for settlement meetings held in late June and
mid-July 1997, Horizon/CMS and the government developed and then refined their
respective analyses of any losses the government may have incurred in this
regard. Following the July 1997 meeting, the government proposed to Horizon/CMS
that the matter be settled by Horizon/CMS paying the government $4.9 million
with respect to alleged Medicare Part A overpayments and that Horizon/CMS and
certain individual physicians pay the government $820,000 with respect to
Medicare Part B claims for physician services. In late July, Horizon/CMS
responded by offering to settle the matter for $3.7 million for alleged Medicare
Part A overpayments and $445,000 for alleged Medicare Part B claims for which
Horizon/CMS potentially could bear any responsibility. Horizon/CMS anticipates
that settlement discussions will continue and, at this time, is optimistic that
the matter can be resolved without litigation.
(16) EXTRAORDINARY ITEM
Fiscal Year 1997
During the second quarter of fiscal 1997, the Company disposed of certain
assets and operations of a non-invasive medical diagnostic company providing
hospital-based and mobile ultrasound and related diagnostic services. The
Company also disposed of a medical office automation operation company providing
medical and financial systems. As a result of these two dispositions, the
Company recorded an extraordinary charge of $2,900, inclusive of income tax
expense of $2,700.
During the third quarter of fiscal 1997, the Company disposed of two
long-term care facilities located in California and Wisconsin and a subacute
care facility located in Maryland. The Company also disposed of its interest in
four rehabilitation hospitals, eleven hospital based or freestanding outpatient
rehabilitation clinics and nine congregate care facilities located in
California. As a result of these three dispositions, an extraordinary charge of
$14,900, net of an income tax benefit of $5,100, was recorded during the second
quarter of fiscal 1997.
80
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(16) EXTRAORDINARY ITEM - (CONTINUED)
During the fourth quarter of fiscal 1997, the Company disposed of one
long-term care facility located in Ohio and its interest in one rehabilitation
hospital located in Tennessee. As a result of these two dispositions, an
extraordinary gain of $4,000, inclusive of income tax expense of $2,800, was
recorded during the fourth quarter of fiscal 1997.
In accordance with the provisions of Accounting Principles Board Opinion
No. 16 ("APB 16"), "Business Combinations," the charges described above were
classified as extraordinary items. Management's decisions with respect to these
operations occurred subsequent to the merger with CMS, in July 1995, which was
accounted for as a pooling of interests. APB 16 requires that profit or loss
resulting from the disposal of assets within two years after a pooling of
interests be classified as an extraordinary item, net of tax.
Fiscal Year 1996
During fiscal 1996, the Company recorded extraordinary charges resulting
from the extinguishment of debt and the decision to dispose of assets following
the CMS merger.
On September 26, 1995, the Company completed a tender offer and consent
solicitation for $256,167 principal amount of its senior subordinated notes. The
103/8% Notes were redeemed at 109.25% plus a consent fee of 1.05% and the 107/8%
Notes were redeemed at 109.0% plus a consent fee of .75%. As a result of the
tender, the Company recorded an extraordinary charge related to the loss on the
retirement of the senior subordinated notes, including the write-off of related
deferred discount, swap cancellation and financing costs, of approximately
$22,075, net of income taxes of approximately $15,987, in the second quarter of
fiscal 1996. The senior subordinated notes were retired with funds drawn on the
NationsBank Facility.
During the three months ended November 30, 1995, the Company recorded
approximately $18,200 of revenue representing the estimated reimbursement
benefit for costs associated with the tender offer and consent solicitation for
the Company's senior subordinated notes discussed above.
As a result of discussions occurring during the fourth quarter of fiscal
1996, management significantly revised and expanded the group of facilities
originally identified for disposal in the first quarter of fiscal 1996.
Management also obtained board of director approval to pursue such a sale.
Subsequent to year end, the Company reached an agreement regarding the sales
price of these assets. The difference between the proposed sales price or
estimated fair value of the properties and the recorded basis of the assets to
be sold was approximately $21,300. As a result, a $9,400 charge was recorded in
the fourth quarter to increase the $11,900 first quarter asset disposal reserve
to $21,300. In accordance with the provisions of APB 16, the fourth quarter
charge was classified as an extraordinary item. Management's decision with
respect to the fourth quarter revision and expansion of the group of facilities
to be disposed of occurred subsequent to the merger with CMS. Since the $11,900
first quarter asset disposal charge occurred prior to the CMS merger, that
charge was appropriately classified within operations.
81
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(16) EXTRAORDINARY ITEM - (CONTINUED)
At May 31, 1997 further efforts to dispose of the previously targeted group
of facilities has been suspended awaiting the outcome of HEALTHSOUTH
Corporation's ("HEALTHSOUTH") pending acquisition of the Company discussed
below. Balance sheet amounts at May 31, 1997 associated with the assets
previously held for sale and previously reclassified as current assets or
liabilities, as appropriate, have not been reclassified at May 31, 1997, and are
not reflected as held for sale.
Fiscal Year 1995
During fiscal 1995, the Company recognized a gain of $2,571 ($4,172 less
related tax effect of $1,601) relating to open market purchases of its senior
subordinated notes and its 83/4% and 61/2% convertible subordinated notes at a
discount.
