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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A
AMENDMENT No. 1
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
FOR THE FISCAL YEAR ENDED MAY 31, 1996
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM -------- TO --------
COMMISSION FILE NO. 1-9369
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HORIZON/CMS HEALTHCARE CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 91-1346899
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6001 INDIAN SCHOOL ROAD, N.E.,
ALBUQUERQUE, NM
(Address of principal 87110
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
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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 SK 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 2, 1996, the registrant had 52,126,842 shares of Common Stock
outstanding. The aggregate market value on July 31, 1996 of the registrant's
Common Stock held by nonaffiliates of the registrant was $495,195,587 (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 on September 10, 1996 are incorporated
into Part III of this Form 10-K.
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<PAGE>
Items 1,2,3,6,7,8 and 14 of Horizon/CMS Healthcare Corporation's Annual
Report on Form 10-K for the year ended May 31, 1996 is hereby amended and
restated as set forth below.
TABLE OF CONTENTS
<TABLE>
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PAGE
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<S> <C>
Item 1. Business .................................................................. 1
Item 2. Properties ................................................................ 31
Item 3. Legal Proceedings.......................................................... 31
Item 6. Selected Financial Data ................................................... 36
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................. 38
Item 8. Financial Statements and Supplementary Data................................ 47
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K .......... 93
Signatures.......................................................................... 102
</TABLE>
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PART I
ITEM 1. BUSINESS
GENERAL OVERVIEW
The Company is a leading provider of post-acute health care services,
including specialty health care services and long-term care services,
principally in the Midwest, Southwest, Northeast and Southeast regions of the
United States. At May 31, 1996, Horizon provided specialty health care services
through 37 acute rehabilitation hospitals in 16 states (2,065 beds), 58
specialty hospitals and subacute care units in 17 states (1,925 beds), 186
outpatient rehabilitation clinics in 22 states and 1,942 rehabilitation therapy
contracts in 36 states. At that date, Horizon provided long-term care services
through 120 owned or leased facilities (14,957 beds) and 142 managed facilities
(15,894 beds) in a total of 18 states. Other medical services offered by the
Company include pharmacy, laboratory, physician placement services, Alzheimer's
care, physician management, non-invasive medical diagnostic, home respiratory,
home infusion therapy and hospice care. For the year ended May 31, 1996, the
Company derived 49% of its revenues from private sources, 33% from Medicare and
18% from Medicaid.
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. Post-acute
care services that the Company provides include: (a) inpatient and outpatient
rehabilitative services; (b) subacute care; (c) long-term care; (d) contract
rehabilitation therapy services; (e) home health care services; (f) pharmacy and
related services; (g) clinical laboratory services; (h) physician placement
services, (i) non-invasive medical diagnostic services; (j) home respiratory
supplies and services; (k) home infusion supplies and services; (l) hospice care
and (m) assisted living care. Horizon'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.
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
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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 40%, 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
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 has implemented and continues to implement a strategy
of extending the continuum of services offered by the Company beyond
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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 intends to continue to use 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 to provide its services to the increasing number of patients who
continue to require rehabilitation, subacute care, long-term care or home
healthcare after being discharged from 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's integrated post-acute care delivery system
now also includes the provision of a wide array of home health care services.
Horizon 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. As a result, the
Company has experienced and expects to continue to experience increased patient
volumes in, and revenues derived from, its various business lines. The Company
intends to diversify further the specialty services it offers. Specifically,
during fiscal 1996, the Company began acquiring physician practices in Florida
to complement the services offered by the Company's contract therapy and
outpatient rehabilitation clinic businesses. In addition, the Company further
diversified the specialty services it offers with its acquisition in July 1996
of Medical Innovations, Inc., a home health care company providing home health
care services in Texas, Nevada, Florida and Virginia. In addition, at the end of
fiscal 1996, Horizon announced the creation of its assisted living initiative as
a part of its long-term care division. At the same time, the Company continues
to assess the roles these various 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
intends to cross-sell the variety of services provided by its business units.
The Company has begun to market aggressively its pharmacy services, various
therapies and other medical services to its existing and newly acquired
operations. 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.
CONCENTRATING OPERATIONS IN TARGETED GEOGRAPHIC AREAS
To realize operating efficiencies, economies of scale and growth
opportunities, Horizon intends to continue to concentrate its operations in
clusters of operating units in selected geographic areas. In effecting this
concentration of operations, the Company continues to assess and identify those
assets, services
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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 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.
DEVELOPING REHABILITATION NETWORKS
Horizon intends to develop rehabilitation networks by concentrating its
outpatient rehabilitation clinics in geographic locations where regional
coverage, combined with the ability to provide multiple services in concert with
existing acute rehabilitation, subacute and long-term care facilities, will
strengthen its position with managed care payors. The Company believes that
these networks better enable it to provide a more complete continuum of care and
also establish the Company as a provider of choice for the region or locality.
By concentrating its rehabilitation facilities, the Company expects to be better
able to negotiate comprehensive rehabilitation contracts and leverage the
clinical expertise in an individual market.
EXPANDING THROUGH ACQUISITIONS
Horizon intends to continue to expand its operations through the acquisition
in select geographic areas of long-term care facilities and providers of
specialty health care services. Management believes that such acquisitions
provide opportunities to realize operating efficiencies, particularly through
(a) margin improvements from enhanced utilization of rehabilitation therapies
and other specialty medical services; (b) the expansion of Horizon's
institutional pharmacy services into new facilities and new markets; (c) the
consolidation of corporate overhead; (d) the potential to increase business by
providing a full range of care to managed care providers who desire "one stop
shopping;" (e) the ability to increase capacity and margins by offering higher
margin and higher acuity services to patients in Company owned or operated
subacute and long-term care facilities; (f) the potential to increase patient
volume by expanding the continuum of care of each acquired entity on a
stand-alone basis; and (g) the potential for improved buying power with respect
to suppliers.
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SERVICES
The following table summarizes revenues for each of the Company's business
units for the periods indicated (As Restated):
<TABLE>
<CAPTION>
FISCAL YEARS ENDED MAY 31,
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1996 1995 1994
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(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
Acute Rehabilitation..... $ 449 25.6% $ 404 24.9% $ 434 31.4%
Subacute Care............ 216 12.3 195 12.0 84 6.1
Long-Term Care........... 384 21.8 340 21.0 225 16.3
Contract
Rehabilitation.......... 392 22.3 395 24.3 384 27.8
Outpatient
Rehabilitation.......... 97 5.5 93 5.7 88 6.4
Institutional Pharmacy
Services................ 45 2.6 39 2.4 27 2.0
Alzheimer's Care......... 25 1.4 21 1.3 18 1.3
Other Services........... 119 6.8 121 7.5 111 8.0
Other Operating
Revenue................. 30 1.7 15 0.9 10 0.7
--------- ----- --------- ----- --------- -----
Total.................. $ 1,757 100% $ 1,623 100.0% $ 1,381 100.0%
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</TABLE>
SPECIALTY HEALTH CARE
Horizon provides a variety of specialty health care services, including
acute rehabilitation, subacute care, rehabilitation therapies (occupational,
speech and physical therapies in both inpatient and outpatient settings) and
treatment of traumatic head injury and other neurological impairments,
institutional pharmacy services, home health care services, physician placement
services, Alzheimer's care, ownership of physician practices and practice
management services, non-invasive medical diagnostic testing services, home
respiratory care services and supplies, and clinical laboratory services.
Horizon believes that providing a broad range of specialty health care services
and programs enables the Company to attract patients with more complex health
care needs. In addition, these services typically generate higher profit margins
than long-term care patient services.
ACUTE REHABILITATION. At May 31, 1996, Horizon operated 37 freestanding
comprehensive acute rehabilitation hospitals with a total of 2,065 licensed
acute rehabilitation beds located in 16 states. Generally, these hospitals are
located in the same geographic area as Horizon's long-term care or subacute care
facilities (including specialty hospitals) and therefore benefit from referrals
from such facilities. Many of Horizon's rehabilitation hospitals are operated
through joint ventures with local general acute care hospitals, physicians and
other investors. Horizon's rehabilitation unit management group operates
inpatient and outpatient rehabilitation programs within acute care hospitals. At
May 31, 1996, the Company managed 12 rehabilitation units with more than 252
beds in such acute care hospitals. In addition, the Company's freestanding
rehabilitation hospitals typically provide on-site outpatient services.
SUBACUTE CARE. Horizon provides subacute care to high acuity patients with
medically complex conditions who require ongoing, multi-disciplinary
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nursing and medical supervision and access to specialized equipment and services
but who do not require many of the other services provided by an acute care
hospital. Horizon's subacute care services include dedicated programs for
rehabilitative ventilator care, wound management, general rehabilitation, head
trauma/coma stimulation and infusion therapy. The Company's subacute care
services are provided through both its specialty hospitals and its subacute care
units. Generally, these specialty hospitals and subacute care units are located
in separate areas within the physical structures of the Company's long-term care
facilities and are supervised by separate nursing staffs employed by the
Company. As of May 31, 1996, the Company operated 58 specialty hospitals and
subacute care units, including one standalone specialty hospital, with 1,925
beds in 17 states. Horizon believes that private insurance companies and other
third party payors, including certain state Medicaid programs, recognize that
treating patients requiring subacute care in specialty units such as those
operated by Horizon is a cost effective alternative to treatment in acute care
hospitals. Horizon believes that it can continue to offer subacute care at rates
substantially below those typically charged by acute care hospitals for
comparable services.
The Company's specialty hospitals are operated under specialty hospital
licenses that permit the Company to provide higher acuity services and, as a
consequence, to receive higher reimbursement rates than subacute care units
which are operated under long-term care facility licenses. It is Horizon's
belief that such specialty hospital licenses enhance its marketing efforts to
referral sources such as physicians, managed care providers and hospital
discharge planners. Once a specialty hospital license has been obtained, the
beds so licensed generally can no longer be used for patients who require only
basic patient care.
Horizon is a party to a number of contracts with commercial insurers and
managed care providers and out-of-state enhanced rate Medicaid provider
agreements. Horizon believes that these relationships will enable it to improve
its reimbursement rates and profit margins.
CONTRACT REHABILITATION THERAPIES. Horizon 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, 1996, Horizon provided these services through approximately 1,942 contracts
in 36 states, 181 of which are with Company-operated long-term care facilities,
specialty hospitals and subacute facilities, and 1,761 of which are with third
party long-term care facilities, home health agencies, hospitals, outpatient
clinics or school systems. Horizon is currently one of the nation's leading
providers of these services.
OUTPATIENT REHABILITATION. The Company provides rehabilitation therapies to
ambulatory patients recovering from industrial injuries, sports-related injuries
and other general orthopedic conditions. Horizon'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. These services are provided
in freestanding outpatient facilities and ambulatory outpatient clinics within
institutional settings, as well as by a staff of fully-trained professionals
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who rehabilitate patients in their own homes. As of May 31, 1996, Horizon
provided outpatient services through 186 outpatient rehabilitation clinics in 22
states.
INSTITUTIONAL PHARMACY. Horizon has established a network of 35 regionally
located pharmacies in 14 states through which it provides a full range of
prescription drugs and infusion therapy services, such as antibiotic therapy,
pain management and chemotherapy, to approximately 43,000 beds in facilities
operated by Horizon and by third parties. These pharmacy operations (certain of
which are managed by third parties) enable Horizon to generate revenues from
services previously provided to Horizon by third-party pharmacy vendors. Of the
total beds serviced by Horizon's institutional pharmacies, 23,750 are located in
facilities not operated by Horizon.
ALZHEIMER'S CARE. Horizon offers a specialized program for persons with
Alzheimer's disease through its Alzheimer's centers. At May 31, 1996, this
program had been instituted at 25 of Horizon's long-term care facilities, with a
total of 816 beds. Each Alzheimer's center is located in a designated wing of a
long-term care facility and is designed 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. Each
Alzheimer's center employs a specially trained nursing staff and an activities
director and engages a medical director with expertise in the treatment of
Alzheimer's disease. The program also provides education and support to the
patient's family.
LONG-TERM CARE
Horizon'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. Such 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, 1996, Horizon operated 262 long-term care
facilities (30,851 beds), of which 44 were owned (5,271 beds) and 76 were leased
(9,686 beds), and also managed 142 long-term care facilities (15,894 beds),
located in a total of 18 states.
OTHER SPECIALTY HEALTH CARE
PHYSICIAN PLACEMENT SERVICES. Horizon provides physician placement services
("locum tenens") to institutional providers and physician practice groups
throughout the United States. The Company recruits, credentials and places
health care providers in appropriate short-term, long-term or permanent
positions in most physician and allied health care specialties. The Company also
provides credentialing assistance, recruitment outsourcing, staff planning
services and educational programs for physicians and health care executives.
HOME HEALTH CARE. During fiscal 1996, the Company began providing home
health care services. In July 1996, the Company acquired Medical Innovations,
Inc., a provider of home health care services in Nevada, Texas, Florida and
Virginia. As a result of this acquisition, the Company has substantially
expanded its presence in the home health care industry. Thus, the home health
services the Company now provides include specialized home nursing services,
outpatient
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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.
NON-INVASIVE MEDICAL DIAGNOSTICS AND PORTABLE X-RAY SERVICES. Horizon
provides non-invasive medical diagnostic testing services by way of mobile units
and fixed location operations (generally in acute care hospitals) through a
network of physicians and surgeons. These services include cardiovascular (both
cardiac imaging and vascular imaging), pelvic and abdominal testing services and
sleep diagnostic services. Horizon continues to expand its diagnostic expertise
and the diagnostic markets it serves through acquisitions. During fiscal 1996,
Horizon began providing portable x-ray services to patients in both the hospital
and the skilled nursing facility settings. Horizon provides these services in
Nevada, Texas, New Mexico and Oklahoma.
PHYSICIAN PRACTICES AND PHYSICIAN PRACTICE MANAGEMENT. During fiscal 1994,
Horizon began providing physician practice management services through CMS'
acquisition of Medical Management Associates, in California. In fiscal 1996, as
a complement to its outpatient rehabilitative services in Florida, Horizon
acquired two orthopedic physician practices in Florida and developed a
Florida-based physician practice management company.
CLINICAL LABORATORY SERVICES. Horizon 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. This laboratory has all necessary
state regulatory approvals to conduct business in the states in which Horizon
currently operates and is certified to receive reimbursement for charges to
patients covered by Medicare and Medicaid. At May 31, 1996, the laboratory
provided services to approximately 10,700 beds.
HOME RESPIRATORY; HOME INFUSION. The Company provides home respiratory care
services and supplies to home care patients in Texas, Oklahoma, Arkansas,
Louisiana, Tennessee and Kentucky through a physician referral base. The Company
employs a fully-trained nursing staff to perform these services, which include
the provision of home infusion and intravenous therapies. Supplies provided by
the Company include gas and liquid oxygen cylinders, oxygen concentrators and
aerosol nebulizers.
HOSPICE CARE. Commencing in fiscal 1996, the Company began providing hospice
care in Texas to home-bound and institutionalized, terminally ill patients.
Hospice care includes the provision of all durable medical equipment,
intravenous therapies and pharmaceuticals incident to such care.
ORGANIZATION
The Company's operations are organized principally according to the services
provided. It is an objective of the Company 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. These managers are
supported by a broad range of support services supplied by the Company's
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corporate and regional staffs. 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.
SPECIALTY HEALTH CARE OPERATIONS
The Company's specialty health care operations are organized as follows:
ACUTE REHABILITATION. The Company's acute rehabilitation business is
supervised by a divisional president and is organized into three regions each
supervised by a regional president. Acute rehabilitation services are provided
in freestanding comprehensive rehabilitation hospitals and provide care in the
form of physical, psychological, 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.
SUBACUTE CARE. The Company's 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/or 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.
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.
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
several freestanding outpatient clinics. Throughout fiscal 1996, the Company has
acquired freestanding outpatient clinics. 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
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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.
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 prepare and provide enteral and
parenteral supplies as ordered in addition to all legally required
pharmaceutical consulting services. These operations are supervised by a vice
president of pharmacy services. In addition, the regional managers recruit,
hire, train and supervise the pharmacists employed by the Company.
LONG-TERM CARE OPERATIONS
The Company's long-term care facilities (including its Alzheimer's centers)
are organized into four regions, each of which is supervised by a vice president
of operations. For every six to twelve centers within each region, a district
director, quality assurance nurse 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 services works with a district director
of clinical services who 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 clinicial 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.
OTHER SPECIALTY HEALTH CARE OPERATIONS
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.
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 are supervised by a regional manager
who oversees seven to eight home health agencies. These regional managers report
to a clincial 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.
NON-INVASIVE MEDICAL DIAGNOSTICS. The Company's non-invasive medical
diagnostic business is headquartered in Albuquerque, New Mexico and is divided
into several geographic regions. Each of these regions is supervised by a
regional
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supervisor, who recruits, hires, trains and supervises diagnostic technicians
who work either in the Company's hospital-based operations or in the Company's
mobile units. The Company also operates one of the largest physician training
programs in the medical diagnostic industry.
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.
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.
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.
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 which 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.
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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.
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 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 constantly enhance the
services it provides to its customers by applying the principles of total
quality management and continuous quality improvement ("TQM/CQI"). Finally, the
Company has a clincial 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.
Under the Company's institutional pharmacy services program, the services
provided by the pharmacy are evaluated semi-annually by a survey instrument
completed by the director of nursing of each client facility. These survey
instruments 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 effectively deal with
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<PAGE>
any negative variances to the standard which are indicated by the survey
instrument. These action plans and the individual survey instruments are
reviewed by corporate pharmacy management for issues dealing with specific
clients, pharmacies, and/or services.
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.
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 credentialling;
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 credentialling policies and procedures for
each medical specialty on an ongoing basis, training personnel, and supporting
practitioners in the field.
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 chart audits,
pharmacy surveys, patient interviews and customer questionaires. 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.
Under the Company's other specialty health care programs, the Company has
established comprehensive 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.