(17) HEALTHSOUTH MERGER
In February 1997, the Company and HEALTHSOUTH jointly announced the signing
of a definitive agreement pursuant to which the Company would be acquired by
HEALTHSOUTH in a stock-for-stock merger in which the stockholders of the Company
will receive 0.84338 of a share of HEALTHSOUTH common stock (as adjusted for the
two-for-one stock split effected by HEALTHSOUTH on March 17, 1997) in exchange
for each share of the Company's common stock. The transaction, which is subject
to the approval of the Company's stockholders, various regulatory approvals,
including clearance under the Hart-Scot-Rodino Antitrust Improvements Act, and
to the satisfaction of certain other conditions, is expected to be consummated
during the second quarter of fiscal 1998. The acquisition is expected to be
treated as a tax-free reorganization and will be accounted for as a purchase.
(18) QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a summary of the unaudited quarterly results of
operations:
<TABLE>
<CAPTION>
FISCAL YEAR 1997
--------------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER(A) QUARTER(B)(C) QUARTER(D) QUARTER(E)(F)
------------ --------------- ------------ --------------
<S> <C> <C> <C> <C>
Total operating revenues ........................... $443,634 444,306 $443,735 $ 468,149
Gross profit ....................................... 71,787 71,531 73,317 69,208
Earnings (loss) before income taxes and extraordinary
item ............................................. 14,261 15,592 (877) (51,858)
Earnings (loss) before extraordinary item ......... 8,061 7,392 (2,492) (35,022)
Net earnings (loss) ................................. 8,061 (10,429) (2,492) (31,059)
Earnings (loss) per common and common equivalent
share:
Earnings (loss) before extraordinary item ......... 0.15 0.14 (0.05) (0.67)
Extraordinary item ................................. - (0.34) - 0.08
--------- -------- -------- ---------
Net earnings (loss) ................................. 0.15 (0.20) $ (0.05) (0.59)
========= ======== ======== =========
</TABLE>
82
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(18) QUARTERLY FINANCIAL DATA (UNAUDITED) - (CONTINUED)
<TABLE>
<CAPTION>
FISCAL YEAR 1996
---------------------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER (G) QUARTER(H)(I)(J) QUARTER(K)(L) QUARTER(M)(N)
------------- ------------------ --------------- --------------
<S> <C> <C> <C> <C>
Total operating revenues ........................... $ 431,407 $458,952 $423,449 $442,726
Gross profit ....................................... 82,260 102,322 61,755 71,212
Earnings (loss) before income taxes and extraordinary
item ............................................. (31,445) 51,926 12,575 7,290
Earnings (loss) before extraordinary item ......... (28,925) 30,736 6,774 89
Net earnings (loss) ................................. (28,925) 8,661 6,774 (9,164)
Earnings (loss) per common and common equivalent
share: .............................................
Earnings (loss) before extraordinary item ......... $ (0.56) $ 0.60 $ 0.13 $ -
Extraordinary item ................................. - (0.43) - (0.18)
--------- -------- --------- --------
Net earnings (loss) ................................. $ (0.56) $ 0.17 $ 0.13 $ (0.18)
========= ======== ========= ========
</TABLE>
- ----------
(a) Includes a $7,200 pre-tax special charge resulting from the approval by
management of the Company of restructuring measures relating to the
Company's rehabilitation hospital corporate office located in
Mechanicsburg, Pennsylvania and certain contract rehabilitation therapy
operations.
(b) Includes a $4,000 pre-tax special charge resulting from the settlement of
the investigation by the OIG and the DOJ of certain of the Company's
Medicare Part B and related co-insurance billings.
(c) Includes a $17,800, net of income tax, extraordinary charge resulting from
the disposition of two long-term care facilities located in California and
Wisconsin, one subacute care facility located in Maryland and interests in
four rehabilitation hospitals, eleven hospital based or freestanding
outpatient rehabilitation clinics and nine congregate care facilities
located in California.
(d) Includes a $19,800 pre-tax special charge resulting primarily from the
settlement of the claims against the Company and certain of its current and
former directors in the consolidated class action lawsuit filed in New
Mexico Federal District Court in April 1996.
(e) Includes a $66,300 pre-tax special charge consisting of: (i) $6,400 related
to threatened or pending litigation (Note 7), (ii) $6,700 related the
reserve established for the potential impairment of the estimated value of
a noncompete agreement with the former principal of an organization the
Company acquired (Note 7) and (iii) $53,200 resulting from the termination
of the Management Agreements between HFM and the HEA Group and to
restructure and forgive certain indebtedness of the HEA Group (Note 7).
(f) Includes a $4,000, net of income tax, extraordinary charge resulting from
the disposition of one long-term care facility located in Ohio and its
interest in one rehabilitation hospital located in Tennessee.
(g) Includes a $63,500 pre-tax special charge resulting primarily from costs
incurred in completing the merger with CMS, the approval by management of
restructuring measures related to efforts to combine the previously
separate companies and a decision by management prior to the CMS merger to
dispose of selected facilities.
83
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995 (DOLLARS IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(18) QUARTERLY FINANCIAL DATA (UNAUDITED)
(h) Includes $9,300 of revenue, net of $3,700 of direct expenses, resulting from
an agreement entered into between the Company and Tenet in connection with
the Company's attempted acquisition of Hillhaven (Note 15).
(i) Includes a $22,100 extraordinary loss (net of tax) relating to the
extinguishment of senior subordinated debt.
(j) Includes $18,200 of revenue resulting from the estimated Medicare
reimbursement for costs incurred by the Company in the tender for CMS's
senior subordinated notes (Note 16).
(k) Includes $7,000 reduction of revenue recorded to increase third-party
settlement receivable reserves.
(l) Includes $1,700 pre-tax charge related to the Company's OIG/DOJ Medicare
Part B billings investigation.