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<PAGE>
FACILITIES
At May 31, 1996, the Company operated (a) 37 acute rehabilitation hospitals,
of which 18 were owned (either directly or through joint venture arrangements)
and the balance were leased; (b) 11 specialty hospitals; (c) 47 subacute care
units; (d) 262 long-term care facilities including 142 which were operated by
the Company under management contracts and 120 which were owned or leased; (e)
186 outpatient rehabilitation units; and (f) 35 pharmacy units. Certain
information regarding the these facilities is provided in the following tables:
<TABLE>
<CAPTION>
ACUTE
REHABILITATION SPECIALTY OUTPATIENT
HOSPITALS HOSPITALS SUBACUTE LONG-TERM CARE REHABILITATION PHARMACY
------------- ------------ ------------- -------------- CLINICS --------
STATE UNITS BEDS UNITS BEDS UNITS BEDS UNITS BEDS UNITS UNITS
- ---------------------------------- ----- ----- ----- ---- ----- ----- ----- ------ -------------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Arizona........................... 1 45 -- -- 1 15 -- -- 4 2
Arkansas.......................... 3 162 -- -- 2 18 -- -- 8 --
California........................ 5 226 -- -- 6 217 1 34 9 1
Colorado.......................... 1 38 -- -- 1 26 2 304 11 --
Connecticut(1).................... -- -- -- -- -- -- 3 585 -- 1
Florida(2)........................ 1 60 -- -- 3 74 9 1,014 20 --
Idaho............................. -- -- -- -- -- -- 2 224 -- --
Illinois.......................... -- -- -- -- -- -- -- -- 1 --
Indiana........................... 3 137 -- -- 3 39 -- -- 4 1
Kansas............................ 3 177 2 54 3 47 5 514 8 --
Kentucky.......................... 1 40 -- -- -- -- -- -- 1 --
Louisiana......................... 4 234 -- -- 4 151 -- -- 11 --
Maryland.......................... 1 20 -- -- -- -- 1 160 2 --
Massachusetts..................... 1 187 -- -- 6 631 4 481 34 1
Michigan(3)....................... -- -- -- -- 3 66 15 1,868 13 1
Missouri.......................... -- -- -- -- -- -- -- -- 1 --
Montana........................... -- -- -- -- -- -- 5 684 1 1
Nevada............................ 2 124 1 27 1 12 11 1,506 3 4
New Mexico(4)..................... -- -- 1 25 -- -- 26 2,451 -- 3
North Carolina.................... -- -- -- -- 1 72 1 53 -- --
Ohio.............................. -- -- -- -- 3 32 18 1,997 -- 1
Oklahoma(5)....................... 1 46 1 43 2 18 16 1,685 1 2
Pennsylvania...................... -- -- -- -- 1 52 1 88 1 --
Rhode Island...................... 1 82 -- -- -- -- -- -- -- 1
Tennessee......................... 2 128 -- -- -- -- -- -- 3 1
Texas(6).......................... 7 359 6 219 7 87 139 16,828 22 15
Virginia.......................... -- -- -- -- -- -- -- -- 1 --
Washington........................ -- -- -- -- -- -- -- -- 27 --
Wisconsin......................... -- -- -- -- -- -- 3 375 -- --
----- ----- ----- --- ----- ----- ----- ------ ---- -----
Totals.......................... 37 2,065 11 368 47 1,557 262 30,851 186 35
----- ----- ----- --- ----- ----- ----- ------ ---- -----
</TABLE>
14
<PAGE>
<TABLE>
<CAPTION>
ACUTE REHABILITATION LONG-TERM CARE/ LONG-TERM CARE/
SPECIALTY HOSPITALS SUBACUTE OCCUPANCY(7) SUBACUTE OCCUPANCY(7)
HOSPITALS OCCUPANCY(7) OCCUPANCY(7) LEASED/OWNED MANAGED
---------------------- ---------------------- ---------------------- ----------------------
STATE 1996 1995 1996 1995 1996 1995 1996 1995
- ----------------------------- ----- ----- ----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Arizona...................... 43% 49% --% --% --% --% --% --%
Arkansas..................... 89 87 -- -- -- -- -- --
California................... 50 54 -- -- 61 68 -- --
Colorado..................... 71 65 -- -- 96 97 -- --
Connecticut(1)............... -- -- -- -- -- -- 92 97
Florida(2)................... 87 90 -- -- 91 93 91 95
Idaho........................ -- -- -- -- 88 -- -- --
Illinois..................... -- -- -- -- -- -- -- --
Indiana...................... 54 49 -- -- -- -- -- --
Kansas....................... 59 57 53 61 91 78 -- --
Kentucky..................... 74 71 -- -- -- -- -- --
Louisiana.................... 74 77 -- -- 85 85 -- --
Maryland..................... 82 73 -- -- 85 98 -- --
Massachusetts................ 92 94 -- -- 95 94 -- --
Michigan(3).................. -- -- -- -- 89 88 76 --
Missouri..................... -- -- -- -- -- -- -- --
Montana...................... -- -- -- -- 93 91 -- --
Nevada....................... 82 80 61 84 94 93 -- --
New Mexico(4)................ -- -- 46 57 91 88 76 86
North Carolina............... -- -- -- -- 96 95 -- --
Ohio......................... -- -- -- -- 87 89 -- --
Oklahoma(5).................. 60 51 85 83 95 91 56 85
Pennsylvania................. -- -- -- -- 89 96 -- --
Rhode Island................. -- -- -- -- -- -- -- --
Tennessee.................... 58 54 -- -- -- -- -- --
Texas(6)..................... 79 75 48 49 88 84 57 88
Virginia..................... -- -- -- -- -- -- -- --
Wisconsin.................... -- -- -- -- 81 82 -- --
----- ----- ----- ----- ----- ----- ----- -----
Totals..................... 72% 70% 54% 59% 90% 88% 62%(8) 94%
----- ----- ----- ----- ----- ----- ----- -----
</TABLE>
- ----------------------------------
(1) Consists of three long-term care facilities operating 585 beds managed by
the Company.
(2) Includes seven long-term care facilities and one subacute care unit
operating 786 beds and 24 beds, respectively, managed by the Company.
(3) Includes eight long-term care facilities operating 946 beds managed by the
Company.
(4) Includes one long-term care facility operating 120 beds managed by the
Company.
(5) Includes 13 long-term care facilities operating 1,351 beds managed by the
Company.
(6) Includes 110 long-term care facilities operating 12,106 beds managed by the
Company.
(7) 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, 1996 or 1995, as appropriate.
(8) 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%.
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 from individuals who pay
directly for services without government assistance as private pay revenues. The
private pay classification includes revenues from sources such as commercial
insurers and health maintenance organizations. The Company bills private pay
patients and rehabilitation therapy customers (or their insurers or health
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<PAGE>
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. However, under certain of the Company's
specialty health care businesses, 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 (As Restated):
<TABLE>
<CAPTION>
FISCAL YEARS ENDED MAY 31,
----------------------------------------------------------------------------------
1996 1995 1994
------------- ------------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Private pay...... $ 862,458 49% $ 881,453 55% $ 714,093 52%
Medicare......... 582,899 33 458,131 28 474,113 34
Medicaid......... 311,177 18 283,074 17 193,174 14
------------- --- ------------- --- ------------- ---
Total........ $ 1,756,534 100% $ 1,622,658 100% $ 1,381,380 100%
------------- --- ------------- --- ------------- ---
</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
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<PAGE>
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.
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.
A key element of the Company's strategy is to expand through the acquisition
of long-term care facilities and specialty medical and related businesses. In
making such acquisitions, the Company competes with other providers, some of
which may have greater financial resources than the Company. Certain of these
providers are operated by not-for-profit organizations and similar businesses
that can finance capital expenditures on a tax-exempt basis or receive
charitable contributions unavailable to the Company. There can be no assurance
that suitable facilities can be located, that acquisitions can be consummated or
that acquired facilities can be integrated successfully into the Company's
operations. See "-- Acquisitions and Expansion."
EMPLOYEES
As of May 31, 1996, the Company employed approximately 38,500 persons, and
approximately 2,400 or 6.2% of the Company's employees were covered by
collective bargaining contracts. Of the 35 collective bargaining contracts
covering the Company's employees, ten will expire in calendar year 1997, nine
will expire in calendar year 1998 and 16 will expire in calendar year 1999. The
Company believes it has had good relationships with the unions which represent
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<PAGE>
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 AND EXPANSION
Since its inception in 1986, Horizon 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
acquisition of Medical Innovations, Inc., (ii) the acquisition of or agreements
to manage long-term care facilities including Greenery Rehabilitation Group,
Inc. ("Greenery"), the peopleCARE Heritage Group ("peopleCARE") and the HEA
Group, (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 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 Horizon's results of operations. In addition, the ability
of Horizon 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 1996, 1995 and 1994, Horizon derived approximately 33%, 28%
and 34%, respectively, of its revenues from Medicare, and 18%, 17% and 14%,
respectively, of its revenues from Medicaid (excluding certain out-of-state
Medicaid revenues). Changes in the mix of patients among different types of
private pay sources and among private pay sources, Medicare and Medicaid can
significantly affect the revenues and profitability of Horizon's operations.
Moreover, there are increasing pressures from many payor sources to control
health-care costs and to limit increases in reimbursement rates for medical
services. There can be no assurance that payments under governmental and third
party payor programs will remain at levels comparable to present levels or that
Horizon 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 expects that there will continue to be, a number of
proposals to limit Medicaid reimbursement for certain services. Horizon 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.
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<PAGE>
MEDICAID AND MEDICARE
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
United States Department of Health and Human Services (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.
However, many state Medicaid programs 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.
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. Medicare reimbursement for services
rendered to Medicare patients will generally cover the costs incurred by the
Company in delivering such services. There can be no assurance, however, that
Medicare reimbursement will be sufficient to cover actual costs incurred by the
Company with respect to Medicare services rendered.
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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 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 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 the HCFA have been held concerning the
merits of the HCFA memorandum. In light of the fluid nature of the HCFA
memorandum, the Company cannot predict what effect, if any, the HCFA memorandum
will have on the Company or if the rates suggested in the HCFA memorandum will
continue to be recommended by the HCFA. Additionally, the Company cannot
determine at this time whether the rates suggested in the HCFA memorandum would
be used by the HCFA as a basis for developing possible future regulations
creating a salary equivalency based reimbursement system for speech and
occupational therapy services. Although management of the Company has developed
strategies to deal with potential future 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.
20
<PAGE>
REGULATION
The federal government and all states in which the Company operates regulate
various aspects of the Company's business. The Company's 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, long-term care facilities are subject to
various local building codes and other ordinances, with which the Company
believes it is in compliance.
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 care facilities are
either accredited by, or are in the process of obtaining accreditation by, the
Joint Commission on Accreditation of Healthcare Organizations. 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 depend 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 or "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 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.
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
21
<PAGE>
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 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 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 cases during fiscal 1996, 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,
subsequent to the end of fiscal 1996, one of the Company's specialty hospitals
was decertified for participation in the Medicare program. The Company has
appealed this determination but cannot now predict the outcome of such appeal.
In addition, to date none of the Company's facilities has had its license
revoked.
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<PAGE>
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.
Further, individuals or entities and their affiliates may be excluded from the
Medicaid and Medicare programs under certain circumstances including, but not
limited to, 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. Further,
the provider could also be excluded from the Medicaid and Medicare programs. 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.
Additionally, the federal Medicare/Medicaid Anti-Fraud and Abuse Amendments
to the Social Security Act (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 the
Medicare or Medicaid programs. 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, 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
prohibited by the statute. Because the regulations do not purport to
comprehensively describe all lawful or unlawful economic arrangements or other
relationships between health care providers and referral sources, hospitals and
other health care providers having these arrangements or relationships 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. On September 21,
1993, DHHS published proposed regulations for comment in the Federal Register
establishing additional Safe Harbors. As of August 13, 1996, such additional
regulations have not been adopted. The Company cannot predict the final form
these regulations will take or their effect, if any, on the Company's business.
Since the passage of the Safe Harbors in July 1991, a number of "Fraud Alerts"
have been distributed by DHHS setting forth certain practices that DHHS
considers suspect under the Anti-Kickback Law. Additionally, on July 21, 1995,
DHHS published a proposed rule aimed at clarifying the existing
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<PAGE>
Safe Harbors. As of August 13, 1996, such rule has not been adopted. The Company
cannot predict the final form such rule will take or its effect, if any, on the
Company's business.
In August 1993, President Clinton signed the Omnibus Budget Reconciliation
Act of 1993, which included certain amendments to Section 1877 of the SSA
dealing with "Physician Ownership of, and Referral to, Healthcare Entities,"
commonly known as the "Stark Bill." The amendments, referred to as 'Stark II,'
significantly broadened the scope of prohibited physician self-referrals
contained in the original Stark Bill, now commonly referred to as "Stark I," to
include, among others, referrals by physicians to entities with which the
physician has a financial relationship and that provide physical and
occupational therapy services that are reimbursable by Medicare or Medicaid.
Specifically, Stark II expanded the original Stark I anti-referral prohibition
from clinical laboratory services to a wide range of Medicare or Medicaid
covered services referred to as "designated services" including, but not limited
to, physical therapy, occupational therapy, radiology services, and inpatient
and outpatient hospital services, subject to certain statutory exceptions to
such referral prohibition. The type 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, and exclusion from the Medicare
and Medicaid programs. Stark II prohibits referrals by physicians and also
applies to financial relationships between family members of a physician and the
entities to which the physician refers.
Stark II became effective on December 31, 1994 and contemplated the
promulgation of regulations implementing the new provisions. As of August 13,
1996, no Stark II regulations have been published. In January 1995, the American
Hospital Association and eleven other healthcare organizations wrote to the HCFA
requesting a moratorium on Stark II sanctions until the date final regulations
are promulgated. In January 1995, the HCFA denied such moratorium request while
acknowledging the need for further advice and guidance regarding the Stark II
statute and distributing a Program Memorandum to intermediaries and carriers
setting forth general information and DHHS' enforcement plans for Stark II. Such
memorandum stated the HCFA's intention, pending final Stark II regulations, to
rely, for enforcement purposes, on the language of the Stark II statute.
Additionally, the HCFA set forth its intentions to publish a final rule for
comment in early 1995 covering Stark I and its plan to utilize such regulations,
once final, in enforcing Stark II in those cases where interpretations of the
law in the context of referrals for clinical lab services apply equally to
situations involving referrals for designated services in Stark II. On August
14, 1995, Stark I final regulations were published for comment. The Company
cannot predict the final form that such Stark I and/or Stark II 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 Law, Stark I, and Stark II
requirements and proscriptions. Both the Anti-Kickback Law and Stark II 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
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<PAGE>
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 II 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 II 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 II 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.
The Company is also subject to various antitrust regulations. On September
17, 1994 the Department of Justice (the "DOJ") and the Federal Trade Commission
(the "FTC") issued updated and expanded enforcement Policy Statements that
provide insight into how the agencies enforce the antitrust laws with regard to
joint ventures, networks and other joint activities in the health care industry.
The 1994 Policy Statements provide insight to the DOJ's and FTC's analytical
process regarding antitrust issues applicable to the health care industry and
provide new guidelines applicable to transactions resulting from changes the
health care industry is experiencing as hospitals explore new ways to cooperate
with each other to provide quality, cost-effective services.
On May 3, 1995 President Clinton announced the creation of "Operation
Restore Trust." A joint federal/state initiative, Operation Restore Trust as
initially developed was 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. On June 14, 1995, the Office of
Inspector General ("OIG") of DHHS announced that the program has been 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 dollars. According to DHHS statistics, the targeted states account
for nearly 40% of all Medicare and Medicaid beneficiaries. Under Operation
Restore Trust, the OIG and HCFA, along with the Administration on Aging, intend
to undertake a variety of activities to address fraud and abuse by nursing homes
and home health providers. These activities will include financial audits,
creation of a Fraud and Waste Report Hotline, and increased investigations and
enforcement activity.
On June 12, 1995 the OIG of DHHS announced implementation of the Voluntary
Disclosure Program (the "VDP") as part of Operation Restore Trust.
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Patterned after the disclosure program in place at the Department of Defense,
the program is being implemented in pilot form in the five targeted states under
Operation Restore Trust. It is intended to provide incentives for specified,
qualifying providers and suppliers to come forward and voluntarily disclose
instances of corporate wrongdoing affecting the Medicare and Medicaid programs.
DHHS intends eventually to expand the program although there is some dispute as
to whether the program will prove sufficient to elicit the desired disclosure.
The Company believes that its operations and practices comply with these
illegal remuneration and fraud and abuse provisions. If any of the Company's
financial practices failed to comply with the 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, 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. There can be no assurance that such
laws will ultimately be interpreted in a manner consistent with the Company's
practices.
As of May 31, 1996, 127 of the Company's leased, owned and managed long-term
care facilities were certified to receive benefits provided under Medicare as
skilled nursing facilities. As stated previously, to participate in the Medicare
program, a facility must be licensed and certified as a provider of skilled
nursing services. 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 August 1, 1996, virtually all of the Company's licensed
specialty hospitals are certified to participate in the Medicare program as
acute long-term care hospitals. Each of the Company's acute rehabilitation
hospitals is certified to participate in the Medicare program as acute
rehabilitation hospitals. The Company's specialty hospitals and acute
rehabilitation hospitals endeavor to comply with the certification standards
enunciated previously.
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 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.
During fiscal 1996, various Congressional legislators introduced reform
proposals that are intended to control health care costs, improve access to
medical services for uninsured individuals and balance the federal budget by the
year 2002. Certain of these budgetary proposals have been passed by both Houses
of Congress, including passage of resultant committee bills. These proposals
include reduced rates of growth in the Medicare and Medicaid programs
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<PAGE>
and proposals to block grant funds to the states to administer the Medicaid
program. These proposals were included in the 1995 budget reconciliation act,
which the President of the United States has vetoed. In January 1996, the
President presented his own plan to balance the federal budget by 2002. From
time to time discussions have occurred between members of the House of
Representatives, members of the Senate and the President to devise a balanced
budget plan. While these proposals do not, at this time, appear to affect the
Company adversely, significant changes in reimbursement levels under Medicare or
Medicaid and changes in applicable governmental regulations could affect the
future results of operations of the Company. There can be no assurance that
future legislation, health care or budgetary, will not have an adverse effect on
the future results of operations of the Company.
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 and/or hospitals of the
Company and non-affiliated facilities and/or hospitals. Under these
arrangements, the Company's rehabilitation therapy and institutional pharmacy
subsidiaries bill and are paid by the facility and/or hospitals for the services
actually rendered and the details of billing the Medicare and Medicaid programs
are handled directly by the facility and/or hospitals. 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. However, the Company's institutional pharmacy business is
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.
INSURANCE
The Company maintains a variety of insurance coverages including, without
limitation, 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. Specifically, the Company maintains malpractice and public
liability insurance coverage. In this regard, the Company's self-insured
retention is $1.0 million and $.25 million per occurrence per policy year,
respectively, and $3.0 million and $1.95 million in the aggregate, respectively.
In addition, the Company maintains umbrella malpractice and public liability
insurance coverage of $30.0 million per occurrence and in the aggregate.
The Company further maintains, in respect of its physician placement
services division, separate malpractice insurance coverage. In this case, the
Company's self-insured retention is $1.0 million per occurrence per policy year
and $6.0 million in the aggregate. In addition, the Company maintains umbrella
malpractice insurance coverage of $40.0 million per occurrence and in the
aggregate.
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<PAGE>
These policies, which are renewable by the carrier at the beginning of each
policy period, were most recently renewed on November 1, 1995 for the policy
period terminating on November 1, 1996. The Company believes that the insurance
coverage it maintains in this regard is adequate and customary in the industries
in which the Company does business. There can be no assurance, however, that
such insurance will be adequate to cover the Company's liabilities or that the
Company will be able to continue its present insurance coverage on terms
satisfactory to it, if at all.
The Company maintains property damage and destruction insurance coverage
with no material self-insured retention in respect of these policies. The
Company believes that the insurance coverage it maintains in this regard is
adequate and customary in respect of the properties owned and/or operated by the
Company and are in substantial compliance with property insurance requirements
imposed by landlords or mortgagees. There can be no assurance, however, that
such insurance will be adequate to cover the Company's liabilities or that the
Company will be able to continue its present insurance coverage on terms
satisfactory to it, if at all.
The Company is 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. However, there can
be no assurance that the Company will continue to have such resources available
to it or that substantial claims will not be made against the Company.
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 Litigation," 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. There can be no assurance, however, that such insurance will be
adequate to cover the Company's potential future liabilities in this regard or
that it will be able to continue its present coverage on terms satisfactory to
it, if at all.
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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 56 President, Chief Executive Officer and Chairman of the
Board
Michael A. Jeffries 46 Senior Vice President of Operations and Director
Charles H. Gonzales 40 Senior Vice President of Subsidiary Operations and
Director
Ernest A. Schofield 38 Senior Vice President, Treasurer, Chief Financial Officer
and Director
Scot Sauder 40 Vice President of Legal Affairs, Secretary and General
Counsel
Frank M. McCord 66 Director
Raymond N. Noveck 53 Director
Charles K. Bradford 62 Director
Maria Pappas 47 Director
Ronald N. Riner, M.D. 47 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.
Michael A. Jeffries, the Company's Senior Vice President of Operations, has
served the Company in such position since June 1989. He became a Director of the
Company in January 1992. Mr. Jeffries has 15 years of experience in the
long-term health care industry. From 1984 to 1989, he served as Senior Vice
President of Operations for the Central Division of Beverly Enterprises, Inc.,
an operator of long-term health care facilities. From 1983 to 1984, Mr.
Jeffries, a certified public accountant, held the positions of Vice President of
Operations and Assistant to the President of Beverly Enterprises, Inc.
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.
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<PAGE>
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).
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
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<PAGE>
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.
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. ("CMS")
As previously disclosed by both CMS and the Company, in late fall 1994, CMS
learned of the 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.
The Company has been 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 will not commence any civil or criminal
action or proceeding against the Company in respect of this investigation. The
Company has also been informed that both the criminal and civil divisions of the
United States Attorney's office in Harrisburg, Pennsylvania are closing their
investigation in this regard and they will not commence any civil or criminal
action or proceeding against the Company in respect of this investigation.
LITIGATION AGAINST TENET HEALTHCARE CORPORATION
The Company 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 the Company
and Tenet in connection with the Company's attempted acquisition of Hillhaven in
January 1995. In the lawsuit, the Company alleges that Tenet has failed to honor
its commitment to pay Horizon approximately $14.5 million pursuant to the
agreement. Tenet has contended that the amount owing to the Company under the
agreement is approximately $5.1 million. In the quarter ended November 30, 1995,
the Company recognized as a receivable approximately $13.0 million of the
approximately $14.5 million the Company contends
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<PAGE>
it is owed under the agreement. While the Company intends to vigorously
prosecute this lawsuit, no assurance can be given that the Company will prevail
or that the Company will not be required at a future date to record a charge for
a portion of the receivable previously recorded.
OIG/DOJ INVESTIGATION INVOLVING CERTAIN MEDICARE PART B AND RELATED
CO-INSURANCE BILLINGS
The Company announced on March 15, 1996 that certain Medicare Part B and
related co-insurance billings previously submitted by the Company are being
investigated by the OIG and the DOJ. These billings, totaling approximately $3.4
million, sought recovery for the costs of certain Medicare Part B covered
medical supplies used in treating Medicare patients in certain facilities at a
time when those facilities were operated by Greenery before the Company acquired
Greenery. These costs were not billed at the time incurred but were billed on a
retroactive basis, as permitted under applicable Medicare Part B rules, after
the Greenery acquisition. Of the $3.4 million billed, approximately $1.3 million
has been remitted to the Company.
The Company has advised the OIG that it appears that a significant portion
of the billings may not have been supportable under applicable Medicare Part B
rules. The Company advised the OIG and the DOJ that it was cooperating, and will
continue to cooperate, in the investigation and was prepared to remit any
overpayment to the appropriate governmental authority. On April 2, 1996, the
Company and DOJ entered into a letter agreement pursuant to which the Company
voluntarily agreed to refund such overpayment to the DOJ. On April 3, 1996, the
Company refunded approximately $1 million to the DOJ. In addition, the Company
voluntarily refunded co-insurance payments to the applicable parties. The
Company believes the errors in these billings were an exception and do not
represent a regular pattern or practice at the Company. Due to the preliminary
nature of the OIG/DOJ investigation, the Company cannot now predict when the
OIG/DOJ investigation will be completed; the ultimate outcome of the OIG/DOJ
investigation; or the effect thereof on the Company's financial condition or
results of operations. If as a result of the OIG/DOJ investigation, civil or
criminal proceedings against the Company are initiated and adversely determined,
civil and/or criminal fines or sanctions could be imposed against the Company,
which could have a material adverse impact on the Company's financial condition
and/or its results of operations.
SECURITIES AND EXCHANGE COMMISSION AND NEW YORK STOCK EXCHANGE
INVESTIGATIONS
The Company has been advised that the staff of the Division of Enforcement
of the Commission has commenced a private investigation with respect to trading
in the securities of the Company and CMS. In connection with that investigation,
the Company has voluntarily produced certain documents and Neal M. Elliott,
Chairman of the Board, President and Chief Executive Officer of the Company, has
voluntarily given testimony to the Commission. The Company has also been
informed that certain of its employees, executive officers and an individual,
affiliates of whom have limited business relationships with the Company, have
responded to subpoenas from the Commission. Mr. Elliott has also produced
certain documents in response to a subpoena from the Commission. In addition,
the Company and Mr. Elliott have responded to separate subpoenas from the
Commission pertaining to trading in the Company's common stock and
32
<PAGE>
the Company's March 1, 1996 press release announcing a revision in the Company's
third quarter earnings estimate, the Company'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 Rehabilitation and Sports
Medicine, Inc. could not be effected by April 1, 1996 and the Company's March
15, 1996 press release announcing the existence of a federal investigation into
certain of the Company's Medicare Part B billings. The investigation is ongoing,
and neither the Company nor Mr. Elliott possesses all the facts with respect to
the matters under investigation. Although neither the Company nor Mr. Elliott
has been advised by the Commission that the Commission has concluded that any of
the Company, Mr. Elliott or any other current or former officer or director of
the Company 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 the Company and Mr. Elliott intend to continue cooperating
fully with the Commission in connection with the investigation.
In March 1995, the New York Stock Exchange, Inc. (the "NYSE") informed the
Company that it had initiated a review of trading in Hillhaven common stock
prior to the announcement of the Company's proposed acquisition of Hillhaven.
The NYSE extended in April 1995 the review of trading to include all dealings
with CMS. On April 3, 1996, the NYSE notified the Company that it had initiated
a review of trading in the Company's Common Stock preceding the Company's March
1, 1996 press release described above. The Company is cooperating with the NYSE
in its reviews and, to the Company's knowledge, the reviews are ongoing.
STOCKHOLDER LITIGATION
On March 28, 1996, the Company 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 VS. 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 the Company
in its June 6, 1995 joint proxy statement/prospectus (the "CMS Prospectus"). The
plaintiff alleges that the Company failed to disclose in the CMS Prospectus
those problems in the Company's Medicare Part B billings the Company described
in its related March 15, 1996 announcement. In this action, the plaintiff seeks
damages in an unspecified amount, plus costs and attorneys' fees. The Company
disputes the factual and legal premises upon which the plaintiff's lawsuit is
based and denies that the plaintiff is entitled to any recovery on his claim. To
that end, the Company intends to contest this litigation vigorously. Subsequent
to the end of fiscal 1996, the Company filed its motion seeking to dismiss this
lawsuit because, among other things, the Company believes the lawsuit fails to
state a claim upon which the plaintiffs are entitled to redress. Because the
lawsuit just began, the Company cannot now predict the outcome of this
litigation; the length of time it will take to resolve this litigation; or the
effect of any such outcome on the Company's financial condition or results of
operations.
33
<PAGE>
Since April 5, 1996, the Company has been served with the below listed
complaints by current or former stockholders of the Company on behalf of all
persons who purchased common stock of the Company 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 these lawsuits,
the plaintiffs have alleged in substantially similar complaints violations of
federal and New Mexico state securities laws. In this connection, the plaintiffs
allege that during the class period, the named defendants disseminated
materially misleading statements or omitted disclosing matieral facts about the
Company, its business, its Greenery and CMS acquisitions, Greenery's improved
operations after the acquisition, the successful integration of CMS's operations
into those of the Company and the cost savings and operating efficiencies
obtained thereby, the Company's earnings growth and financial statements, the
Company's ability to continue to achieve profitable growth and the status and
magnitude of regulatory investigations into and audits of the Company. The
plaintiffs seek damages in an unspecified amount and extraordinary, equitable or
injunctive relief, including attachment, impoundment, or imposition of a
constructive trust against the individual defendants, plus costs and attorneys'
fees. The Company disputes the factual and legal bases upon which the
plaintiffs' lawsuits are based and denies that the plaintiffs are entitled to
any recovery on their claims. To that end, the Company intends to contest these
litigation matters vigorously. The following actions are currently pending:
ROSENBAUM V. HORIZON/CMS HEALTHCARE CORPORATION, NEAL M. ELLIOTT, ROBERT
A. ORTENZIO, KLEMETT L. BELT, JR., ROCCO A. ORTENZIO, ERNEST A.
SCHOFIELD AND RUSSELL L. CARSON, No. CIV 96-0447-JC.
DONNARUMMA ET AL., V. HORIZON/CMS HEALTHCARE CORPORATION, ROCCO A.
ORTENZIO, NEAL M. ELLIOTT, ROBERT A. ORTENZIO, RUSSELL L. CARSON,
KLEMETT L. BELT, JR., AND ERNEST A. SCHOFIELD, No. CIV 96-0442-BB.
BOWLES V. ROCCO A. ORTENZIO, NEAL M. ELLIOTT, ROBERT A. ORTENZIO,
RUSSELL L. CARSON, KLEMETT L. BELT, JR., ERNEST A. SCHOFIELD AND
HORIZON/CMS HEALTHCARE CORPORATION, No. CIV 96-0555-SC.
MARSCHKE V. ROCCO A. ORTENZIO, NEAL M. ELLIOTT, ROBERT A. ORTENZIO,
RUSSELL L. CARSON, KLEMETT L. BELT, JR., ERNEST A. SCHOFIELD AND
HORIZON/CMS HEALTHCARE CORPORATION, No. CIV 96-0560-MV.
WEINGARTEN V. HORIZON/CMS HEALTHCARE CORPORATION, HORIZON HEALTHCARE
CORPORATION, NEAL ELLIOTT, KLEMETT L. BELT, JR., ROCCO ORTENZIO, LEROY
S. ZIMMERMAN, BRIAN C. CRESSEY, RUSSELL L. CARSON, ROBERT A. ORTENZIO
AND ERNEST A. SCHOFIELD, No. CIV 96-0610-MV.
THEOPHANO V. NEAL M. ELLIOTT, ROCCO ORTENZIO, ROBERT A. ORTENZIO,
RUSSELL L. CARSON, KLEMETT L. BELT, JR., ERNEST A. SCHOFIELD AND
HORIZON/CMS HEALTHCARE CORPORATION, No. CIV 96-0626-MV.
BERENDA V. ROCCO A. ORTENZIO, NEAL M. ELLIOTT, ROBERT A. ORTENZIO,
RUSSELL L. CARSON, KLEMETT L. BELT, JR., ERNEST A. SCHOFIELD AND
HORIZON/CMS HEALTHCARE CORPORATION, No. CIV 96-0634-BB.
WIESEL V. HORIZON/CMS HEALTHCARE CORPORATION, NEAL M. ELLIOTT AND ROBERT
A. ORTENZIO, No. 96-0614-MV.
34
<PAGE>
GOLDFARB V. HORIZON/CMS HEALTHCARE CORPORATION, ROCCO A. ORTENZIO, NEAL
M. ELLIOTT, ROBERT A. ORTENZIO, RUSSELL L. CARSON, KLEMETT L. BELT, JR.,
AND ERNEST A. SCHOFIELD, No. CIV 96-0752-LH.
Subsequent to fiscal year end, 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.
Because these lawsuits are in their initial stages, the Company cannot now
predict the outcome of this litigation; the length of time it will take to
resolve this litigation; or the effect of any such outcome on the Company's
financial condition or results of operations.
STOCKHOLDER DERIVATIVE ACTIONS
Commencing in April and continuing into May 1996, the Company was served
with six complaints alleging a class action derivative action brought by
stockholders of the Company for and on behalf of the Company 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 N. Noveck, Barry M. Portnoy, and LeRoy S. Zimmerman. The six
lawsuits have been consolidated into one action styled IN RE HORIZON/CMS
HEALTHCARE CORPORATION SHAREHOLDERS LITIGATION. The plaintiffs allege, among
other things, that the Company's current and former directors breached their
fiduciary duties to the Company and the stockholders as a result of (i) the
purported failure to supervise adequately and the purported knowing
mismanagement of the operations of the Company, and the (ii) purported misuse of
inside information in connection with the sale of Horizon 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 as a result of the transaction
complained of in the complaint and attorneys' fees and costs. The Company cannot
now predict the outcome or the effect of this litigation or the length of time
it will take to resolve this litigation. 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.
In April 1996, the Company was served with a complaint in a stockholders
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 the
Company's current and former directors breached their fiduciary duties to the
Company and the stockholders as a result of (i) the purported failure to
supervise adequately and the purported knowing mismanagement of the operations
of the Company, and the (ii) purported misuse of inside information in
connection with the sale of Horizon 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
35
<PAGE>
by Horizon as a result of the transaction complained of in the complaint and
attorneys' fees and costs. The Company 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.
The Company cannot now predict the outcome or the effect of this litigation or
the length of time it will take or resolve this litigation.
ITEM 6. SELECTED FINANCIAL DATA
The following selected income statement and balance sheet data for the
periods ended May 31, 1992 through May 31, 1996 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,
----------------------------------------------------------
1996 1995 1994 1993 1992
---------- ---------- ---------- ---------- ----------
(AS RESTATED)
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENTS OF
OPERATIONS DATA (1):
Total operating revenues (2)...... $1,756,534 $1,622,658 $1,381,380 $1,136,358 $ 843,740
---------- ---------- ---------- ---------- ----------
COSTS AND EXPENSES:
Cost of services................ 1,438,985 1,343,533 1,159,270 935,186 699,420
Facility leases................. 84,234 81,590 68,832 64,461 56,277
Depreciation and amortization... 57,883 56,618 48,249 33,915 19,923
Interest expense................ 47,318 53,045 44,396 26,999 8,423
Special charge (3).............. 80,540 36,922 74,834 17,154 4,319
---------- ---------- ---------- ---------- ----------
Total costs and expenses...... 1,708,960 1,571,708 1,395,581 1,077,715 788,362
---------- ---------- ---------- ---------- ----------
Earnings (loss) before minority
interests, income taxes,
cumulative effect of accounting
change and extraordinary item.... 47,574 50,950 (14,201) 58,643 55,378
Minority interests................ (7,228) (5,245) (4,664) (6,787) (6,771)
---------- ---------- ---------- ---------- ----------
Earnings (loss) before income
taxes, cumulative effect of
accounting change and
extraordinary item............... 40,346 45,705 (18,865) 51,856 48,607
Income taxes...................... 31,672 22,348 1,430 21,520 16,489
---------- ---------- ---------- ---------- ----------
Earnings (loss) before cumulative
effect of accounting change and
extraordinary item............... 8,674 23,357 (20,295) 30,336 32,118
Cumulative effect of accounting
change, net of tax............... -- -- -- (3,204) --
---------- ---------- ---------- ---------- ----------
Earnings (loss) before
extraordinary item............... 8,674 23,357 (20,295) 27,132 32,118
Extraordinary item, net of tax
(4).............................. (31,328) 2,571 734 -- --
---------- ---------- ---------- ---------- ----------
Net earnings (loss)............... $ (22,654) $ 25,928 $ (19,561) $ 27,132 $ 32,118
========== ========== ========== ========== ==========
EARNINGS (LOSS) PER COMMON AND
COMMON EQUIVALENT SHARE:
Earnings (loss) before
cumulative effect of accounting
change and extraordinary
item........................... $ 0.16 $ 0.49 $ (0.55) $ 0.94 $ 1.02
Cumulative effect of accounting
change, net of tax............. -- -- -- (0.10) --
---------- ---------- ---------- ---------- ----------
Earnings (loss) before
extraordinary item............. $ 0.16 $ 0.49 $ (0.55) $ 0.84 $ 1.02
Extraordinary item, net of tax
(4)............................ (0.60) 0.05 0.02 -- --
---------- ---------- ---------- ---------- ----------
Net earnings (loss)........... $ (0.44) $ 0.54 $ (0.53) 0.84 $ 1.02
========== ========== ========== ========== ==========
</TABLE>
36
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED MAY 31,
----------------------------------------------------------
1996 1995 1994 1993 1992
---------- ---------- ---------- ---------- ----------
(AS RESTATED)
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
EARNINGS (LOSS) PER COMMON SHARE
-- ASSUMING FULL DILUTION:
Earnings (loss) before cumulative
effect of accounting change and
extraordinary item............... $ 0.16 $ 0.49 $ (0.55) $ 0.89 $ 1.00
Cumulative effect of accounting
change, net of tax............... -- -- -- (0.09) --
---------- ---------- ---------- ---------- ----------
Earnings (loss) before
extraordinary item............... $ 0.16 $ 0.49 $ (0.55) $ 0.80 $ 1.00
Extraordinary item, net of tax
(4).............................. (0.60) 0.05 0.02 -- --
---------- ---------- ---------- ---------- ----------
Net earnings (loss) per share..... $ (0.44) $ 0.54 $ (0.53) $ 0.80 $ 1.00
========== ========== ========== ========== ==========
Weighted average shares outstanding (in thousands):
Primary........................... 52,048 47,850 37,078 32,248 31,462
---------- ---------- ---------- ---------- ----------
Fully diluted..................... 52,200 47,857 40,051 36,941 32,964
---------- ---------- ---------- ---------- ----------
MAY 31,
----------------------------------------------------------
1996 1995 1994 1993 1992
---------- ---------- ---------- ---------- ----------
(AS RESTATED)
(DOLLARS IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
Working capital................. $ 394,954 $ 282,221 $ 232,158 $ 227,199 $ 151,090
Total assets.................... 1,512,751 1,402,813 1,151,695 926,398 580,149
Long-term debt, excluding
current portion................ 637,884 525,096 453,489 455,408 184,622
Total stockholders' equity...... 651,348 650,892 463,135 305,892 263,767
</TABLE>
- ------------------------------
(1) The Company completed the following material business acquisitions using
the purchase method of accounting:
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 through a merger of
Greenery into the Company. Consideration given for the acquisition included
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.