(m) Includes a $17.000 pre-tax special charge resulting from the impairment of
certain long-lived assets and the accrual for estimated costs of litigation
and investigations.
(n) Includes a $9,300 extraordinary loss (net of tax) related to a decision by
management subsequent to the CMS merger to revise and expand the group of
facilities held for sale prior to the CMS merger.
84
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
NONE.
PART III
For information concerning Item 10 - Directors and Executive Officers of
the Registrant, Item 11 - Executive Compensation, Item 12 - Security Ownership
of Certain Beneficial Owners and Management and Item 13 - Certain Relationships
and Related Transactions, see the Proxy Statement of the Company for the Annual
Meeting of Stockholders to be held in November 1997, if necessary, which will be
filed with the Securities and Exchange Commission and is incorporated herein by
reference, and "Business - Directors and Executive Officers" included in Item 1
of Part I of this Annual Report on Form 10-K. If the Annual Meeting will not be
held as a result of the Merger discussed under "Business - Proposed Merger of
Horizon/CMS with HEALTHSOUTH Corporation" in Item 1. of Part I of this Annual
Report, such information will be provided by amendment to this Annual Report.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A) 1. FINANCIAL STATEMENTS:
See Index to Consolidated Financial Statements in Item 8 of this report.
2. Financial Statement Schedule:
The following Schedule is filed herewith on the page indicated:
SCHEDULE
II - Valuation and Qualifying Accounts
3. Exhibits:
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- --------- --------------------------------------------------------------------
**2.1 First Amendment to Agreement and Plan of Merger dated September 30,
1993 between the Company and Greenery.
**2.2 Agreement dated July 30, 1993 between the Company, Health and
Rehabilitation Properties Trust ("HRPT") and Greenery.
**2.3 Letter Agreement between the Company, Greenery and HRPT (amending
Exhibit 2.2 above).
**2.4 Purchase Agreement dated as of July 30, 1993 between M&P Partners
Limited Partnership, Greenery and 99111 Chestnut Hill Avenue Corp.
**2.5 First Amendment to Purchase Agreement (amending Exhibit 2.4 above)
dated October 29, 1993.
**2.6 Agreement and Plan of Reorganization dated as of June 9, 1994, by
and among the Company, peopleCARE Heritage Manor Plano, Inc.,
peopleCARE Heritage Manor Canton, Inc., peopleCARE Heritage Park,
Inc., peopleCARE Heritage Village, Inc., peopleCARE Winter- haven,
Inc., peopleCARE Heritage Place, Inc., peopleCARE Heritage Forest
Lane, Inc., peopleCARE Heritage Oaks, Inc., peopleCARE Heritage
Manor Longview, Inc., peopleCARE Heritage Gardens Carrollton, Inc.,
peopleCARE Heritage Estates, Inc., peopleCARE Heritage Country
Manor, Inc., and peopleCARE Heritage Western Hills, Inc., as amended
by Amend- ment No. 1 to Agreement and Plan of Reorganization dated
June 30, 1994.
85
<PAGE>
2.7 Plan and Agreement of Merger dated February 17, 1997, by and among
HEALTHSOUTH Corporation, Reid Acquisition Corp., and the Company
(incorporated by reference to Exhibit 2.1 to Current Report on Form
8-K dated February 24, 1997).
**3.1 Restated Certificate of Incorporation of the Company dated March 6,
1987, together with Certificate of Amendment of Certificate of
Incorporation dated January 6, 1992.
3.2 Certificate of Amendment of Restated Certificate of Incorporation
dated September 12, 1994 (incorporated by reference to Exhibit 4.2
to the Company's Registration Statement on Form S-8 (Registration
No. 33-84502)).
3.3 Certificate of Amendment of Restated Certificate of Incorporation
dated July 6, 1995 (incorporated by reference to the Company's
Registration Statement on Form S-8 (Registration No. 33-61697)).
3.4 Amended and Restated Bylaws dated as of February 28, 1987, together
with Amendment to Bylaws Section 9.1.1 dated August 30, 1993
(incorporated by reference to Exhibit 3.2 to the Company's 1994
Annual Report on Form 10-K (the "1994 10-K")).
3.5 Certificate of Designation of Series A Junior Participating
Preferred Stock of Horizon Healthcare Corporation dated September
16, 1994 (incorporated by reference to Exhibit 4.3 to Horizon's
Registration Statement on Form S-8 (Registration No. 33-84502)).
3.6 Rights Agreement, dated as of September 15, 1994, between Horizon
Healthcare Corporation and Chemical Trust Company of California, as
Rights Agent, specifying the terms of the rights to purchase
Horizon's Series A Junior Participating Preferred Stock, and the
exhibits thereto (incorporated by reference to Exhibit 1 to
Horizon's Registration Statement on Form 8-A dated September 16,
1994).
3.6.1 First Amendment to Rights Agreement dated as of February 17, 1997,
between the Company and ChaseMellon Shareholder Services, L.L.C., as
Rights Agent (incorporated by reference to Exhibit 4.6.1 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
February 28, 1997).
4.1 Restated Certificate of Incorporation of the Company dated March 6,
1987, together with Certificate of Amendment of Certificate of
Incorporation dated January 6, 1992 (incorporated by reference to
Exhibit 3.1).
4.2 Certificate of Amendment of Restated Certificate of Incorporation
dated September 12, 1994 (incorporated by reference to Exhibit 3.2).