(3) Special charges represent the following items by period: (i) 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; (ii) 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; (iii) 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; (iv)
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; and (v) fiscal
1992 -- reflects $1,000 of merger expenses incurred in connection with an
acquisition accounted for as a pooling of interests and $3,319 related to a
terminated merger agreement.
(4) Extraordinary items represent the following items by period: (i) 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
37
<PAGE>
prior to the CMS merger; (ii) fiscal 1995 -- reflects gains recognized
related to open market purchases of the Company's subordinated debt and
convertible subordinated notes at a discount; and (iii) fiscal 1994 --
reflects gains recognized related to open market purchases of the Company's
convertible subordinated notes at a discount.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
GENERAL OVERVIEW
The Company is a leading provider of post-acute health care services,
including specialty health care services and long-term care services,
principally in the Midwest, Southwest, Northeast and Southeast regions of the
United States. At May 31, 1996, Horizon provided specialty health care services
through 37 acute rehabilitation hospitals in 16 states (2,065 beds), 58
specialty hospitals and subacute care units in 17 states (1,925 beds), 186
outpatient rehabilitation clinics in 22 states and 1,942 rehabilitation therapy
contracts in 36 states. At that date, Horizon provided long-term care services
through 120 owned or leased facilities (14,957 beds) and 142 managed facilities
(15,894 beds) in a total of 18 states. Other medical services offered by the
Company include pharmacy, laboratory, physician placement services, Alzheimer's
care, physician management, non-invasive medical diagnostic, home respiratory,
home infusion therapy and hospice care. For the year ended May 31, 1996, the
Company derived 49% of its revenues from private sources, 33% from Medicare and
18% from Medicaid.
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. Post-acute
care services that the Company provides include: (a) inpatient and outpatient
rehabilitative services; (b) subacute care; (c) long-term care; (d) contract
rehabilitation therapy services; (e) home health care services; (f) pharmacy and
related services; (g) clinical laboratory services; (h) physician placement
services, (i) non-invasive medical diagnostic services; (j) home respiratory
supplies and services; (k) home infusion supplies and services; and (l) hospice
care and (m) assisted living care. Horizon'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.
38
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth certain statement of operations data
expressed as a percentage of total operating revenues (As Restated):
<TABLE>
<CAPTION>
YEAR ENDED MAY 31,
-------------------------------------
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Total operating revenues....................... 100.0% 100.0% 100.0%
Cost of services............................... 81.9 82.8 83.9
Facility leases................................ 4.8 5.0 5.0
Depreciation and amortization.................. 3.3 3.5 3.5
Interest expense............................... 2.7 3.3 3.2
Special charge................................. 4.6 2.3 5.4
----- ----- -----
Earnings (loss) before minority interests,
income taxes and extraordinary item........... 2.7 3.1 (1.0)
Minority interests............................. (0.4) (0.3) (0.4)
----- ----- -----
Earnings (loss) before income taxes and
extraordinary item............................ 2.3 2.8 (1.4)
Income taxes................................... 1.8 1.4 0.1
----- ----- -----
Earnings (loss) before extraordinary item...... 0.5 1.4 (1.5)
Extraordinary item, net of tax................. (1.8) 0.2 0.1
----- ----- -----
Net earnings (loss)............................ (1.3)% 1.6% (1.4)%
===== ===== =====
</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 (As Restated):
<TABLE>
<CAPTION>
YEAR ENDED MAY 31,
-------------------------------------------------------------------
1996 1995 1994
--------------------- --------------------- ---------------------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
Long-term care services............ $ 384 21.8% $ 340 21.0% $ 225 16.3%
Specialty health care services:
Acute and outpatient
rehabilitation.................. 546 31.1 497 30.6 522 37.8
Contract rehabilitation
therapy......................... 392 22.3 395 24.3 384 27.8
Other (1)........................ 405 23.1 376 23.2 240 17.4
Other operating revenues (2)....... 30 1.7 15 0.9 10 0.7
--------- ----- --------- ----- --------- -----
Total operating revenues....... $ 1,757 100.0% $ 1,623 100.0% $ 1,381 100.0%
========= ===== ========= ===== ========= =====
- ------------------------
</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 the second quarter of fiscal 1996. With
respect to the latter, see "Item 3. Litigation -- Litigation against Tenet
Healthcare Corporation" in Part I of this Form 10-K.
39
<PAGE>
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 is due in large part to (i) numerous
acquisitions in the long-term care, outpatient rehabilitation and other
specialty health care areas, (ii) increases in the rates realized in the
long-term and subacute care operations, and (iii) increases 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. The Company also recorded in total operating
revenues $9.3 million, net of direct expenses, during the second quarter of
fiscal 1996 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 1 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 with a cumulative total fair value 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 of the
acquisitions was comprised 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. See
"Medicaid and Medicare" and "Regulation" in Item 1 of Part I of this Form 10-K.
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.
40
<PAGE>
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
made.
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 (as hereinafter defined) 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 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.
As discussed above, several components of the fiscal 1996 charges were
related to the Company's expansion through acquisition. The Company intends to
continue to expand its operations through acquisitions in selected geographic
areas and will rely on cash as a currency to effect future acquisitions. Growth
through acquisition entails certain risks in that acquired operations could be
subject to unanticipated business uncertainties or legal liabilities. The
Company 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 Company's results of operations. Following each
acquisition, management will consider opportunities to eliminate excess or
duplicative operations, processes or personnel or other measures to maximize the
potential of the combined operations. As a result of these considerations,
management may commit to undertake restructuring measures which would result in
a current
41
<PAGE>
charge against earnings. Depending upon the relative significance of an
acquisition and the extent of the restructuring program undertaken, such charge
could be material to the Company.
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 indebtedness of CMS (together, the
"Senior Subordinated Notes"). 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. In accordance with the provisions of Accounting
Principles Board Opinion No. 16 ("APB 16"), "Business Combinations," 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, 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 should be classified as an extraordinary item, net of tax.
Because the $11.9 million first quarter asset disposal charge occurred prior to
the CMS merger, that charge was appropriately classified within operations.
The operations currently proposed for disposition include 21 leased long-
term care facilities, ten owned long-term care facilities, three managed long-
term care facilities and three pharmacy operations. The assets to be disposed of
comprise substantially all of the Company's long-term care and pharmacy
operations in the states of Massachusetts, Connecticut, Ohio and Wisconsin.
Certain other of the targeted assets are located in Michigan and Colorado. The
fiscal 1996 revenues and pre-tax loss of the operations held for sale were
$180.2 million and $(4.9) million, respectively.
42
<PAGE>
The proposed disposition, though subject to final approval of the purchaser
and the approval of various regulatory authorities, is expected to be completed
in the second or third third quarter of fiscal 1997.
YEAR ENDED MAY 31, 1995 COMPARED TO YEAR ENDED MAY 31, 1994
REVENUES
Total operating revenues increased approximately $241.3 million or 17.5% for
the year ended May 31, 1995, compared to the year ended May 31, 1994. The
increase in total operating revenues for the period is due in large part to (i)
significant acquisitions of long-term and subacute care operations, (ii)
increases in the average rates realized in the long-term and specialty health
care operations and (iii) an increase in occupancy in the rehabilitation
hospital operations. These increases were offset somewhat due to the divestiture
of two rehabilitation hospitals in the fourth quarter of fiscal 1994 and due to
lower physician filled days in the Company's physician placement operations.
As a result of the Company's expansion efforts, significant increases in
operating revenues were noted from fiscal 1994 to 1995. The operations included
in the Greenery acquisition, which was completed in February 1994, contributed
$130.7 million of operating revenues in fiscal 1995 as compared to $46.2 million
contributed during the three and one-half months Greenery was owned by the
Company in fiscal 1994. The peopleCARE acquisition, which was completed in July
1994, as well as other long-term care acquisitions, contributed $78.3 million of
operating revenues in fiscal 1995. Internal growth and acquisitions in various
other specialty health care operations contributed $49.5 million of operating
revenues in fiscal 1995. These increases were partially offset by the Company's
divestiture of two rehabilitation hospitals in the fourth quarter of fiscal 1994
which accounted for approximately $23.0 million in operating revenues and a
decrease in revenues of approximately $14.1 million due to lower physician
filled days in the Company's physician placement operations.
In addition, revenues increased by approximately $46.3 million due to an
increase in the average rates realized in the long-term and subacute care
operations and the rehabilitation hospital operations. This increase was
achieved as a result of a much more favorable payor mix. Revenues also increased
in fiscal 1995 by approximately $19.1 million due to an increase in average
occupancy in the long-term and subacute care operations and rehabilitation
hospital operations.
COSTS AND EXPENSES
Cost of services increased approximately $184.3 million, or 15.9% for the
year ended May 31, 1995, compared to the corresponding period in fiscal 1994.
The increases in cost of services is primarily attributable to the significant
expansion through acquisitions of the long-term and subacute care operations. As
a percentage of total operating revenues, cost of services declined to 82.8%
from 83.9% for the year ended May 31, 1995, compared to the corresponding period
in 1994, due largely to the effect of increased revenues from higher margin
operations and increased overhead efficiencies.
Facility lease expense increased $12.8 million, or 18.5% for the year ended
May 31, 1995, compared to the corresponding period in fiscal 1994. The increase
in facility lease expense is attributable to the significant increase in the
number of leased facilities operated in 1995 following the various acquisitions.
As a percentage of total operating revenues, facility lease expense remained
constant at 5.0% for the year ended May 31, 1995, compared to the corresponding
period in fiscal 1994.
43
<PAGE>
Depreciation and amortization increased $8.4 million, or 17.4% for the year
ended May 31, 1995, compared to the corresponding period in fiscal 1994,
primarily as a result of acquisitions during the period. As a percentage of
total operating revenues, depreciation and amortization remained constant at
3.5% for the year ended May 31, 1995, compared to the corresponding period in
fiscal 1994.
Interest expense increased $8.6 million, or 19.5% for the year ended May 31,
1995, compared to the corresponding period in 1994. As a percentage of total
operating revenues, interest expense increased slightly from 3.2% to 3.3% for
fiscal year 1995 as compared with fiscal 1994. This increase is primarily
attributable to higher rate fixed rate debt assumed in connection with the
Greenery acquisition and the fluctuations in interest on the floating rate
credit facility.
During fiscal 1995, the Company recorded special charges of $36.9 million.
Approximately $18.4 million of the fiscal 1995 special charge was recorded to
reflect the revision in the Company's estimate of settlements receivable from
third party payors in the contract rehabilitation therapy division.
Approximately $5.0 million reflects the costs of eliminating management and
staff positions, office lease terminations and certain other costs of the
changes implemented at the Company's contract rehabilitation therapy division.
The $13.5 million dollar balance of the fiscal 1995 special charge resulted from
the settlement of litigation and termination of related contracts. See note 7 of
the Notes to Consolidated Financial Statements for a more complete discussion of
these charges.
During fiscal 1994, the Company recorded special charges of $74.8 million.
Approximately $50.2 million of the fiscal 1994 special charge related to the
impairment of selected rehabilitation hospital division assets. Approximately
$22.8 million resulted from costs associated with the consolidation of contract
therapy companies and losses related to the termination of certain relationships
in the contract therapy business. The remaining $1.8 million balance of the
fiscal 1994 special charge resulted from costs related to the reduction of
corporate office work force and other restructuring costs. See note 7 of the
Notes to Consolidated Financial Statements for a more complete discussion of
these charges.
EXTRAORDINARY ITEM
During fiscal 1995, the Company recognized a gain of $2.6 million, net of
tax, relating to open market purchases at a discount of its subordinated debt
and its 8 3/4% and 6 1/2% convertible subordinated notes. During fiscal 1994,
the Company recognized a gain of $734,000, net of tax, relating to open market
purchases at a discount of its 8 3/4% and 6 1/2% convertible subordinated notes.
LIQUIDITY AND CAPITAL RESOURCES
At May 31, 1996, the Company's working capital was $395.0 million and
included cash and cash equivalents of $31.3 million as compared with $282.2
million in working capital and $40.1 million in cash and cash equivalents at May
31, 1995. During the year ended May 31, 1996, the Company's operating activities
provided $32.6 million of net cash. During the years ended May 31, 1995 and
1994, the Company's operating activities provided $10.0 million and $29.0
million of net cash, respectively.
While the allowance for doubtful accounts as of May 31, 1996 has increased
approximately 47.0% as compared with May 31, 1995, net patient care accounts
receivable has increased by only 1.3% over the same period. The disparate
increase in the allowance is due to several factors including: (i) an increase
in the general accounts receivable reserve balances of approximately $5.2
million, or 1.5% of total accounts receivable, established in response to what
management determined to be a slight deterioration in private and other accounts
receivable in fiscal year 1996 as measured based upon an increase in the number
of days required to collect these classes of accounts receivable, (ii) an
approximate $3.9 million increase in the allowance associated with specific
accounts receivable for which circumstances developed during fiscal year 1996
that negatively affected the likelihood of recovering some or all of these
accounts, (iii) an approximate $2.8 million increase as a result of acquisitions
completed during fiscal year 1996 in which the accounts receivable acquired was
of poor quality and established reserves were significantly higher than those
recorded on the Company's receivables and (iv) an approximate $1.3 million
decrease in the level of write-offs of accounts receivable as management focused
additional efforts on the collection of problem accounts prior to charging these
accounts against the allowance.
44
<PAGE>
In connection with the special charges recorded by the Company during
fiscals 1996, 1995 and 1994, the Company made cash payments totaling $34.0
million, $13.4 million and $0, during each of those years, respectively. There
were no significant asset dispositions related to the restructuring during the
year ended May 31, 1996.
EXPANSION PROGRAM
The net cash used in the Company's investing activities decreased from
$158.6 million for the year ended May 31, 1995 to $133.7 million for the year
ended May 31, 1996. The primary uses of cash in investing activities have been
cash acquisitions and internal construction and capital expenditures for
property and equipment. The Company has used its common stock rather than cash
to effect a portion of the acquisitions during the year ended May 31, 1996. In
addition, cash paid in connection with acquisitions during fiscal 1996 has
decreased as compared to 1995. However, under existing circumstances, the
Company will rely on cash as a currency to effect future acquisitions. Cash
required for internal construction and capital expenditures for property and
equipment has remained relatively stable during the year ended May 31, 1996 as
compared with the corresponding period of fiscal 1995. As of May 31, 1996, the
Company has future plans or commitments to fund construction totaling
approximately $49.3 million. The majority of this total is comprised of amounts
necessary to complete construction on an office building to house corporate
operations.
The Company's expansion program requires 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 financing activities and, to a lesser extent, from operating and
investing activities. During the years ended May 31, 1996 and May 31, 1995,
proceeds from the issuance of Company debt, net of debt repayments and
repurchases, amounted to $112.0 million and $14.6 million, respectively, and
proceeds from the issuance of common stock totaled $18.4 million and $124.2
million, respectively.
SOURCES
At May 31, 1996, the available credit under the Company's Credit Facility
(as defined below) was $203.5 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, to a lesser extent,
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 $508.6
million and had outstanding letters of credit of $37.9 million at May 31, 1996.
Borrowings under the Credit Facility bear interest, payable monthly, at a
45
<PAGE>
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 1.25% per annum, depending on the
maintenance of specified financial ratios. The applicable interest rates at May
31, 1996 were 8.25% and 6.44% - 6.50% 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. After discussions between the Company and
representatives of the Agent, the Company does not believe the existence of, or
the occurrence of the events giving rise to, the OIG/DOJ investigation into
certain Medicare Part B and related co-insurance billings, the pending SEC
investigation or the pending stockholder litigation (see "Item 3. Legal
Proceedings" in Part I of this report) will prevent satisfaction of these
conditions at this time. In addition, pursuant to an amendment to the credit
agreement underlying the NationsBank Facility, the Company, the Agent and each
of the participating lenders agreed that the Company's knowledge of the
existence of these matters will not prevent satisfaction of these conditions at
this time or in the future. No assurance can be given, however, that future
adverse developments or determinations with respect to these matters will not
prevent satisfaction of such conditions.
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.
46
<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
47
<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, 1996 and 1995, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended May 31, 1996, as restated (Note 18).
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 15. Such statements are included in the consolidated
financial statements of Horizon/CMS Healthcare Corporation and reflect total
operating revenues of 72.9 percent in 1994, and total assets and total operating
revenues of 49.1 and 60.8 percent in 1995, respectively, of the related
consolidated totals. 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, 1996 and 1995, and the results of their operations
and their cash flows for each of the three years in the period ended May 31,
1996, 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
July 23, 1996 (except with respect to the matter discussed in Note 18,
paragraphs 2 and 3, as to which the date is July 18, 1997)
48
<PAGE>
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders
of Horizon/CMS Healthcare Corporation
We have audited the consolidated balance sheet of Continental Medical
Systems, Inc. and subsidiaries (the Company) as of June 30, 1995, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the two years in the period 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
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Continental Medical Systems, Inc. and subsidiaries at June 30, 1995, and the
consolidated results of their operations and their cash flows for each of the
two years in the period 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
49
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
CONSOLIDATED BALANCE SHEETS
MAY 31, 1996 AND 1995
(AS RESTATED)
(DOLLARS IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
1996 1995
------------ ------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents................................... $ 31,307 $ 40,057
Patient care accounts receivable, net of allowance for
doubtful accounts of $41,347 in 1996 and $28,120 in 1995... 309,216 305,210
Estimated third party settlements........................... 47,630 --
Prepaid and other assets (Note 17).......................... 183,108 88,698
Deferred income taxes....................................... 21,287 21,806
------------ ------------
Total current assets...................................... 592,548 455,771
PROPERTY AND EQUIPMENT, net................................... 594,373 553,797
GOODWILL, net................................................. 164,269 147,675
OTHER INTANGIBLE ASSETS, net.................................. 38,269 42,164
NOTES RECEIVABLE, excluding current portion................... 73,017 47,981
DEFERRED INCOME TAXES......................................... 3,166 --
OTHER ASSETS (Note 17)........................................ 47,109 155,425
------------ ------------
Total assets.............................................. $ 1,512,751 $ 1,402,813
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt........................... $ 6,522 $ 4,782
Accounts payable............................................ 19,910 27,904
Accrued expenses and other liabilities (Note 17)............ 171,162 134,130
Estimated third party settlements........................... -- 6,734
------------ ------------
Total current liabilities................................. 197,594 173,550
LONG-TERM DEBT, excluding current portion..................... 637,884 525,096
OTHER LIABILITIES (Note 17)................................... 9,753 32,945
DEFERRED INCOME TAXES......................................... -- 6,141
------------ ------------
Total liabilities......................................... 845,231 737,732
MINORITY INTERESTS............................................ 16,172 14,189
COMMITMENTS AND CONTINGENCIES
(Note 14)....................................................
STOCKHOLDERS' EQUITY:
Common stock of $.001 par value, authorized 150,000,000 shares, 52,581,762 and
50,679,107 shares issued with 51,941,751 and 50,174,218 shares outstanding at
May 31,
1996 and 1995, respectively................................ 53 51
Additional paid-in capital.................................. 589,516 559,168
Retained earnings........................................... 70,484 97,260
Treasury stock.............................................. (8,705) (5,587)
------------ ------------
Total stockholders' equity................................ 651,348 650,892
------------ ------------
Total liabilities and stockholders' equity................ $ 1,512,751 $ 1,402,813
============ ============
</TABLE>
The accompanying notes are an integral part of these balance sheets.
50
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(AS RESTATED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1996 1995 1994
------------- ------------- -------------
<S> <C> <C> <C>
TOTAL OPERATING REVENUES..................... $ 1,756,534 $ 1,622,658 $ 1,381,380
------------- ------------- -------------
COSTS AND EXPENSES:
Cost of services........................... 1,438,985 1,343,533 1,159,270
Facility leases............................ 84,234 81,590 68,832
Depreciation and amortization.............. 57,883 56,618 48,249
Interest expense........................... 47,318 53,045 44,396
Special charge............................. 80,540 36,922 74,834
------------- ------------- -------------
Total costs and expenses................. 1,708,960 1,571,708 1,395,581
------------- ------------- -------------
Earnings (loss) before minority interests,
income taxes and extraordinary item....... 47,574 50,950 (14,201)
Minority interests........................... (7,228) (5,245) (4,664)
------------- ------------- -------------
Earnings (loss) before income taxes and
extraordinary item........................ 40,346 45,705 (18,865)
Income taxes................................. 31,672 22,348 1,430
------------- ------------- -------------
Earnings (loss) before extraordinary item.... 8,674 23,357 (20,295)
Extraordinary item, net of tax............... (31,328) 2,571 734
------------- ------------- -------------
Net earnings (loss).......................... $ (22,654) $ 25,928 $ (19,561)
============= ============= =============
Earnings (loss) per common and common equivalent share:
Earnings (loss) before extraordinary
item...................................... $ 0.16 $ 0.49 $ (0.55)
Extraordinary item, net of tax............. (0.60) 0.05 0.02
------------- ------------- -------------
Net earnings (loss)........................ $ (0.44) $ 0.54 $ (0.53)
============= ============= =============
Weighted average number of shares
outstanding................................. 52,048 47,850 37,078
============= ============= =============
</TABLE>
The accompanying notes are an integral part of these statements.
51
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(AS RESTATED)
(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, 1993................... 31,572,900 $ 32 $ 216,295 $ 90,184 $ (740) $ 305,771
Common stock offering, net of $1,365 of
issue costs.............................. 4,025,000 4 58,215 -- -- 58,219
Common stock issued in connection with
acquisitions............................. 2,828,968 3 62,141 -- -- 62,144
Conversion of 6.75% convertible
subordinated notes, net of $1,897 of
previously capitalized financing costs
and $507 of conversion costs............. 4,522,500 4 51,861 -- -- 51,865
Exercise of stock purchase warrants,
options and issuance of shares under the
employee stock purchase plan............. 491,190 -- 4,697 -- -- 4,697
Net loss.................................. -- -- -- (19,561) -- (19,561)
----------- --- ----------- --------- ----------- ---------
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,
options 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
Excercise of stock purchase warrants,
options 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
(Note 15)................................ -- -- -- (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
=========== === =========== ========= =========== =========
</TABLE>
The accompanying notes are an integral part of these statements.
52
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(AS RESTATED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings (loss).............................. $ (22,654) $ 25,928 $ (19,561)
Adjustments:
Depreciation and amortization.................. 57,883 56,618 48,249
Other.......................................... 15,070 (2,437) 690
Special charge................................. 80,540 36,922 74,834
Extraordinary item............................. 47,462 (4,172) (1,214)
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........... (78,059) (30,491) (48,751)
Prepaid and other assets..................... (18,694) (22,800) (23,067)
Deferred income taxes........................ (9,288) 168 (1,178)
Accounts payable and accrued expenses........ (42,018) (24,062) (692)
Other liabilities............................ 2,388 (25,666) (281)
----------- ----------- -----------
Total adjustments................................ 55,284 (15,920) 48,590
----------- ----------- -----------
Net cash provided by operating activities........ 32,630 10,008 29,029
----------- ----------- -----------
Cash flows from investing activities:
Payments pursuant to acquisition agreements, net
of cash acquired................................ (50,080) (117,359) (27,091)
Cash proceeds from sale of property and
equipment....................................... -- 22,718 24,096
Other intangible assets.......................... (14,072) (863) (5,010)
Acquisition of property and equipment............ (48,506) (52,622) (67,026)
Notes receivable................................. (22,509) 2,215 5,072
Other investing activities....................... 1,469 (12,688) (9,950)
----------- ----------- -----------
Net cash used in investing activities............ (133,698) (158,599) (79,909)
----------- ----------- -----------
Cash flows from financing activities:
Long-term debt borrowings........................ 925,343 211,484 122,604
Long-term debt repayments........................ (813,296) (196,906) (120,959)
Deferred financing costs......................... (1,700) (3,104) (893)
Repurchase of convertible subordinated notes..... -- (3,812) (19,999)
Issuance of common stock......................... 18,394 124,217 61,894
Distributions to minority interests.............. (2,476) (4,975) (3,143)
Other financing activities....................... (30,636) 360 2,388
----------- ----------- -----------
Net cash provided by financing activities........ 95,629 127,264 41,892
----------- ----------- -----------
Net decrease in cash and cash equivalents.......... (5,439) (21,327) (8,988)
Cash and cash equivalents, beginning of year....... 40,057 61,384 70,372
Effect of pooling of interests restatement (Note
15)............................................... (3,311) -- --
----------- ----------- -----------
Cash and cash equivalents, end of year............. $ 31,307 $ 40,057 $ 61,384
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
53
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(AS RESTATED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest....................................... $ 56,260 $ 54,351 $ 44,852
=========== =========== ===========
Income taxes, net.............................. $ (4,953) $ 19,236 $ 12,848
=========== =========== ===========
Noncash investing and financing activities:
Net assets acquired in exchange for common
stock......................................... $ 1,444 $ 22,030 $ 16,573
=========== =========== ===========
Assumption of long-term debt in connection with
acquisitions.................................. $ 2,232 $ 19,900 $ 19,300
=========== =========== ===========
Assumption of obligations under capital lease
in connection with acquisitions............... $ -- $ 48,600 $ --
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
54
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS
Horizon/CMS Healthcare Corporation (formerly known as Horizon Healthcare
Corporation) and its subsidiaries (collectively, the "Company") is a leading
provider of post-acute 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 15, 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 assets, liabilities and stockholders equity of CMS as of
June 30, 1995 and the results of operations of CMS for each of the two years in
the period ended June 30, 1995.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its 50% or greater owned subsidiaries which the Company controls. 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 20% or more
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.
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 1996, 1995 and 1994,
the Company derived 33%, 28% and 34% of its revenues from Medicare. For fiscal
55
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
years 1996, 1995 and 1994, the Company derived 18%, 17% and 14% 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 reimburseable 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 which 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.
56
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(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
57
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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%. On June 1, 1993, the Company adopted 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.
WORKERS' COMPENSATION
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.
STOCK-BASED COMPENSATION
The Financial Accounting Standards Board (FASB) recently issued Statement of
Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based
Compensation." This new standard encourages, but does not require, companies to
recognize compensation expense for grants of stock, stock options, and other
equity instruments based on a fair-value method of accounting.
Companies that do not choose to adopt the new expense recognition rules of
SFAS No. 123 will continue to apply the existing accounting rules contained in
Accounting Principles Board Opinion (ABP) No. 25, but will be required to
provide pro forma disclosures of the compensation expense determined under the
fair-value provisions of SFAS No. 123, if material. APB No. 25 requires no
recognition of compensation expense for most of the stock-based compensation
arrangements provided by the Company, namely, a broad-based employee stock
purchase plan and option grants where the exercise price is equal to the market
price at the date of grant.
The Company is required to adopt either the recognition or the disclosure
provisions of SFAS No. 123 in fiscal year 1997. The Company expects to continue
to follow the accounting provisions of APB No. 25 for stock-based compensation
and to furnish the pro forma disclosures required under SFAS No. 123, if
material.
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 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 reassesses its position and adjusts
recorded reserves, as necessary.
58
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(2) NOTES RECEIVABLE
Notes receivable consist of the following:
1996 1995
--------- ---------
Variable rate note receivable (7.3% at May 31, 1996)
payable in variable monthly installments including
interest; due December 2005; secured by accounts
receivable and other assets............................. $ 21,650 $ --
Variable rate note receivable based on lesser of 8% or
LIBOR + 2.25% (8.0% at May 31, 1996), full recourse;
interest payable semi-annually; principal payable
December 2008; unsecured................................ 10,653 10,653
7% notes receivable; payable in monthly installments of
$60 including interest; due April 2004; secured by real
property................................................ 9,567 9,571
Variable rate note receivable (7.0% at May 31, 1996);
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% notes receivable, payable in monthly installments of
$27 including interest; due January 2016; secured by
real property........................................... 3,496 3,569
Other notes receivable bearing interest at 6% to 12%; due
at varying dates through fiscal 2036.................... 25,851 20,011
--------- ---------
Notes receivable..................................... 77,217 49,804
Less current portion, included in prepaid and other
assets.................................................. 4,200 1,823
--------- ---------
Notes receivable, excluding current portion.............. $ 73,017 $ 47,981
========= =========
In November 1987, the Company loaned a former executive officer $2,000 to
purchase a 7 3/4% convertible subordinated debenture (see note 5 for description
of the debenture). The loan is evidenced by a promissory note bearing interest
at 7 3/4%, payable on the maturity date of the debenture or earlier to the
extent that the debenture is converted. At May 31, 1996 and 1995, $1,000 was
oustanding on the note, which is included within notes receivable in the
accompanying balance sheets.
During fiscal year 1993, the Company loaned former executive officers $5,078
for the exercise of stock options and the payment of the resulting income taxes.
The tax loans were authorized under the Company's stock compensation plans, and
the remaining loan was authorized by the board of directors. The loans are
repayable upon demand with interest payable monthly at the IRS'
59
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(2) NOTES RECEIVABLE (CONTINUED)
applicable federal rate, adjusted semi-annually on January 1 and July 1. At May
31, 1996 and 1995, $2,362 was outstanding on the note, which is included within
notes receivable in the accompanying balance sheets.
(3) PROPERTY AND EQUIPMENT
Property and equipment owned and held under capital lease is stated at cost
and consists of the following:
1996 1995
----------- -----------
Land.................................................. $ 63,250 $ 59,907
Buildings............................................. 474,830 431,820
Equipment............................................. 175,329 149,208
----------- -----------
713,409 640,935
Less accumulated depreciation and amortization........ 119,036 87,138
----------- -----------
Property and equipment, net........................... $ 594,373 $ 553,797
=========== ===========
(4) ACCRUED EXPENSES AND OTHER LIABILITIES
Accrued expenses and other liabilities are comprised of the following:
1996 1995
----------- -----------
Salaries, wages and benefits.......................... $ 46,872 $ 53,696
Accrued insurance..................................... 23,957 18,297
Accruals for special charges (Note 7)................. 17,453 23,541
Total liabilities for assets held for sale (Note 17).. 27,932 13,678
Accrued property and payroll taxes.................... 13,565 11,414
Accrued income taxes.................................. 13,414 -
Accrued interest...................................... 6,896 11,058
Other................................................. 21,073 2,446
----------- -----------
$ 171,162 $ 134,130
=========== ===========
60
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(5) LONG-TERM DEBT
Long-term debt consists of the following:
1996 1995
----------- -----------
Revolving credit drawn on credit agreement; interest
due monthly; principal due in fiscal 2001............ $ 508,622 $ 138,750
10 7/8% senior subordinated notes; due in fiscal
2002................................................. 8,562 145,125
10 3/8% senior subordinated notes; due in fiscal
2003................................................. 65 117,991
Convertible subordinated debenture; interest at
8 3/4%; due in fiscal 2015........................... 20,400 20,400
Convertible subordinated debenture; interest at
6 1/2%; due in fiscal 2012........................... 5,680 5,680
Convertible subordinated debenture; interest at
7 3/4%; due in fiscal 2012........................... 2,000 2,000
Obligations under capital leases and other long-term
debt bearing interest ranging from 5.0% to 14.0%; due
at varying dates through fiscal 2017; secured by
related land, buildings and equipment................ 99,077 99,932
----------- -----------
Long-term debt...................................... 644,406 529,878
Less current portion.................................. 6,522 4,782
----------- -----------
Long-term debt, excluding current portion........... $ 637,884 $ 525,096
=========== ===========
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, which replaced the
revolving loan agreement outstanding at May 31, 1994, 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 Offered
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 several 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
61
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(5) LONG-TERM DEBT (CONTINUED)
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 plus 0.625% to 1.25% 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 NationsBank Facility was
6.65% at May 31, 1996. The NationsBank Facility matures in September 2000. The
credit agreement underlying the NationsBank Facility contains certain covenants
and restrictions including, without limitation, the following: (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. After discussions between the Company and
representatives of the agent, the Company does not believe the existence of, or
the occurrence of the events giving rise to, the Office of Inspector General of
the Department of Health and Human Services (the "OIG") and the Department of
Justice (the "DOJ") investigation into certain Medicare Part B and related
co-insurance billings, the pending SEC investigation or the pending stockholder
litigation (see note 16) will prevent satisfaction of these conditions at this
time. In addition, pursuant to an amendment to the credit agreement underlying
the NationsBank Facility, the Company, the agent and each of the participating
lenders agreed that the Company's knowledge of the existence of these matters
will not prevent satisfaction of these conditions at this time or in the future.
No assurance can be given, however, that future adverse developments or
determinations with respect to these matters will not prevent satisfaction of
such conditions.
62
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(5) LONG-TERM DEBT (CONTINUED)
Simultaneous with the tender offer for the 10 3/8% and 10 7/8% 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, 1996, $203,500 was available to
be drawn under this facility.
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, 1996 would require that a
$106 payment be made by the Company to terminate the agreement.
On August 17, 1992, the Company issued 10 7/8% Senior Subordinated Notes due
2002 ("10 7/8% Notes") in the amount of $200,000 in a public offering in which
the Company received net proceeds of $192,500. The 10 7/8% Notes were priced at
99.25%, to yield 11% annually to maturity. On March 16, 1993 the Company issued
its 10 3/8% Senior Subordinated Notes due 2003 ("10 3/8% Notes") in the amount
of $150,000 in a private placement in which the Company received net proceeds of
$144,586. The 10 3/8% Notes were priced at 99.22% to yield 10 1/2% annually to
maturity.
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 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.
63
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(5) LONG-TERM DEBT (CONTINUED)
On February 14, 1992, the Company issued $57,500 of 6.75% convertible
subordinated notes (the "6.75% Notes") due February 1, 2002. The 6.75% Notes
were convertible at any time prior to maturity into shares of common stock of
the Company at a conversion price of $12.00 per share, subject to adjustment in
certain events. Interest on the 6.75% Notes was payable semi-annually on each
February 1, and August 1, commencing August 1, 1992. During the year ended May
31, 1992, the Company redeemed $3,230 of 6.75% Notes at approximately 80% of par
value, resulting in a gain of $475, net of allocable deferred financing costs of
approximately $140. During the third quarter of fiscal 1994, the remaining
$54,270 of 6.75% Notes were converted into the Company's common stock at the
conversion price stated above. In connection therewith, approximately $1,900 of
deferred financing costs and $500 of conversion costs were offset against
additional paid-in capital at the time of conversion.
In connection with the merger of Greenery Rehabilitation Group, Inc.
("Greenery") into the Company (Note 12), the Company assumed the obligations
under Greenery's 6 1/2% convertible subordinated notes and 8 3/4% 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 6 1/2% convertible
subordinated notes of $2,663.
The 6 1/2% 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 103 1/4% of par, plus accrued
interest, declining annually to par on June 15, 1996. Commencing June 15, 1996,
the Company is obligated to retire 5% of the issue amount annually to maturity.
The 8 3/4% 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 6 1/2% debentures, but will be
subordinated to any future senior indebtedness.
During fiscal 1995, the Company repurchased $4,800 of its 6 1/2% convertible
subordinated notes and $506 of its 8 3/4% convertible senior subordinated notes.
Also during fiscal 1995, the Company purchased $85,206 principal amount of its
10 7/8% and 10 3/8% Notes, (collectively its "Senior Subordinated Notes" or
"Subordinated Debt"), at a discount in a series of open market transactions.
On September 26, 1995, the Company completed a tender offer and consent
solicitation for $256,167 principal amount of its Senior Subordinated Notes.