4.3 Certificate of Amendment of Restated Certificate of Incorporation
dated July 6, 1995 (incorporated by reference to Exhibit 3.3).
4.4 Amended and Restated Bylaws dated as of February 28, 1987, together
with Amendment to Bylaws Section 9.1.1 dated August 30, 1993
(incorporated by reference to Exhibit 3.4).
4.5 Certificate of Designation of Series A Junior Participating
Preferred Stock of Horizon Healthcare Corporation dated September
16, 1994 (incorporated by reference to Exhibit 3.5).
4.6 Rights Agreement, dated as of September 15, 1994, between Horizon
Healthcare Corporation and Chemical Trust Company of California, as
Rights Agent, specifying the terms of the rights to purchase
Horizon's Series A Junior Participating Preferred Stock, and the
exhibits thereto (incorporated by reference to Exhibit 3.6).
4.6.1 First Amendment to Rights Agreement dated as of February 17, 1997,
between the Company and ChaseMellon Shareholder Services, L.L.C., as
Rights Agent (incorporated by reference to Exhibit 3.6.1.).
4.7 Indenture dated as of February 6, 1992, between the Company and
Security Pacific National Bank, Trustee, with respect to 6 3/4%
Convertible Subordinated Notes due 2002 (incorporated by reference
to Exhibit 4.3 to the Company's 1994 Form 10-K).
4.8 Form of 6 3/4% Convertible Subordinated Note due 2002 (included in
Exhibit 4.7) (incorporated by reference to Exhibit 4.4 to the
Company's 1994 Form 10-K).
86
<PAGE>
4.9 Indenture dated as of June 16, 1986, between Greenery and Shawmut
Bank of Boston, N.A., Trustee, with respect to 6 1/2% Convertible
Subordinated Debentures due 2011 (incorporated by reference to
Exhibit 4.5 to the Company's 1994 Form 10-K).
4.10 Form of 6 1/2% Convertible Subordinated Debenture due 2011 (included
in Exhibit 4.9).
4.11 First Supplemental Indenture dated as of December 1, 1993
(supplementing Exhibit 4.9), between the Company and Shawmut Bank
N.A., Trustee (incorporated by reference to Exhibit 4.7 to the
Company's 1994 Form 10-K).
4.12 Indenture dated as of April 1, 1990, between Greenery and The
Connecticut National Bank, Trustee, with respect to 8 3/4%
Convertible Senior Subordinated Notes Due 2015 (incorporated by
reference to Exhibit 4.8 to the Company's 1994 Form 10-K).
4.13 Form of 8 3/4% Convertible Senior Subordinated Note (included in
Exhibit 4.12).
4.14 First Supplemental Indenture dated as of December 1, 1993
(supplementing Exhibit 4.12), between the Company and Shawmut Bank
Connecticut, N.A., Trustee (incorporated by reference to Exhibit
4.10 to the Company's 1994 Form 10-K).
4.15 Indenture, dated as of August 17, 1992, between CMS and NationsBank
of Virginia, N.A., as Trustee, with respect to 10 7/8% Senior
Subordinated Notes due 2002 (incorporated by reference to CMS's 1992
Form 10-K).
4.16 Form of 10 7/8% Senior Subordinated Notes due 2002 (included in
Exhibit 4.15).
4.17 First Supplemental Indenture dated as of June 22, 1994
(supplementing Exhibit 4.15 above), between CMS and NationsBank of
Virginia, N.A., as Trustee (incorporated by reference to Exhibit
4.17 to the Company's Annual Report on Form 10-K (the "1995 Form
10-K")).
***4.17.1 Supplemental Indenture dated as of September 12, 1995 (supplementing
Exhibits 4.15 and 4.17 above), between CMS and NationsBank of
Virginia, N.A., as Trustee.
4.18 Indenture, dated as of March 15, 1993, between CMS and NationsBank
of Virginia, N.A., as Trustee, with respect to 10 3/8% Senior
Subordinated Notes due 2003 (incorporated by reference to
Continental Medical's Registration Statement on Form S-4
(Registration No. 33-60004).
4.19 Form of 10 3/8% Senior Subordinated Notes due 2003 (included in
Exhibit 4.17).
4.20 First Supplemental Indenture dated as of June 27, 1994
(supplementing Exhibit 4.18 above), between CMS and NationsBank of
Virginia, N.A., as Trustee (incorporated by reference to Exhibit
4.20 to the Company's 1995 Form 10-K).
***4.20.1 Supplemental Indenture dated as of September 12, 1995,
(supplementing Exhibits 4.18 and 4.20 above), between CMS and
NationsBank of Virginia, N.A., as Trustee.
4.21 Credit Agreement dated as of July 6, 1995 among the Company, CMS,
the Lenders named therein and NationsBank of Texas, N.A., as Agent
and Issuing Bank (incorporated by reference to Exhibit 99 of the
Company's Form 8-K dated July 10, 1995).
4.22 Amended and Restated Credit Agreement dated as of September 26,
1995 by and among the Company, CMS, the Lenders named therein and
NationsBank of Texas, N.A., as Agent and Issuing Bank (incorporated
by reference to Exhibit 10.1 of the Company's August 31, 1995 Form
10-Q dated October 16, 1995).
***4.23 First Amendment dated as of April 15, 1996 to the Amended and
Restated Credit Agreement dated as of September 26, 1995 by and
among the Company, CMS, the Lenders named therein and NationsBank of
Texas, N.A., as Agent and Issuing Bank.