64
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(5) LONG-TERM DEBT (CONTINUED)
During the fourth quarter of fiscal 1994, the Company redeemed $15,520 of
the 6 1/2% convertible subordinated notes and $7,244 of the 8 3/4% convertible
senior subordinated notes.
In November 1987, a 7 3/4% convertible subordinated debenture was sold to
the Company's former vice chairman. This $2,000 debenture is convertible into
shares of common stock at a conversion price of $8.56 per share.
The approximate aggregate maturities of long-term debt are as follows:
YEAR ENDING MAY 31,
- -------------------
1997..................................................... $ 6,522
1998..................................................... 7,036
1999..................................................... 2,569
2000..................................................... 2,756
2001..................................................... 520,442
Thereafter............................................... 105,081
-----------
$ 644,406
===========
(6) LEASE COMMITMENTS
The Company has noncancelable operating leases primarily for facilities and
equipment. Certain leases provide for purchase and renewal options of 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, 1996, 1995 and 1994
was approximately $6,501, $6,346 and $6,198, respectively.
Future minimum payments under noncancelable operating leases are as follows:
YEAR ENDING MAY 31,
- -------------------
1997..................................................... $ 88,899
1998..................................................... 79,033
1999..................................................... 64,395
2000..................................................... 49,673
2001..................................................... 43,767
Thereafter............................................... 142,142
-----------
$ 467,909
===========
The Company is contingently liable for annual lease payments of
approximately $2,655 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 $6,484 for leases on managed facilities. The leases
expire at varying dates through fiscal 2007.
65
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(6) LEASE COMMITMENTS (CONTINUED)
The Company has been party to various contracts with Commercial Construction
Company, Inc. ("CCI") for the construction of new rehabilitation hospitals to be
owned and operated by the Company. CCI has represented to the Company that it is
wholly owned by the brother of a former divisional president of the Company. In
addition, the Company purchases other development and maintenance services,
equipment, furniture and supplies for its rehabilitation hospitals through CCI
and its affiliates. The Company also leases certain clinic and office space in
the greater Harrisburg, PA area under leases with various partnerships, of which
a former divisional president is a partner. In fiscal 1996, 1995, and 1994, the
Company made payments to these related parties aggregating approximately $4,501,
$7,401 and $16,950, respectively. Of these payments, $2,292 and $7,189, were
recorded in property and equipment for fiscal 1995, and 1994, respectively, and
$4,501, $5,109 and $9,761 were charged to cost of services for fiscal 1996,
1995, and 1994, respectively. As of May 31, 1996, future commitments under
outstanding contracts with an affiliate of CCI were $1,826 plus reimbursement of
certain personnel costs.
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 $782, $589 and $328 under
this lease during fiscal 1996, 1995 and 1994, 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 $3,326
under these leases during fiscal 1996.
(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 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
66
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(7) SPECIAL CHARGE (CONTINUED)
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 17, the charge was later revised upward based upon management's
decision in the fourth quarter of fiscal 1996 to revise and significantly
expand 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 resulted in the
$1,500 balance of the $14,200 total. Substantially all of the actions which
comprise this total were completed during fiscal 1996. Any remaining actions
are expected to occur prior to the end of the first quarter of fiscal 1997.
(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. The
completion of these terminations is expected to occur prior to August 1996.
Management had approved and committed the Company to the employee
terminations and, during the first quarter of fiscal 1996, communicated the
termination benefits payable to the employees. The Company does not
anticipate any significant changes to the plan to occur through the expected
completion date. Of the $20,600 total, approximately $9,250 was
67
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(7) SPECIAL CHARGE (CONTINUED)
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 does not reflect any estimate for settlement of the
OIG/ DOJ, shareholder or any of the other matters discussed. See Note 16 for
a detailed discussion of pending or 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.
In March 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 121, "Accounting for Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed of" ("SFAS 121"). The provisions
of SFAS 121 must be implemented by the Company in the first quarter of fiscal
1997. The Company believes that its current impairment policy is substantially
similar to SFAS 121 and, accordingly, the adoption of SFAS 121 is not expected
to have a significant effect on the Company's financial position or results of
operations.
The components of the fiscal year 1996 special charge are as follows (in
thousands):
<TABLE>
<CAPTION>
Impairment
and Noncancellable Termination Lease Exit Transaction
Committments Legal Benefits and 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
================= ============ ============ ============ ============= ============
</TABLE>
At May 31, 1996, 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.
68
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(7) SPECIAL CHARGE (CONTINUED)
(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 (in
thousands):
<TABLE>
<CAPTION>
Impairment
and Noncancellable Termination Transaction Lease Exit
Committments Legal Benefits Costs and Other Total
----------------- ------------ ------------ ------------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Fiscal Year 1995 Special Charge $ 19,077 $ 12,800 $ 2,158 $ 200 $ 2,687 $ 36,922
Fiscal Year 1995 Activity:
Payments - (12,800) (498) - (462) (13,760)
Asset Impairment (19,077) - - - - (19,077)
----------------- ------------ ------------ ------------- ------------ ------------
Balance May 31, 1995 - - 1,660 200 2,225 4,085
Fiscal Year 1996 Activity:
Payments - - (1,593) (183) (1,625) (3,401)
----------------- ------------ ------------ ------------- ------------ ------------
Balance May 31, 1996 $ - $ - $ 67 $ 17 $ 600 $ 684
================= ============ ============ ============= ============ ============
</TABLE>
At May 31, 1996, the number of employees terminated in connection with the
fiscal 1995 restructuring charge totaled 200.
FISCAL YEAR 1994
The Company recorded a $74,834 special charge during the fiscal year ended
May 31, 1994. The special charge resulted from several measures to streamline
operations and improve productivity. This charge was comprised of several items
including the following:
(i) Approximately $50,244 of the charge was associated with the
impairment of assets at eight rehabilitation hospitals, divestiture of two
rehabilitation hospitals, closure of a select group of outpatient locations
and miscellaneous other charges.
(ii) Approximately $12,042 of the charge was related to the
consolidation of certain contract therapy companies and the exit from
certain markets and businesses. This consolidation process involved the
closure of offices, relocation and severance of personnel and the
elimination of duplicative processes.
(iii) Approximately $10,800 of the charge is related to the write-down
of uncollectible receivables resulting from the termination of certain
business relationships at its contract therapy division. During fiscal 1994,
the Company exited business arrangements in which it provided therapists to
unrelated Medicare certified agencies which in turn supplied those
therapists to non-Medicare certified skilled nursing facilities. For a
variety of business reasons the Company exited those relationships and, in
many instances, began to provide the same services directly to Medicare
patients upon termination of the contracts with the agencies. Following
termination of the contracts, the Company continued to assess the
collectability of the agency receivables and, due to deteriorating business
relations and declining financial condition of the agencies, it was
determined a write-down of these receivables was required as of May 31,
1994.
(iv) The remainder of the charge, $1,748, was to reduce the work force
at a divisional corporate office and provide for transaction costs to
execute the plan.
69
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
For the Years Ended May 31, 1996, 1995 and 1994
(dollars in thousands, except per share amounts)
(7) SPECIAL CHARGE (CONTINUED)
All restructuring measures committed to during fiscal 1994 have been
substantially completed and the costs accrued and write-downs anticipated in
connection with these charges have been recorded during fiscal 1994 and paid
during and subsequent to fiscal 1994 substantially as planned.
The components of the fiscal year 1994 special charge are as follows (in
thousands):
<TABLE>
<CAPTION>
Impairment
and Noncancellable Termination Transaction Lease Exit
Committments Benefits Costs and Other Total
----------------- ------------ ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Fiscal Year 1994 Special Charge $ 61,044 $ 7,516 $ 2,192 $ 4,082 $ 74,834
Fiscal Year 1994 Activity:
Payments (372) - (730) (828) (1,930)
----------------- ------------ ------------- ------------ ------------
Balance May 31, 1994 $ 60,672 7,516 1,462 3,254 72,904
Fiscal Year 1995 Activity:
Payments - (7,135) (1,462) (3,254) (11,851)
Asset Impairment (54,397) - - - (54,397)
----------------- ------------ ------------- ------------ ------------
Balance May 31, 1995 $ 6,275 381 - - 6,656
Fiscal Year 1996 Activity:
Payments (1,380) (3) - - (1,383)
----------------- ------------ ------------- ------------ ------------
Balance May 31, 1996 $ 4,895 $ 378 $ - $ - $ 5,273
================= ============ ============= ============ ============
</TABLE>
At May 31, 1996, the number of employees terminated in connection with the
fiscal 1994 restructuring charge totaled 196.
(8) INCOME TAXES
On June 1, 1993, the Company adopted SFAS 109 through retroactive
restatement of its financial statements from June 1, 1990. The adoption did not
have a material effect on the Company's financial condition or results of
operations.
The provision for income taxes on earnings (loss) before extraordinary items
consists of the following:
1996 1995 1994
--------- --------- ---------
Current
Federal.................................... $ 32,785 $ 5,801 $ 11,397
State...................................... 8,314 3,686 2,462
--------- --------- ---------
41,099 9,487 13,859
Deferred:
Federal.................................... (8,646) 10,594 (11,475)
State...................................... (781) 2,267 (954)
--------- --------- ---------
(9,427) 12,861 (12,429)
--------- --------- ---------
Total...................................... $ 31,672 $ 22,348 $ 1,430
========= ========= =========
70
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(8) INCOME TAXES (CONTINUED)
The differences between the total tax expense recorded on earnings (loss)
before extraordinary item and the income tax expense using the statutory federal
income tax rate (35 percent) were as follows:
1996 1995 1994
--------- --------- ---------
Computed tax expense at statutory rate....... $ 14,121 $ 15,997 ($ 6,603)
State income tax expense, net of federal
income tax benefit.......................... 5,629 4,597 886
Amortization of goodwill..................... 1,295 1,245 640
Assessments.................................. -- 83 2,983
Change in valuation allowance................ (579) (800) 970
Goodwill, write-offs, merger costs and other
special charges............................. 10,234 850 1,730
Other........................................ 972 376 824
--------- --------- ---------
Total income tax expense................. $ 31,672 $ 22,348 $ 1,430
========= ========= =========
The components of the net deferred tax assets and liabilities are as
follows:
<TABLE>
<CAPTION>
1996 1995
---------- ----------
<S> <C> <C>
Components of the deferred tax asset:
Reserves for special charges................................... $ 25,216 $ 19,023
Allowance for doubtful accounts................................ 13,902 11,148
Accrued payroll and related benefits........................... 6,197 3,867
Other accrued liabilities...................................... 13,020 7,879
Tax carryforward items......................................... 4,702 5,283
Deferred lease credit.......................................... 2,065 7,630
Other.......................................................... 3,163 3,885
---------- ----------
Total deferred tax asset......................................... 68,265 58,715
---------- ----------
Valuation allowance.............................................. (2,250) (4,051)
---------- ----------
Net deferred tax asset........................................... 66,015 54,664
---------- ----------
Components of the deferred tax liability:
Buildings and equipment, related basis differences, deferred
gain and depreciation......................................... (34,704) (31,114)
Difference between reporting income/loss from partnership
investments for financial and income tax reporting............ (1,971) (2,172)
Other.......................................................... (4,887) (5,713)
---------- ----------
Total deferred tax liability..................................... (41,562) (38,999)
---------- ----------
Excess deferred assets over liabilities...................... $ 24,453 $ 15,665
========== ==========
</TABLE>
71
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(8) INCOME TAXES (CONTINUED)
As a result of business combinations during the years ended May 31, 1996 and
1995, net deferred income tax assets of $567 and $4,238, respectively, and
related valuation allowances of $1,179 and $0 respectively, were recorded.
The valuation allowance is the result of: (i) separate return loss
carryforward limitations; (ii) states with no or limited loss carryover
provisions; and (iii) limitations on the Company's ability to absorb capital
losses in the five year carryforward period. The valuation allowance decreased
by $2,980 during fiscal 1996, of which $2,401 resulted from the recognition of
certain federal and state loss carryover benefits from a prior business
combination. This recognized tax benefit has been recorded as a reduction in
goodwill. The balance of the reduction is primarily due to recognized state tax
benefits and is reflected in the tax provision.
The Company has regular tax net operating loss carryforwards of
approximately $6,000 which are subject to separate return year limitations and
expire in years 2007 through 2010. In addition, the Company also has an
estimated alternative minimum tax credit carryforward of $1,300 which is
available for utilization indefinitely and has an estimated $1,400 separate
return limitation year capital loss carryforward. The capital loss is only
available to offset future capital gain income and will expire in fiscal 1998.
(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. Net proceeds of approximately $119,600 were used to repay
outstanding debt under the revolving credit loan agreement and to fund
acquisitions.
As discussed in note 5, the Company converted $54,270 of its 6 3/4%
convertible subordinated notes into 4,522,500 shares of the Company's common
stock during the third quarter of fiscal 1994. The conversion price was $12 per
share.
In October 1993, the Company completed a common stock offering of 4,025,000
shares. Net proceeds of approximately $58,200 were used to repay outstanding
debt under the revolving credit loan agreement and to fund acquisitions.
72
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(9) CAPITAL STOCK (CONTINUED)
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, 1996,
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 which 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-statutory 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.
73
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(9) CAPITAL STOCK (CONTINUED)
In connection with the administrative 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.
No compensation has been recorded in the accompanying consolidated financial
statements for the options granted.
All options granted under the previous employee plan and directors' plan
expire ten 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 the following stock compensation plans at
May 31, 1996: the 1986 stock option plan (1986 Plan), the 1989 non-qualified
stock option agreement, the 1989 non-employee directors' stock option plan, the
1992 CEO stock option plan (1992 Plan), the 1993 non-qualified stock option plan
(1993 Plan), and the 1994 stock option plan (1994 Plan). Options outstanding at
May 31, 1996, are at prices ranging from $9.73 to $40.47 per share, as adjusted
for the Exchange Rate (as defined below). As options are granted at exercise
prices which represent the fair market value of the stock at the date of grant,
no compensation expense has been recorded for these awards. 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.
The 1994 plan was adopted in August 1993, which authorized options of
809,550 shares, as adjusted for the Exchange Rate. In May 1993, the 1993 Plan
was adopted which authorized options on 539,700 shares, as adjusted for the
Exchange Rate. Officers and directors were not eligible to receive options under
the 1993 Stock Option Plan.
In May 1993, options, exercisable at the market price on the date of grant
($20.38 per share, as adjusted for the Exchange Rate), were granted to
substantially all CMS employees holding outstanding options with exercise prices
higher than such current market price. The number of shares subject to the
options granted to each employee was equal in number to the shares covered by
options previously granted to such employee at higher exercise prices. The new
options were granted subject to each employee's agreement to cancel their
previously
74
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(9) CAPITAL STOCK (CONTINUED)
granted options for an equal number of shares at the higher exercise prices. The
term, vesting rate and other provisions of the new options were otherwise
identical to the options canceled. As a result, options on 1,802,159 shares with
exercise prices per share ranging from $24.09 to $42.39 per share, as adjusted
for the Exchange Rate, were canceled and the same number of new options were
granted at an exercise price of $20.38 per share, as adjusted for the Exchange
Rate.
The following information is a summary of the stock option activity under
the plans as adjusted for a three-for-two stock split paid November 15, 1991 on
CMS common stock and the exchange of .5397 shares (the "Exchange Rate") of CMS
common stock for each share of the Company's common stock in connection with the
CMS merger:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED MAY 31,
-------------------------------------------------------
1996 1995 1994
----------------- ----------------- -----------------
<S> <C> <C> <C>
Options outstanding at beginning
of year......................... 6,221,774 4,916,079 3,951,921
Granted.......................... 2,198,265 1,934,116 1,518,311
Options exercised:
1996 ($1.38 to $25.50)......... (1,366,557)
1995 ($1.38 to $20.75)......... (338,881)
1994 ($1.38 to $14.63)......... (319,997)
Canceled and other adjustments... (2,106,239) (289,540) (234,156)
----------------- ----------------- -----------------
Options outstanding at end of
year............................ 4,947,243 6,221,774 4,916,079
================= ================= =================
Options exercisable at end of
year............................ 1,885,420 2,596,947 1,576,011
================= ================= =================
Option price range............... $1.38 - $40.47 $1.38 - $28.75 $1.38 - $26.13
================= ================= =================
</TABLE>
The Company had an employee stock purchase plan (the "ESP Plan") until June
30, 1996. The ESP Plan 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. For the year ended May 31, 1996, 25,307 shares of the Company's stock
had been purchased under the ESP Plan. The board of directors of the Company
terminated the ESP Plan effective as of June 30, 1996. In its place, the board
of directors adopted the Horizon/CMS Healthcare Corporation 1996 Employee Stock
Purchase Plan (the "1996 ESP Plan"). The 1996 ESP Plan, which provides for
issuance of up to 250,000 shares of common stock, 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
75
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(9) CAPITAL STOCK (CONTINUED)
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. The board of directors has submitted
the 1996 ESP Plan for approval by the stockholders at the Company's 1996 Annual
Meeting of Stockholders.
In connection with the Greenery acquisition, the Company issued to one of
the Company's former directors 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
$238, $261 and $254 to these plans for the years ended May 31, 1996, 1995 and
1994, 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. The Company
contributed approximately $2,286, $1,890 and $1,377 to these plans for the years
ended May 31, 1996, 1995 and 1994, 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.
76
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(11) FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the Company's financial instruments at May 31,
are as follows:
<TABLE>
<CAPTION>
1996 1995
------------------------ ------------------------
CARRYING CARRYING
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Notes receivable...................... $ 77,217 $ 77,717 $ 49,804 $ 47,769
Investments in marketable equity
securities and other short-term
investments.......................... 1,425 1,425 3,287 8,500
Long-term debt........................ 591,601 593,593 478,955 492,392
Interest rate hedges.................. -- (106) -- (3,572)
</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 comprise
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 collars are the estimated amounts that the
Company would pay to terminate the swap agreements, taking into account current
interest rates.
The market value of the outstanding convertible subordinated notes at May
31, 1996 of $21,835 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 1996, 1995 and 1994, the Company implemented its strategy of
expanding its operations through the acquisition in select geographic areas of
long-term care facilities and providers of specialty health care services. The
acquisitions, with exception of the CMS merger, have been accounted for under
the purchase method of accounting.
In July 1995, the Company completed the CMS merger (see Note 15 for expanded
disclosure regarding this merger). In connection with this acquisition the
Company issued approximately 20.9 million shares of common stock, valued at
approximately $393,900. The merger was accounted for as a pooling of interests.
77
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(12) ACQUISITIONS (CONTINUED)
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.