***4.24 Second Amendment dated as of July 16, 1996 to the Amended and
Restated Credit Agreement dated as of September 26, 1995 by and
among the Company, CMS, the Lenders named therein and NationsBank of
Texas, N.A., as Agent and Issuing Bank.
***4.25 Letter Agreement dated as of October 18, 1995 confirming interest
rate collar agreement.
87
<PAGE>
4.26 Third Amendment dated as of November 6, 1996 to the Amended and
Restated Credit Agreement dated as of September 26, 1995 by
among the Company, CMS, the Lenders named therein and
NationsBank of Texas, N.A., as Agent and Issuing Bank.
(incorporated herein by reference to Exhibit 4.24.1 to the
Company's Quarterly Report on Form 10-Q for the Quarter ended
November 30, 1996).
4.27 Fourth Amendment dated as of December 20, 1996 to the Amended
and Restated Credit Agreement dated as of September 26, 1995 by
among the Company, CMS, the Lenders named therein and
NationsBank of Texas, N.A., as Agent and Issuing Bank
(incorporated herein by reference to Exhibit 10.24.1 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
February 28, 1997).
4.28 Fifth Amendment dated as of March 7, 1997 to the Amended and
Restated Credit Agreement dated as of September 26, 1995 by
among the Company, CMS, the Lenders named therein and
NationsBank of Texas, N.A., as Agent and Issuing Bank,
(incorporated herein by reference to Exhibit 10.24.2 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
February 28, 1997).
4.29 Sixth Amendment dated as of May 9, 1997 to the Amended and
Restated Credit Agreement dated as of September 26, 1995 by
among the Company, CMS, the Lenders named therein and
NationsBank of Texas, N.A., as Agent and Issuing Bank.
(incorporated herein by reference to Exhibit 99.2 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
February 28, 1997).
10.1 Employment and change of control Agreement dated as of December
24, 1996, between the Company and Neal M. Elliott.
+**10.2 Employment Agreement dated as of August 19, 1993 between the
Company and Klemett L. Belt, Jr.
+***10.2.1 Severance and Retirement Agreement dated as of December 19,
1995, between the Company and Klemett L. Belt, Jr.
+10.3 Employment Agreement dated as of July 10, 1995 between the
Company and Robert A. Ortenzio (incorporated by reference to
Exhibit 10.3 to the Company's 1995 Form 10-K).
10.4 Subscription and Lending Agreement between CMS and Rocco A.
Ortenzio and 7 3/4% Convertible Subordinated Debentures due
2012 and $2,000,000 Note relating thereto (incorporated by
reference to Exhibit 10.4 to the Company's 1995 Form 10-K).
+***10.5 Consulting Agreement dated August 10, 1995 between the Company
and Rocco A. Ortenzio.
+***10.6 Letter Agreement dated July 17, 1995 between the Company and
Rocco A. Ortenzio relating to his termination of employment
with CMS.
+10.7 Merrill Lynch 401(k) Services Adoption Agreement and related
Merrill Lynch Special Prototype Defined Contribution Plan
(incorporated by reference to Exhibit 10.48 to the Company's
1994 Form 10-K).
+10.8 Consulting Agreement dated February 11, 1994 between the
Company and Gerard M. Martin (incorporated by reference to
Exhibit 10.27 to the Company's 1994 Form 10-K).
+10.9 Employee Stock Option Plan of the Company (incorporated by
reference to Exhibit 10.5 to the Company's 1994 Form 10-K).
+10.10 First Amendment to Stock Option Plan of the Company (amending
Exhibit 10.8) (incorporated by reference to Exhibit 10.6 to the
Company's 1994 Form 10-K).
+10.11 Corrected Second Amendment to Stock Option Plan (amending
Exhibit 10.9) (incorporated by reference to Exhibit 10.7 to the
Company's 1994 Form 10-K).
+10.12 Amendment No. 3 to Horizon Healthcare Corporation Employee
Stock Option Plan (incorporated by reference to Exhibit 10.12
to the Company's 1995 Form 10-K).
88
<PAGE>
+10.13 Horizon Healthcare Corporation Stock Option Plan for Non-Employee
Directors of the Company (incorporated by reference to Exhibit
10.6 to the Company's 1994 Form 10-K).
+***10.14 Amendment No. 1 to Horizon Healthcare Corporation Stock Option
Plan for Non-Employee Directors.
+10.15 Horizon/CMS Healthcare Corporation 1995 Incentive Plan
(incorporated by reference to Exhibit 4.1 to the Company's
Registration Statement on Form S-8 (Registration No. 33-63199)).
+10.16 Horizon/CMS Healthcare Corporation 1995 Non-Employee Directors'
Stock Option Plan (incorporated by reference to Exhibit 4.2 to
the Company's Registration Statement on Form S-8 (Registration
No. 33-63199)).
+10.17 Employee Stock Purchase Plan of the Company (incorporated by
reference to Exhibit 10.9 to the Company's 1994 Form 10-K).
+***10.18 First Amendment to Horizon Healthcare Corporation Employee Stock
Purchase Plan.
+***10.19 Horizon/CMS Healthcare Corporation 1996 Employee Stock Purchase
Plan.
+10.20 Continental Medical Systems, Inc. 1986 Stock Option Plan (as
amended and restated effective December 1, 1991), Amendment No. 1
to Continental Medical Systems, Inc. 1986 Stock Option Plan,
Amendment No. 2 to Continental Medical Systems Inc. 1986 Stock
Option Plan and form of option agreement (incorporated by
reference to Exhibit 4.1 to the Company's Registration
Statement on Form S-8 (Registration No. 33-61697)).
+10.21 Continental Medical Systems, Inc. 1989 Non-Employee Directors'
Stock Option Plan (as amended and restated effective December 1,
1991) and form of option agreement (incorporated by reference
to Exhibit 4.2 to the Company's Registration Statement on Form
S-8 (Registration No. 33-61697)).
+10.22 Continental Medical Systems, Inc. 1992 CEO Stock Option Plan,
Amendment No. 1 to Continental Medical Systems, Inc. 1992 CEO
Stock Option Plan and form of option agreement (incorporated by
reference to Exhibit 4.3 to the Company's Registration Statement
on Form S-8 (Registration No. 33-61697)).
+10.23 Continental Medical Systems, Inc. 1993 Nonqualified Stock Option
Plan, Amendment No. 1 to Continental Medical Systems, Inc. 1993
Nonqualified Stock Option Plan, Amendment No. 2 to Continental
Medical Systems, Inc. 1993 Nonqualified Stock Option Plan and
form of option agreement (incorporated by reference to Exhibit
4.4 to the Company's Registration Statement on Form S-8
(Registration No. 33-61697)).
+10.24 Continental Medical Systems, Inc. 1994 Stock Option Plan and form
of option agreement (incorporated by reference to Exhibit 4.5
to the Company's Registration Statement on Form S-8 (Registration
No. 33-61697))
+10.25 Assignment and Assumption of Lease dated August 10, 1989 between
the Company and Elliott-Belt Partners (Horizon Healthcare Nursing
Center Albuquerque) (incorporated by reference to Exhibit 10.13
to the Company's 1994 Form 10-K).
+10.26 Registration Rights and Stock Restriction Agreement dated as of
February 11, 1994 between the Company and Gerard M. Martin and
Kathleen R. Martin (incorporated by reference to Exhibit 10.28 to
the Company's 1994 Form 10-K).
+10.27 Promissory Note together with Mortgage and Security Agreement
made by the Company for the benefit of HRPT (Howell, Michigan)
(incorporated by reference to Exhibit 10.30 to the Company's 1994
Form 10-K).
+10.28 Promissory Note together with Mortgage and Security Agreement
made by the Company for the benefit of HRPT (Farmington,
Michigan) (incorporated by reference to Exhibit 10.31 to the
Company's 1994 Form 10-K).
+10.29 Guaranty of Lease dated as of February 11, 1994 made by the
Company for benefit of HRPT (Connecticut facilities)
(incorporated by reference to Exhibit 10.34 to the Company's 1994
Form 10-K).
89
<PAGE>
+10.30 Form of Management Agreements between the Company and Connecticut
Subacute Corporation II (form used for each of the Connecticut
facilities) (incorporated by reference to Exhibit 10.40 to the
Company's 1994 Form 10-K).
+10.31 Promissory Note dated December 10, 1993 made by B&G Partners
Limited Partnership to the order of the Company in the original
principal amount of $20,000,000 (incorporated by reference to
Exhibit 10.41 to the Company's 1994 Form 10-K).
+10.32 Unconditional and Continuing Guaranty dated February 11, 1994
made by Barry M. Portnoy for the benefit of the Company, as
successor to Greenery (incorporated by reference to Exhibit 10.42
to the Company's 1994 Form 10-K).
+10.33 Unconditional and Continuing Guaranty dated February 11, 1994
made by Gerard M. Martin for the benefit of the Company as
successor to Greenery (incorporated by reference to Exhibit 10.43
to the Company's 1994 Form 10-K).
+10.34 Purchase Option Agreement dated February 11, 1994 between the
Company and HRPT (incorporated by reference to Exhibit 10.44 to
the Company's 1994 Form 10-K).
10.35 Real Estate Contract of Sale dated as of June 9, 1994 by and
among the White Oaks Investments, L.P., Four-K Investments, L.P.,
Sellers, and the Company, Purchaser, as amended by Amendment No.
1 to Real Estate Contract of Sale dated June 30, 1994
(incorporated by reference to Exhibit 10.45 to the Company's 1994
Form 10-K).
10.36 Real Estate Contract of Sale and Master Lease Agreement between
White Oaks Investment, L.P., Robert J. Schlegel and the Company
dated as of June 9, 1994, as amended by Amendment No. 1 to Real
Estate Contract of Sale and Master Lease Agreement dated June 30,
1994 (incorporated by reference to Exhibit 10.46 to the Company's
1994 Form 10-K).
10.37 Master Lease Agreement between White Oaks Investment, L.P. and
the Company dated Ju- ly 31, 1994 (incorporated by reference to
Exhibit 10.47 to the Company's 1994 Form 10-K).
10.38 Office Lease Agreement between CMS (as tenant) and LeRoy S.
Zimmerman (as landlord) dated December 29, 1994 relating to
Liberty Plaza I (incorporated by reference to Exhibit 10.34 to
the Company's 1995 Form 10-K).
10.39 Office Lease Agreement between CMS (as tenant) and Liberty Plaza
Associates II (as landlord) dated February 1, 1995 relating to
Liberty Plaza II (incorporated by reference to Exhibit
10.35 to the Company's 1995 Form 10-K).
10.40 Office Lease Agreement between CMS (as tenant) and Liberty Plaza
Associates III (as landlord) dated February 1, 1995 (incorporated
by reference to Exhibit 10.36 to the Company's 1995 Form 10-K).