In February 1994, the Company completed its merger of Greenery
Rehabilitation Group, Inc. ("Greenery") into the Company. Pursuant to the
merger, the Company issued approximately 2,050,000 shares of its common stock,
valued at approximately $48,000, and assumed approximately $58,000 in debt for
all of the outstanding shares of Greenery common stock. This merger added the
operations of 17 rehabilitation and skilled nursing facilities and 3 managed
facilities to the Company's operations. The Company has announced plans to
dispose of certain of the acquired facilities in the Greenery merger. The
decision to sell the facilities was based upon financial, regulatory and
operational considerations.
During fiscal 1996, 1995 and 1994, the Company made various other
acquisitions which individually and in the aggregate were insignificant.
Subsequent to year end, on July 11, 1996, the Company completed the merger
of a wholly owned subsidiary of the Company and Medical Innovations, Inc. Under
the merger agreement, the Company paid $1.85 for each share of Medical
Innovations, Inc. common stock. The total purchase price, including transaction
costs, of this acquisition, which has been accounted for under the purchase
method of accounting, was approximately $31,800 in cash. In addition, the
Company assumed approximately $10,700 in debt. Medical Innovations, Inc.
provides specialized home care services, home medical equipment, home medical
services, and intravenous therapies, as well as comprehensive home healthcare
management services under contractual arrangements with hospitals and other
providers. Total revenues of Medical Innovations, Inc. for its fiscal year ended
December 31, 1995 was $69.4 million.
(13) MANAGEMENT AGREEMENT
In December 1995, the Company announced that it had finalized a contract to
manage the operations of 134 long-term care facilities in Texas, Michigan and
Oklahoma which are operated under long-term leases by Texas Health Enterprises,
Inc., HEA of Michigan, Inc. and HEA of Oklahoma, Inc. (Collectively, the "HEA
Group"). The Company began managing these facilities on January 1, 1996 under a
management contract between a subsidiary of the Company and the HEA Group, which
has an initial term of ten years. The Company will receive a management fee
equal to 6.5% of the annual gross revenues generated from the operation of the
HEA Group facilities which revenues, in the aggregate, for the year ended
December 31, 1995 approximated $220,000. The Company has made available a
$30,000 credit line for, among other things, the working capital and capital
improvement requirements of the facilities covered by the
78
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(13) MANAGEMENT AGREEMENT (CONTINUED)
management contract. Amounts outstanding under the credit line and the related
management agreement of May 31, 1996 totaled approximately $21,600 and $5,100,
respectively, and were secured by accounts receivable and other assets of the
HEA Group facilities. The Company believes the terms of this contract are
representative of the market rates for such services.
(14) COMMITMENTS AND CONTINGENCIES
LETTERS OF CREDIT
The Company was contingently liable for letters of credit aggregating
$37,900 and $40,900 at May 31, 1996 and 1995, 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 annual employment agreements with two executive officers, the Company
is committed to pay minimum annual salaries totaling $816, subject to certain
covenants. In addition, the employment agreements provide for annual retirement
benefits and disability benefits equal to a maximum of 50 percent of each
officer's base salary. The retirement benefits vest in equivalent increments
over 10 years and 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 one-half of the vested 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.
In connection with the retirement of an executive officer in December 1995,
the Company entered into a two year consulting arrangement that provides for
payments totaling $350 each year. In accordance with the terms of a preexisting
employment agreement, the Company will begin making annual retirement benefit
payments totaling approximately $175 each year.
In connection with the CMS merger, the Company has entered into a two year
consulting agreement with a former executive officer of CMS commencing on July
10, 1995 for which the Company has agreed to pay an annual retainer fee of $50
annually. This agreement will be automatically extended for additional one year
periods unless notice is given by either the Company or the former executive
officer.
In addition and in connection with the Greenery merger, the Company has
entered into a seven year consulting agreement with a former officer of Greenery
for which the Company has agreed to pay annual consulting fees of $175.
79
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(14) COMMITMENTS AND CONTINGENCIES (CONTINUED)
LIFE INSURANCE PREMIUMS
The Company funds life insurance premiums for certain current and former
executive officers. As of May 31, 1996, such advances totaled approximately
$2,193 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 for up to five
years, subject to the affiliate's right to terminate sooner at any time with 90
days notice.
The Company guarantees payment throughout the term of a bond issue to an
economic development authority of amounts due and payable by the owner of a
long-term care facility previously managed by the Company. The outstanding bonds
total approximately $5,920 at May 31, 1996.
As of May 31, 1996, the Company has future commitments to fund construction
totaling approximately $49,298. The substantial majority of this total is
comprised of amounts necessary to complete construction on an office building to
house corporate operations.
(15) 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
80
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(15) CMS MERGER (CONTINUED)
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 qualifies 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 balance sheet as of May 31, 1995, gives effect
to the combination of the historical cost basis of the Company's assets,
liabilities and stockholders' equity as of May 31, 1995, with the historical
cost basis of the assets, liabilities and stockholders' equity of CMS as of June
30, 1995, the fiscal year end of CMS prior to the CMS Merger. The accompanying
consolidated statements of operations for the years ended May 31, 1995 and 1994,
include the results of operations of the Company for the years ended May 31,
1995 and 1994, and the results of operations of CMS for the years ended June 30,
1995 and 1994, respectively. 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
$4.1 million 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.
81
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(15) CMS MERGER (CONTINUED)
Separate results of the Company and CMS for the three years in the period
ended May 31, 1996 are as follows:
<TABLE>
<CAPTION>
1996 1995 1994
------------- ------------- -------------
<S> <C> <C> <C>
Total operating revenues:
The Company................................ $ 59,065 $ 635,398 $ 373,099
CMS........................................ 83,684 987,260 1,008,281
The Company, subsequent to the CMS
merger.................................... 1,613,785 -- --
------------- ------------- -------------
$ 1,756,534 $ 1,622,658 $ 1,381,380
============= ============= =============
Earnings (loss) before extraordinary item:
The Company................................ $ 2,280 $ 28,238 $ 14,250
CMS........................................ 4,122 (4,881) (34,545)
The Company, subsequent to the CMS
merger.................................... 2,272 -- --
------------- ------------- -------------
$ 8,674 $ 23,357 $ (20,295)
============= ============= =============
Net earnings (loss):
The Company................................ $ 2,280 $ 28,851 $ 14,984
CMS........................................ 4,122 (2,923) (34,545)
The Company, subsequent to the CMS
merger.................................... (29,056) -- --
------------- ------------- -------------
$ (22,654) $ 25,928 $ (19,561)
============= ============= =============
</TABLE>
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 1994
----------- -----------
Total operating revenues:
As previously reported.................. $ 636,412 $ 374,313
Adjustments............................. (1,014) (1,214)
----------- -----------
$ 635,398 $ 373,099
----------- -----------
----------- -----------
Net earnings:
As previously reported.................. $ 29,580 $ 16,125
Adjustments............................. (729) (1,141)
----------- -----------
$ 28,851 $ 14,984
----------- -----------
----------- -----------
82
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(16) 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 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.
The Company has been 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 will not commence any civil or criminal
action or proceeding against the Company in respect of this investigation. The
Company has also been informed that both the criminal and civil divisions of the
United States Attorney's office in Harrisburg, Pennsylvania are closing their
investigation in this regard and they will not commence any civil or criminal
action or proceeding against the Company in respect of this investigation.
LITIGATION AGAINST TENET HEALTHCARE CORPORATION
The Company 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 the Company
and Tenet in connection with the Company's attempted acquisition of The
Hillhaven Corporation ("Hillhaven") in January 1995. In the lawsuit, the Company
alleges that Tenet has failed to honor its commitment to pay Horizon
approximately $14.5 million pursuant to the agreement. Tenet has contended that
the amount owing to the Company under the agreement is approximately $5.1
million. In the quarter ended November 30, 1995, the Company recognized as a
receivable approximately $13.0 million of the approximately $14.5 million the
Company contends it is owed under the agreement and reserved approximately $1.5
million of such amount. The Company intends to vigorously prosecute this
lawsuit. By its very nature, however, litigation is an uncertain process and no
assurance can be given that Horizon will ultimately prevail. In considering
whether any additional reserve was required because of this uncertainty,
management of the Company consulted with its outside legal counsel handling this
matter, reviewed documents produced by Tenet in the litigation, reviewed public
announcements by Tenet at or around the time of the Hillhaven merger and other
materials and analyzed the ability of Tenet to pay the amounts owing to the
Company under the agreement. Based upon these considerations, management of the
Company determined that, although a future material charge in this regard was
reasonably possible, it was not probable and, as a result, no additional reserve
was required.
OIG/DOJ INVESTIGATION INVOLVING CERTAIN MEDICARE PART B
AND RELATED CO-INSURANCE BILLINGS
The Company announced on March 15, 1996 that certain Medicare Part B and
related co-insurance billings previously submitted by the Company are being
investigated by the OIG and the DOJ. These billings, totaling approximately $3.4
million, sought recovery for the costs of certain Medicare Part B covered
medical supplies used in treating Medicare patients in certain facilities at a
time when those facilities were operated by Greenery before the Company acquired
Greenery. These costs were not billed at the time incurred but were billed on a
retroactive basis, as permitted under applicable Medicare Part B rules, after
the Greenery acquisition. Of the $3.4 million billed, approximately $1.3 million
has been remitted to the Company.
83
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(16) LEGAL PROCEEDINGS (CONTINUED)
The Company has advised the OIG that it appears that a significant portion
of the billings may not have been in accordance with applicable Medicare Part B
rules. The Company advised the OIG and the DOJ that it was cooperating, and will
continue to cooperate, in the investigation and was prepared to remit any
overpayment to the appropriate governmental authority. On April 2, 1996, the
Company and DOJ entered into a letter agreement pursuant to which the Company
voluntarily agreed to refund such overpayment to the DOJ. On April 3, 1996, the
Company refunded approximately $1 million to the DOJ. In addition, the Company
voluntarily refunded co-insurance payments to the applicable parties. The
Company believes the errors in these billings were an exception and do not
represent a regular pattern or practice at the Company. Due to the preliminary
nature of the OIG/DOJ investigation, the Company cannot now predict when the
OIG/DOJ investigation will be completed; the ultimate outcome of the OIG/DOJ
investigation; or the effect thereof on the Company's financial condition or
results of operations. If as a result of the OIG/DOJ investigation, civil or
criminal proceedings against the Company are initiated and adversely determined,
civil and/or criminal fines or sanctions could be imposed against the Company,
which could have a material adverse impact on the Company's financial condition
and/or its results of operations.
The Company recorded a charge during the years ended May 31, 1995 and 1994
of approximately $2.7 million and $0.7 million, pre-tax, respectively, to write
off all revenue associated with the retroactive Medicare Part B and related
co-insurance billings. In addition, the Company recorded a charge during the
year ended May 31, 1996 of approximately $1.7 million related to the costs of
both the Company's internal investigations and the OIG/DOJ investigation.
SECURITIES AND EXCHANGE COMMISSION AND NEW YORK STOCK EXCHANGE
INVESTIGATIONS
The Company has been advised that the staff of the Division of Enforcement
of the Commission has commenced a private investigation with respect to trading
in the securities of the Company and CMS. In connection with that investigation,
the Company has voluntarily produced certain documents and Neal M. Elliott,
Chairman of the Board, President and Chief Executive Officer of the Company, has
voluntarily given testimony to the Commission. The Company has also been
informed that certain of its employees, executive officers and an individual,
affiliates of whom have limited business relationships with the Company, have
responded to subpoenas from the Commission. Mr. Elliott has also produced
certain documents in response to a subpoena from the Commission. In addition,
the Company and Mr. Elliott have responded to separate subpoenas from the
Commission pertaining to trading in the Company's common stock and the Company's
March 1, 1996 press release announcing a revision in the Company's third quarter
earnings estimate, the Company'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 Rehabilitation & Sports
84
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(16) LEGAL PROCEEDINGS (CONTINUED)
Medicine, Inc. could not be effected by April 1, 1996 and the Company's March
15, 1996 press release announcing the existence of a federal investigation into
certain of the Company's Medicare Part B billings. The investigation is ongoing,
and neither the Company nor Mr. Elliott possesses all the facts with respect to
the matters under investigation. Although neither the Company nor Mr. Elliott
has been advised by the Commission that the Commission has concluded that any of
the Company, Mr. Elliott or any other current or former officer or director of
the Company 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 the Company and Mr. Elliott intend to continue cooperating
fully with the Commission in connection with the investigation.
In March 1995, the New York Stock Exchange, Inc. (the "NYSE") informed the
Company that it had initiated a review of trading in Hillhaven common stock
prior to the announcement of the Company's proposed acquisition of Hillhaven.
The NYSE extended in April 1995 the review of trading to include all dealings
with CMS. On April 3, 1996, the NYSE notified the Company that it had initiated
a review of trading in the Company's common stock preceding the Company's March
1, 1996 press release described above. The Company is cooperating with the NYSE
in its review and, to the Company's knowledge, the reviews are ongoing.
STOCKHOLDER LITIGATION
On March 28, 1996, the Company 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 VS. 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 the Company
in its June 6, 1995 joint proxy statement/prospectus (the "CMS Prospectus"). The
plaintiff alleges that the Company failed to disclose in the CMS Prospectus
those problems in the Company's Medicare Part B billings the Company described
in its related March 15, 1996 announcement. In this action, the plaintiff seeks
damages in an unspecified amount, plus costs and attorneys' fees. The Company
disputes the factual and legal premises upon which the plaintiff's lawsuit is
based and denies that the plaintiff is entitled to any recovery on his claim. To
that end, the Company intends to contest this litigation vigorously. Subsequent
to the end of fiscal 1996, the Company filed its motion seeking to dismiss this
lawsuit because, among other things, the Company believes the lawsuit fails to
state a claim upon which the plaintiffs are entitled to redress. Because the
lawsuit just began, the Company cannot now predict the outcome of
85
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(16) LEGAL PROCEEDINGS (CONTINUED)
this litigation; the length of time it will take to resolve this litigation; or
the effect of any such outcome on the Company's financial condition or results
of operations.
Since April 5, 1996, the Company has been served with the below listed
complaints by current or former stockholders of the Company on behalf of all
persons who purchased common stock of the Company 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 these lawsuits,
the plaintiffs have alleged in substantially similar complaints violations of
federal and New Mexico state securities laws. In this connection, the plaintiffs
allege that during the class period, the named defendants disseminated
materially misleading statements or omitted disclosing material facts about the
Company, its business, its Greenery and CMS acquisitions, Greenery's improved
operations after the acquisition, the successful integration of CMS's operations
into those of the Company and the cost savings and operating efficiencies
obtained thereby, the Company's earnings growth and financial statements, the
Company's ability to continue to achieve profitable growth and the status and
magnitude of regulatory investigations into and audits of the Company. The
plaintiffs seek damages in an unspecified amount and extraordinary, equitable or
injunctive relief, including attachment, impoundment, or imposition of a
constructive trust against the individual defendants, plus costs and attorneys'
fees. The Company disputes the factual and legal bases upon which the
plaintiffs' lawsuits are based and denies that the plaintiffs are entitled to
any recovery on their claims. To that end, the Company intends to contest these
litigation matters vigorously. The following actions are currently pending:
ROSENBAUM V. HORIZON/CMS HEALTHCARE CORPORATION, NEAL M. ELLIOTT, ROBERT
A. ORTENZIO, KLEMETT L. BELT, JR., ROCCO A. ORTENZIO, ERNEST A.
SCHOFIELD AND RUSSELL L. CARSON, No. CIV 96-0447-JC.
DONNARUMMA ET AL., V. HORIZON/CMS HEALTHCARE CORPORATION, ROCCO A.
ORTENZIO, NEAL M. ELLIOTT, ROBERT A. ORTENZIO, RUSSELL L. CARSON,
KLEMETT L. BELT, JR., AND ERNEST A. SCHOFIELD, No. CIV 96-0442-BB.
BOWLES V. ROCCO A. ORTENZIO, NEAL M. ELLIOTT, ROBERT A. ORTENZIO,
RUSSELL L. CARSON, KLEMETT L. BELT, JR., ERNEST A. SCHOFIELD AND
HORIZON/CMS HEALTHCARE CORPORATION, No. CIV 96-0555-SC.
MARSCHKE V. ROCCO A. ORTENZIO, NEAL M. ELLIOTT, ROBERT A. ORTENZIO,
RUSSELL L. CARSON, KLEMETT L. BELT, JR., ERNEST A. SCHOFIELD AND
HORIZON/CMS HEALTHCARE CORPORATION, No. CIV 96-0560-MV.
WEINGARTEN V. HORIZON/CMS HEALTHCARE CORPORATION, HORIZON HEALTHCARE
CORPORATION, NEAL ELLIOTT, KLEMETT L. BELT, JR., ROCCO ORTENZIO, LEROY
S. ZIMMERMAN, BRIAN C. CRESSEY, RUSSELL L. CARSON, ROBERT A. ORTENZIO
AND ERNEST A. SCHOFIELD, No. CIV 96-0610-MV.
86
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(16) LEGAL PROCEEDINGS (CONTINUED)
THEOPHANO V. NEAL M. ELLIOTT, ROCCO ORTENZIO, ROBERT A. ORTENZIO,
RUSSELL L. CARSON, KLEMETT L. BELT, JR., ERNEST A. SCHOFIELD AND
HORIZON/CMS HEALTHCARE CORPORATION, No. CIV 96-0626-MV.
BERENDA V. ROCCO A. ORTENZIO, NEAL M. ELLIOTT, ROBERT A. ORTENZIO,
RUSSELL L. CARSON, KLEMETT L. BELT, JR., ERNEST A. SCHOFIELD AND
HORIZON/CMS HEALTHCARE CORPORATION, No. CIV 96-0634-BB.
WIESEL V. HORIZON/CMS HEALTHCARE CORPORATION, NEAL M. ELLIOTT AND ROBERT
A. ORTENZIO, No. 96-0614-MV.
GOLDFARB V. HORIZON/CMS HEALTHCARE CORPORATION, ROCCO A. ORTENZIO, NEAL
M. ELLIOTT, ROBERT A. ORTENZIO, RUSSELL L. CARSON, KLEMETT L. BELT, JR.,
AND ERNEST A. SCHOFIELD, No. CIV 96-0752-LH.
Subsequent to fiscal 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.
Because these lawsuits are in their initial stages, the Company cannot now
predict the outcome of this litigation; the length of time it will take to
resolve this litigation; or the effect of any such outcome on the Company's
financial condition or results of operations.