+10.41 Office Building Lease dated June 1, 1994 between Albuquerque
Centre Ltd. Co., a New Mexico limited liability company, and the
Company (principal corporate offices) and Office Lease Addendum
dated June 1, 1995 (incorporated by reference to Exhibit 10.37 to
the Company's 1995 Form 10-K).
+***10.42 IDS Financial Services Inc. Defined Contribution Prototype Plan
and Trust Agreement.
+*10.42.1 Amendment No. 1 to the CMS 401(k) Profit Sharing Plan (amending
Exhibit 10.42 above).
***10.43 Master Management Agreement dated as of January 1, 1996, by and
among the Company, Texas Health Enterprises, Inc., Health
Enterprises of Oklahoma, Inc., Health Enterprises of Michigan,
Inc., HEA Management Group, Inc., and PCK-TEX, Ltd.
***10.44 Loan Agreement dated as of January 1, 1996, by and among the
Company, Texas Health Enterprises Inc., Health Enterprises of
Oklahoma, Inc., Health Enterprises of Michigan, Inc., HEA
Management Group, Inc. and PCK-TEX, Ltd.
10.45 Compromise, Settlement, Release and Termination Agreement dated
May 12, 1997 by and among Horizon/CMS and the subsidiaries named
therein and the HEA Group (incorporated herein by reference to
Exhibit 99.1 to the Company's Current Report on Form 8-K dated
May 27, 1997).
90
<PAGE>
*11.1 Statement re: Computation of Per Share Earnings.
***21 List of subsidiaries of the Company.
*23.1 Consent of Arthur Andersen LLP
*23.2 Consent of Ernst & Young LLP
*27 Financial Data Schedule.
- ----------
+ Identifies management contracts and compensatory plans or arrangements.
* Filed herewith.
** Incorporated by reference to the same-numbered exhibit to the Company's
1994 Form 10-K.
*** Incorporated by reference to the same-numbered exhibit to the Company's
1996 Form 10-K
(b) Reports on Form 8-K:
<TABLE>
<CAPTION>
DATE OF REPORT ITEMS REPORTED
- ---------------- ----------------------------------------------------------
<S> <C>
May 12, 1997 Filed on May 27, 1997, reporting under "Item 5. Other
Events" announcing that the Company agreed to ter-
minate certain agreements between its wholly-owned
subsidiary, Horizon Facilities Management, and Texas
Health Enterprises, Inc. and certain affiliates (collec-
tively, the "HEA Group") and to restructure and for-
give certain indebtedness of the HEA Group.
</TABLE>
- ----------
91
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on the 29th day of
August, 1997.
HORIZON/CMS HEALTHCARE CORPORATION
By /s/ Neal M. Elliott
-----------------------------------------
Neal M. Elliott
Chairman of the Board, President
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated. Each person whose
individual signature appears below hereby authorizes Scot Sauder and Ernest A.
Schofield or either of them, as attorneys-in-fact with full power of
substitution, to execute in the name and on behalf of each person, individual,
and in each capacity stated below, and to file, any and all amendments to this
report.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------ ------------------------------------ ----------------
<S> <C> <C>
/s/ NEAL M. ELLIOTT President, Chief Executive Officer August 29, 1997
- --------------------------- and Chairman of the Board
Neal M. Elliott of Directors
(Principal Executive Officer)
/s/ CHARLES H. GONZALES Director August 29, 1997
- ---------------------------
Charles H. Gonzales
/s/ FRANK M. MCCORD Director August 29, 1997
- ---------------------------
Frank M. McCord
/s/ RAYMOND N. NOVECK Director August 29, 1997
- ---------------------------
Raymond N. Noveck
/s/ CHARLES K. BRADFORD Director August 29, 1997
- ---------------------------
Charles K. Bradford
/s/ MARIA PAPPAS Director August 29, 1997
- ---------------------------
Maria Pappas
/s/ RONALD N. RINER, MD Director August 29, 1997
- ---------------------------
Ronald N. Riner, MD
/s/ ERNEST A. SCHOFIELD Senior Vice President, August 29, 1997
- --------------------------- Chief Financial Officer,
Ernest A. Schofield Chief Accounting Officer
and Director (Principal Financial
and Accounting Officer)
</TABLE>
92
<PAGE>
SCHEDULE II
HORIZON/CMS HEALTHCARE CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED MAY 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONS
--------------------------
BALANCE AT CHARGED TO
BEGINNING OF COSTS AND BALANCE AT
DESCRIPTION PERIOD EXPENSES OTHER DEDUCTIONS END OF PERIOD
- ---------------------------------- -------------- ----------- ------------ ------------------- --------------
<S> <C> <C> <C> <C> <C>
Allowance for doubtful accounts:
1997 ........................... $43,097 $27,552 $ 6,002 (1) $ (26,409)(2) $50,242
======== ======== ========== ============ ========
1996 ........................... $29,595 $27,735 $ 3,211 (1) $ (17,444)(2) $43,097
======== ======== ========== ============ ========
1995 ........................... $24,843 $23,584 $ 1,634 (1) $ (20,466)(2) $29,595
======== ======== ========== ============ ========
Valuation allowance on deferred tax
assets:
1997 ........................... $ 2,250 $ - $ 1,000 (3) $ - $ 3,250
======== ======== ========== ============ ========
1996 ........................... $ 4,051 $ - $ 1,179 (4) $ (2,980)(5) $ 2,250
======== ======== ========== ============ ========
1995 ........................... $ 4,851 $ - $ - $ (800)(6) $ 4,051
======== ======== ========== ============ ========
</TABLE>
- ----------
(1) In fiscal 1997, 1996 and 1995 the Company completed various acquisitions.