STOCKHOLDER DERIVATIVE ACTIONS
Commencing in April and continuing into May 1996, the Company was served
with six complaints alleging a class action derivative action brought by
stockholders of the Company for and on behalf of the Company 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 N. Noveck, Barry M. Portnoy, and LeRoy S. Zimmerman. The six
lawsuits have been consolidated into one action styled IN RE HORIZON/CMS
HEALTHCARE CORPORATION SHAREHOLDERS LITIGATION. The plaintiffs allege, among
other things, that the Company's current and former directors breached their
fiduciary duties to the Company and the stockholders as a result of (i) the
purported failure to supervise adequately and the purported knowing
mismanagement of the operations of the Company, and the (ii) purported misuse of
inside information in connection with the sale of the Company'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 the Company as a result of the transaction
complained of in the complaint and attorneys' fees and costs. The Company cannot
now predict the outcome or the effect of this litigation or the length of time
it will take to resolve this litigation. On June 21, 1996, the individual
87
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(16) LEGAL PROCEEDINGS (CONTINUED)
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.
In April 1996, the Company was served with a complaint in a stockholders
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 the
Company's current and former directors breached their fiduciary duties to the
Company and the stockholders as a result of (i) the purported failure to
supervise adequately and the purported knowing mismanagement of the operations
of the Company, and the (ii) purported misuse of inside information in
connection with the sale of the Company'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 the Company as a result of the transaction complained of in the
complaint and attorneys' fees and costs. The Company 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. The Company cannot now predict the outcome or the effect of this
litigation or the length of time it will take or resolve this litigation.
(17) EXTRAORDINARY ITEM
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
10 3/8% Notes were redeemed at 109.25% plus a consent fee of 1.05% and the 10
7/8% 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 Subordinared 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 $18.2 million 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
88
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(17) EXTRAORDINARY ITEM (CONTINUED)
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. In accordance with the provisions of Accounting Principles Board
Opinion No. 16 ("APB 16"), "Business Combinations," 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, 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 should be classified as an extraordinary item, net of tax. Because the
$11.9 million first quarter asset disposal charge occurred prior to the CMS
merger, that charge was appropriately classified within operations.
The operations currently proposed for disposition include 21 leased long-
term care facilities, ten owned long-term care facilities, three managed long-
term care facilities, one pharmacy operation, the Company's rights in respect of
one pharmacy operation, and the Company's investment interest in a pharmacy
operation. The assets to be disposed of comprise substantially all of the
Company's operations in the states of Massachusetts, Connecticut, Ohio and
Wisconsin. Certain other of the targeted assets are located in Michigan and
Colorado.
The results of operations of the properties held for sale as of May 31, are
as follows (unaudited):
1996 1995 1994
------------ ------------ ------------
Revenues............................. $ 180,212 $ 171,874 $ 111,602
Expenses............................. (176,033) (165,365) (101,877)
Pre-tax income (loss)................ (4,850) (3,480) 4,081
Total assets, net of the impairment reserve discussed above, or
approximately $118,697 related to the operations to be disposed of have been
reclassified and are included within prepaid and other assets in the May 31,
1996 balance sheet. Total liabilities of $27,932 related to these operations
have been reclassified to accrued expenses and other liabilities in the May 31,
1996 balance sheet. In the May 31, 1995 balance sheet, the related assets and
liabilities held for sale have been aggregated and reclassified as follows: (i)
$34,608 of current assets is recorded as prepaid and other assets, (ii) $90,522
of non-current assets is recorded as other assets, (iii) $13,678 of current
liabilities is recorded as accrued expenses and other, and (iv) $20,846 of
non-current liabilities is recorded as other liabilities.
89
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(17) EXTRAORDINARY ITEM (CONTINUED)
The proposed disposition, though subject to final approval of the purchaser,
the consent of the Company's landlords, the consent and release of liability by
one of the Company's landlords, and the approval of various regulatory
authorities, is expected to be completed in the second or third quarter of
fiscal 1997.
This planned disposition, approved in the first quarter of fiscal 1996 and
originally expected to be completed during fiscal 1996, has been delayed several
times due to protracted negotiations with several potential acquirers.
Negotiations and the subsequent approval process pursuant to the purchase and
sale agreement currently pending have been ongoing since March of 1996.
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 8 3/4% and 6 1/2% convertible subordinated notes at a
discount.
FISCAL YEAR 1994
During fiscal 1994, the Company recognized a gain of $734 ($1,214 less
related tax effect of $480) relating to open market purchases of its 8 3/4% and
6 1/2% convertible subordinated notes at a discount.
(18) PRIOR PERIOD ADJUSTMENTS
During the three months ended February 29, 1996, the Company originally
recorded approximately $18.2 million of estimated reimbursement benefit for
costs incurred in connection with the CMS bond tender offer completed during the
three month period ended November 30, 1995 (See Note 17). In light of the fact
that the reimbursement benefit is directly related to the incurrance of the bond
tender costs, subsequent to fiscal 1996 the Company restated the fiscal 1996
second and third quarter financial statements to record this revenue during the
three months ended November 30, 1995 rather than during the three months ended
February 29, 1996.
In addition, during the three months ended February 29, 1996, the Company
originally recorded a charge of approximately $3.4 million, pre-tax, to write
off revenue associated with certain retroactive Medicare Part B and related
co-insurance billings (See Note 16 - Legal Proceedings - OIG/DOJ Investigation
Involving Certain Medicare Part B and Related Co-Insurance Billings). As
previously disclosed, the reversal of the $3.4 million in previous billings was
based, in part, on errors in the original determinations of billable revenue
made during fiscal years 1995 and 1994. As a result, subsequent to fiscal 1996,
the Company restated the fiscal year 1996, 1995 and 1994 financial statements to
eliminate the revenue recorded originally during fiscal 1995 and 1994 in the
amounts of approximately $2.7 million and $0.8 million, respectively, and to
eliminate the $3.4 million reversal of revenue originally recorded during fiscal
1996.
The effect of the restatements discussed above on earnings (loss) before
income taxes and extraordinary items, earnings (loss) before extraordinary
items, net earnings (loss) and earnings (loss) per share was $3.5 million, $2.1
million, $2.1 million and $0.04 million during the fiscal 1996, respectively,
($2.7) million, ($1.6) million, ($1.6) million and ($0.04) million during fiscal
1995, repectively, and ($0.8) million, ($0.5)million, ($0.5) million and ($0.01)
million during fiscal 1994, respectively.
90
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(19) QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a summary of the unaudited quarterly results of operations
(As Restated):
<TABLE>
<CAPTION>
FISCAL YEAR 1996
-------------------------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER(A) QUARTER(B)(C)(D) QUARTER(E)(F) QUARTER(G)(H)
----------- --------------- ----------------- ---------------
<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>
<TABLE>
<CAPTION>
FISCAL YEAR 1995
-------------------------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER(I) QUARTER(J)(K) QUARTER(L)(M)
----------- --------------- ----------------- ---------------
<S> <C> <C> <C> <C>
Total operating revenues.................................... $381,540 $400,472 $ 414,610 $426,036
Gross profit................................................ 66,492 67,066 72,086 73,481
Earnings before income taxes and extraordinary item......... 20,471 2,921 16,728 5,585
Earnings before extraordinary item.......................... 11,975 577 9,448 1,357
Net earnings................................................ 11,975 577 11,945 1,431
Earnings per common and common equivalent share:
Earnings before extraordinary item.......................... $ 0.27 $ 0.01 $ 0.19 $ 0.02
Extraordinary item.......................................... -- -- 0.05 0.01
----------- --------------- ----------------- ---------------
Net earnings................................................ $ 0.27 $ 0.01 $ 0.24 $ 0.03
=========== =============== ================= ===============
</TABLE>
- ----------------------------------
(a) Includes a $63.5 million 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.
(b) Includes $9.3 million of revenue, net of $3.7 million 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 16).
(c) Includes a $22.1 million extraordinary loss (net of tax) relating to the
extinguishment of senior subordinated debt.
(d) Includes $18.2 million of revenue resulting from the estimated Medicare
reimbursement for costs incurred by the Company in the tender for CMS's
Senior Subordinated Notes (Note 17)
(e) Includes $7.0 million reduction of revenue recorded to increase third-party
settlement receivable reserves.
(f) Includes $1.7 million pre-tax charge related to the Company's OIG/DOJ
Medicare Part B billings investigation.
(g) Includes a $17.0 million pre-tax special charge resulting from the
impairment of certain long-lived assets and the accrual for estimated costs
of litigation and investigations.
(h) Includes a $9.3 million 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. (h) Includes
$13.4 million pre-tax special charge related to a revision in the Company's
estimate of receivables from third party payors at its CMS Therapies, Inc.
subsidiary.
(i) Includes a $13.4 million pre-tax special charge related to a revision in
the Company's estimate of receivables from third party payors at its CMS
Therapies, Inc. subsidiary.
91
<PAGE>
HORIZON/CMS HEALTHCARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(19) QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED)
(j) Includes $5,045 pre-tax special charge related to eliminations of management
and staff positions, office lease terminations and certain other costs of
changes implemented during the third quarter at CMS Therapies, Inc.
(k) Includes a $2,497 extraordinary gain (net of tax) relating to open market
purchases of its subordinated debt and its 8 3/4% and 6 1/2% convertible
subordinated notes at a discount.
(l) Includes a $4,979 pre-tax special charge related to a revision in the
Company's estimate of receivables from third party payors at its CMS
Therapies, Inc. subsidiary and $13,500 pre-tax settlement charge related to
a contract dispute.
(m) Includes a $74 extraordinary gain (net of tax) related to open market
purchases of its subordinated debt and its 8 3/4% and 6 1/2% convertible
subordinated notes at a discount.
92
<PAGE>
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 103
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 2.3 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 Winterhaven,
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
93
<PAGE>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------------ ------------------------------------------------------------------
Country Manor, Inc., and peopleCARE Heritage Western Hills, Inc.,
as amended by Amendment No. 1 to Agreement and Plan of
Reorganization dated June 30, 1994.
**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).
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).
94
<PAGE>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------------ ------------------------------------------------------------------
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).
4.7 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 4.6) (incorporated by reference to Exhibit 4.4 to the
Company's 1994 Form 10-K).
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.
95
<PAGE>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------------ ------------------------------------------------------------------
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.
+**10.1 Employment Agreement dated as of August 19, 1993 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
96
<PAGE>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------------ ------------------------------------------------------------------
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).
+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.
97
<PAGE>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------------ ------------------------------------------------------------------
+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).
98
<PAGE>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------------ ------------------------------------------------------------------
+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).
+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 July 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).
99
<PAGE>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------------ ------------------------------------------------------------------
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.
*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 Restated 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:
100
<PAGE>
DATE OF REPORT ITEMS REPORTED
- ------------------ ------------------------------------------------------------
March 6, 1996 Filed on March 21, 1996, reporting under "Item 5. Other
Events" the (i) existence of OIG/DOJ investigation involving
certain of the Company's Medicare Part B and related
co-insurance billings, and (ii) commencement of litigation
against Tenet Healthcare Corporation.
April 1, 1996 Filed on April 8, 1996, reporting under "Item 5. Other
Events" the commencement of class action litigation against
the Company and certain of its current and former officers
and directors alleging violations of the Federal and State
securities laws.
July 10, 1995 Filed on April 23, 1996, amending that certain Current
Report on Form 8-K filed with the Commission on November 21,
1995, which was filed under "Item 7. Financial Statements
and Exhibits" which provided audited restated financial
statements for the years ended May 31, 1995, and 1994,
respectively, and for each of the three years in the period
ended May 31, 1995, to reflect the merger with CMS pursuant
to Rule 11-01(b) of Regulation S-X.
April 22, 1996 Filed on May 3, 1996, reporting under "Item 5. Other Events"
the commencement of (i) class action litigation against the
Company and certain of its current and former officers and
directors alleging violations of the Federal and State
securities laws, and (ii) stockholders' derivative lawsuits
against the Company (as a nominal defendant) and the
Company's current and former directors.
May 9, 1996 Filed on May 20, 1996, reporting under "Item 5. Other
Events" the commencement of (i) additional class action
litigation against the Company and certain of its current
and former officers and directors alleging violations of the
Federal and State securities laws substantially identical to
that previously reported by the Company, and (ii) additional
stockholders' derivative lawsuits against the Company (as a
nominal defendant) and the Company's current and former
directors substantially identical to that previously
reported by the Company.
101
<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 11th day of
August, 1997.
HORIZON/CMS HEALTHCARE CORPORATION
By /s/ ERNEST A. SCHOFIELD
----------------------------------------
Ernest A. Schofield
Senior Vice President, Chief Financial
Officer, Chief Accounting Officer and
Director (Principal Financial and Accounting
Officer)
102
<PAGE>
SCHEDULE II
HORIZON/CMS HEALTHCARE CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONS
------------------
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND END OF
DESCRIPTION OF PERIOD EXPENSES OTHER DEDUCTIONS PERIOD
- ---------------------------------------- ---------- ---------- ----- ---------- ----------
<S> <C> <C> <C> <C> <C>
Allowance for doubtful accounts:........
1996................................ $ 28,120 $ 27,163 $3,211(1) $ (17,147)(2) $ 41,347
========== ========== ====== ========== ==========
1995................................ $ 20,192 $ 23,158 $1,634(1) $ (16,864)(2) $ 28,120
========== ========== ====== ========== ==========
1994................................ $ 18,494 $ 20,694 $5,586(3) $ (24,582)(2) $ 20,192
========== ========== ===== ========== ==========
Valuation allowance on deferred tax
assets:................................
1996................................ $ 4,051 $ -- $1,179(4) $ (2,980)(5) $ 2,250
========== ========== ===== ========== ==========
1995................................ $ 4,851 $ -- $-- $ (800)(6) $ 4,051
========== ========== ===== ========== ==========
1994................................ $ -- $ -- $4,851(3) $ -- $ 4,851
========== ========== ===== ========== ==========
</TABLE>
- --------------------------
(1) In fiscal 1996 and 1995 the Company had various acquisitions which in the
aggregate were insignificant. Additions in the amount of $3,211 and $1,634
in the allowance for doubtful accounts were recorded in connection with
these acquisitions during fiscal 1996 and 1995, respectively.
(2) Represents write-offs against the allowance.
(3) In fiscal 1994, the Company purchased Greenery Rehabilitation Group, Inc.
and had other acquisitions which in the aggregate were insignificant.
Additions in the amounts of $5,586 and $3,051 in the allowance for doubtful
accounts and valuation on deferred tax assets, respectively, were recorded
in connection with these acquisitions. The remaining addition of $1,800 in
the valuation on deferred tax assets resulted from uncertain state tax
benefits resulting from states requiring separate return filings and capital
loss carryforward limitations.
(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.
103
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,
---------------------------------
1996 1995 1994
---------- --------- ----------
<S> <C> <C> <C>
COMMON AND COMMON EQUIVALENTS:
Earnings before extraordinary item................... $ 8,674 $ 23,357 $ (20,295)
Extraordinary item, net of tax....................... (31,328) 2,571 734
---------- --------- ----------
Net earnings (loss).................................. $ (22,654) $ 25,928 $ (19,561)
========== ========= ==========
Applicable common shares:
Weighted average outstanding shares during the
period.............................................. 51,406 47,207 36,078
Weighted average shares issuable upon excercise of
common stock equivalents outstanding (principally
stock options and warrants using the treasury stock
method)............................................. 642 643 1,000
---------- --------- ----------
Total................................................ 52,048 47,850 37,078
========== ========= ==========
Earnings (loss) per share:
Earnings before extraordinary item................... $ 0.16 $ 0.49 $ (0.55)
Extraordinary item, net of tax....................... (0.60) 0.05 0.02
---------- --------- ----------
Net earnings (loss).................................. $ (0.44) $ 0.54 $ (0.53)
---------- --------- ----------
ASSUMING FULL DILUTION:
Earnings before extraordinary item................... $ 8,674 $ 23,357 $ (20,295)
Extraordinary item, net of tax....................... (31,328) 2,571 734
---------- --------- ----------
Net earnings (loss).................................. $ (22,654) $ 25,928 $ (19,561)
========== ========= ==========
Applicable common shares:
Weighted average outstanding shares during the
period.............................................. 51,406 47,207 37,150
Weighted average shares issuable upon exercise of
common stock equivalents outstanding (principally
stock options and warrants using the treasury stock
method and convertible debentures).................. 794 650 2,901
---------- --------- ----------
Total................................................ 52,200 47,857 40,051
---------- --------- ----------
Earnings (loss) per share:
Earnings before extraordinary item................... $ 0.16 $ 0.49 $ (0.55)
Extraordinary item, net of tax....................... (0.60) 0.05 0.02
---------- --------- ----------
Net earnings (loss).................................. $ (0.44) $ 0.54 $ (0.53)
========== ========= ==========
</TABLE>
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/A Amendment No.1, 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
July 18, 1997
EXHIBIT 23.2
CONSENT OF INDEPENDENT AUDITORS
We hereby consent to the inclusion in this Annual Report (Amendment No. 1
on Form 10-K/A) 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 years ended June 30, 1995
and June 30, 1994.
/s/ Ernst & Young LLP
------------------------
Ernst & Young LLP
Harrisburg, Pennsylvania
July 18, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the Form
10-K/A Amendment No. 1 for the year ended May 31, 1996 and is qualified in its
entirety by reference to such financial statements.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<CURRENCY> US DOLLARS
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAY-31-1996
<PERIOD-START> JUN-01-1995
<PERIOD-END> MAY-31-1996
<EXCHANGE-RATE> 1
<CASH> 31,307
<SECURITIES> 0
<RECEIVABLES> 350,563
<ALLOWANCES> (41,347)
<INVENTORY> 0
<CURRENT-ASSETS> 592,548
<PP&E> 713,409
<DEPRECIATION> (119,036)
<TOTAL-ASSETS> 1,512,751
<CURRENT-LIABILITIES> 197,594
<BONDS> 637,884
0
0
<COMMON> 53
<OTHER-SE> 651,295
<TOTAL-LIABILITY-AND-EQUITY> 1,512,751
<SALES> 0
<TOTAL-REVENUES> 1,756,534
<CGS> 0
<TOTAL-COSTS> 1,708,960
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 27,163
<INTEREST-EXPENSE> 47,318
<INCOME-PRETAX> 40,346
<INCOME-TAX> 31,672
<INCOME-CONTINUING> 8,674
<DISCONTINUED> 0
<EXTRAORDINARY> (31,328)
<CHANGES> 0
<NET-INCOME> (22,654)
<EPS-PRIMARY> (0.44)
<EPS-DILUTED> (0.44)
</TABLE>