Additions in the amount of $6,002, $3,211 and $1,634 in the allowance for
doubtful accounts were recorded in connection with these acquisitions
during fiscal 1997, 1996 and 1995, respectively.
(2) Represents write-offs against the allowance.
(3) Resulted from current year losses which significantly reduced the Company's
ability to utilize certain preacquisition losses and credits.
(4) Resulted from business combinations during fiscal 1996.
(5) Resulted from the recognition of certain federal and state loss carryover
benefits from a prior business combination.
(6) Resulted primarily from the utilization of capital loss carryforwards.
93
EXHIBIT 11.1
HORIZON/CMS HEALTHCARE CORPORATION
STATEMENT RE COMPUTATION OF PER SHARE EARNINGS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED MAY 31,
--------------------------------------
1997 1996 1995
----------- ------------ ---------
<S> <C> <C> <C>
COMMON AND COMMON EQUIVALENTS:
Earnings (loss) before extraordinary item ......... $(22,061) $ 8,674 $23,357
Extraordinary item, net of tax ..................... (13,858) (31,328) 2,571
--------- --------- --------
Net earnings (loss) ................................. $(35,919) $ (22,654) $25,928
========= ========= ========
Applicable common shares:
Weighted average outstanding shares during the period 52,039 51,406 47,207
Weighted average shares issuable upon exercise of
common stock equivalents outstanding (principally
stock options and warrants using the treasury stock
method) .......................................... 230 642 643
--------- --------- --------
Total .......................................... 52,269 52,048 47,850
========= ========= ========
Earnings (loss) per share:
Earnings (loss) before extraordinary item ......... $ (0.42) $ 0.16 $ 0.49
Extraordinary item, net of tax ..................... (0.27) (0.60) 0.05
--------- --------- --------
Net earnings (loss) ................................. $ (0.69) $ (0.44) $ 0.54
========= ========= ========
ASSUMING FULL DILUTION:
Earnings (loss) before extraordinary item ......... $(22,061) $ 8,674 $23,357
Extraordinary item, net of tax ..................... (13,858) (31,328) 2,571
--------- --------- --------
Net earnings (loss) ................................. $(35,919) $ (22,654) $25,928
========= ========= ========
Applicable common shares:
Weighted average outstanding shares during the period 52,039 51,406 47,207
Weighted average shares issuable upon exercise of
common stock equivalents outstanding (principally
stock options and warrants using the treasury stock
method and convertible debentures) ............... 433 794 650
--------- --------- --------
Total .......................................... 52,472 52,200 47,857
========= ========= ========
Earnings (loss) per share:
Earnings (loss) before extraordinary item ......... $ (0.42) $ 0.16 $ 0.49
Extraordinary item, net of tax ..................... (0.27) (0.60) 0.05
--------- --------- --------
Net earnings (loss) ................................. $ (0.69) $ (0.44) $ 0.54
========= ========= ========
</TABLE>
94
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation
of our report included in this Form 10-K, into the Company's previously filed
Registration Statements File No. 33-61697, File No. 33-63199, File No. 33-80660
and File No. 33-84502.
/s/ ARTHUR ANDERSEN LLP
----------------------
ARTHUR ANDERSEN LLP
Albuquerque, New Mexico
August 27, 1997
EXHIBIT 23.2
CONSENT OF INDEPENDENT AUDITORS
We hereby consent to the inclusion in this Annual Report on Form 10-K and
the further incorporation by reference into the Registration Statements on Form
S-3 (Registration No. 33-80660), Form S-8 (Registration No. 33-84502). Form S-8
(Registration No. 33-61697), and Form S-8 (Registration No. 33-63199) of
Horizon/CMS Healthcare Corporation of our report dated August 3, 1995, except
for Note 6 and Note 19 for which the date is September 26, 1995; Note 14 for
which the date is September 12, 1995; and Note 20 for which the date is
September 27, 1995, with respect to the consolidated financial statements and
schedule of Continental Medical Systems, Inc. for the year ended June 30, 1995.
/s/ ERNST & YOUNG LLP
--------------------
ERNST & YOUNG LLP
Harrisburg, Pennsylvania
August 27, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the Form
10-K for the year ended May 31, 1997 and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> US DOLLARS
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAY-31-1997
<PERIOD-START> JUN-01-1996
<PERIOD-END> MAY-31-1997
<EXCHANGE-RATE> 1
<CASH> 44,287
<SECURITIES> 0
<RECEIVABLES> 384,395
<ALLOWANCES> (50,242)
<INVENTORY> 0
<CURRENT-ASSETS> 502,016
<PP&E> 769,771
<DEPRECIATION> (143,101)
<TOTAL-ASSETS> 1,606,381
<CURRENT-LIABILITIES> 212,279
<BONDS> 732,657
0
0
<COMMON> 53
<OTHER-SE> 620,436
<TOTAL-LIABILITY-AND-EQUITY> 1,606,381
<SALES> 0
<TOTAL-REVENUES> 1,799,824
<CGS> 0
<TOTAL-COSTS> 1,815,331
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 27,552
<INTEREST-EXPENSE> 53,539
<INCOME-PRETAX> (22,882)
<INCOME-TAX> (821)
<INCOME-CONTINUING> (22,061)
<DISCONTINUED> 0
<EXTRAORDINARY> (13,858)
<CHANGES> 0
<NET-INCOME> (35,919)
<EPS-PRIMARY> (0.69)
<EPS-DILUTED> (0.69)
</TABLE>
