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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended August 31, 1997
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) of the
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to _______________
Commission File number 1-13626
HORIZON HEALTH CORPORATION
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(Exact name of registrant as specified in its charter)
Delaware 75-2293354
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1500 Waters Ridge Drive
Lewisville, Texas 75057-6011
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(Address of principal executive offices, including zip code)
(972) 420-8200
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Title of each class
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Common Stock, $.01 par value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ x ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of November 18, 1997, there were 7,000,262 shares of the registrant's Common
Stock, $.01 par value, outstanding and the aggregate market value of the shares
of such stock held by non-affiliates of the registrant was $118,849,884. Solely
for purposes of computing such aggregate market value of the outstanding Common
Stock, shares owned by directors and executive officers of the registrant have
been excluded.
DOCUMENTS INCORPORATED BY REFERENCE
There is incorporated by reference in Part III of this Annual Report on Form
10-K portions of the information contained in the registrant's proxy statement
for its annual meeting of stockholders to be held on January 23, 1998.
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TABLE OF CONTENTS
HORIZON HEALTH CORPORATION
<TABLE>
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PART I Page
<S> <C> <C> <C>
Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3
Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18
Item 4. Submission of Matters to a Vote of Security Holders. . . . . . . . . . . . . . . . .19
PART II
Item 5. Market for the Company's Common Equity
and Related Stockholder Matters . . . . . . . . . . . . . . . . . . . . . 21
Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . 26
Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . .36
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure . . . . . . . . . . . . . . . . . . . . . . . . .36
PART III
Item 10. Directors and Executive Officers of the Registrant . . . . . . . . . . . . . . . . . 37
Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
Item 12. Security Ownership of Certain Beneficial Owners and Management . . . . . . . . . . . 37
Item 13. Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . 37
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K . . . . . . . . . .38
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PART 1
ITEM 1. BUSINESS
Unless the context otherwise requires, when used herein the term
"Company" refers to Horizon Health Corporation, formerly known as Horizon Mental
Health Management, Inc., and its subsidiaries, the term "Specialty" refers to
Specialty Healthcare Management, Inc., a Delaware corporation acquired by the
Company in August 1997 in a share exchange transaction accounted for as a
pooling of interests, and the term "Horizon" refers to the Company prior to the
acquisition of Specialty. Unless the context otherwise requires, the information
contained in this Report concerning the Company with respect to any periods
beginning on or after January 1, 1995 (the date Specialty commenced operations)
represents combined information of both Horizon and Specialty.
GENERAL
The Company provides contract management of clinical and related
services for general acute care hospitals and is currently the leading contract
manager of mental health programs offered by general acute care hospitals in the
United States. The Company has grown both internally and through acquisitions,
increasing both the number of its management contracts and the variety of its
treatment programs and services. Over the last five years, the Company has
increased its management contracts from 43 to a total of 195 as of August 31,
1997 and currently operates in 38 states. Of those management contracts, 177
related to mental health programs and 18 related to physical rehabilitation
programs. The Company has also developed a proprietary mental health outcomes
measurement system known as CQI+ and at August 31, 1997 provided outcome
measurement services at 86 contract locations. The Company was incorporated in
1989 and is the successor to Horizon Health Management Company, which began the
development and management of mental health programs for general acute care
hospitals in 1981.
The Company's strategy is to enhance its position as the leader in the
contract management of mental health programs and to further expand the range of
services which it offers to its existing and new client hospitals to include
other clinical and related services and programs. A significant challenge in
obtaining clinical management contracts from hospitals is overcoming the initial
reservations that many hospital administrators have with outsourcing key
clinical services. The Company believes its expertise in working with hospital
administrators, its reputation in the industry and its existing contractual
relationships with 195 hospitals nationwide provide it with a significant
advantage in obtaining new contracts. The Company also believes it has
substantial opportunities to cross-sell a broad range of mental health and
physical rehabilitation services to client hospitals by marketing and selling
its mental health services to client hospitals for which the Company currently
manages only physical rehabilitation programs, and by marketing and selling its
physical rehabilitation services to client hospitals for which the Company
currently manages only mental health programs. The Company is pursuing the
development of such opportunities as a primary part of its business strategy.
The Company has successfully expanded the breadth of services it offers to
include the full continuum of mental health services, including outcome
measurement services, and physical rehabilitation services and its contracts
increasingly provide for multiple services. In addition, the Company capitalizes
on its expertise in managing the delivery of mental health services by directly
offering mental health services and employee assistance programs to businesses
and managed care organizations.
General acute care hospitals are increasingly outsourcing key clinical
departments to independent contract management companies for several reasons,
including: (i) the expertise necessary for the development, management and
operation of specialized clinical programs differs from that for traditional
medical/surgical services, (ii) hospitals often lack access to skilled
professionals and the support staff needed to operate specialized clinical
programs, (iii) hospitals often lack expertise in the marketing and development
activities required to support
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specialized clinical programs, and (iv) hospitals often lack expertise necessary
to design and operate specialized clinical programs that satisfy regulatory,
licensing, accreditation and reimbursement requirements.
MENTAL HEALTH SERVICES
The Company believes that there continue to be substantial
opportunities to provide mental health contract management services to general
acute care hospitals in the United States. A major shift in the delivery of
mental health services is occurring as payors are increasingly using managed
care methods to review and require pre-approval for mental health treatment and
to evaluate alternatives to inpatient hospitalization in order to ensure that
each patient's treatment regimen utilizes clinical resources effectively. The
Company believes that general acute care hospitals need to be able to offer a
broad array of mental health care services in order to develop or participate in
integrated delivery systems responsive to the demands of managed care companies
and other third-party payors. The Company also believes that it costs general
acute care hospitals less to provide inpatient and partial hospitalization
mental health services than it costs freestanding psychiatric hospitals in part
due to the ability of acute care hospitals to utilize excess capacity. General
acute care hospitals are also able to provide their mental health patients with
needed medical care on-site and in a more cost effective manner than
freestanding psychiatric hospitals. Furthermore, general acute care hospitals
are eligible to receive reimbursement under the Medicaid program for mental
health care provided to Medicaid-eligible adults, unlike freestanding
psychiatric hospitals which are not presently eligible.
The Company believes that, due to the increasing emphasis on
cost-effective treatment, significant demand exists for a complete continuum of
mental health services. In response to this demand, it has expanded the mental
health programs it offers to provide partial hospitalization (or day treatment),
outpatient treatment, short-term crisis intervention and residential treatment
as alternatives and complements to inpatient care. The Company believes it is
uniquely positioned to capitalize on the increased demand for mental health
contract management services as a result of its ability to provide a full
continuum of mental health services, its proprietary quality and outcomes
measurement system and its demonstrated industry expertise. In addition, the
Company believes its position as the leading contract manager of mental health
programs provides the Company with a significant advantage in attracting and
retaining employees and yields several economies of scale such as the ability to
consolidate accounting and administrative functions.
The Company intends to continue to emphasize the area of mental health
programs for the elderly ("geropsychiatric programs"). At August 31, 1997, 67.7%
of the mental health treatment programs managed by the Company were
geropsychiatric programs. Many elderly patients with short-term mental illness
also have physical problems that make the general acute care hospital
environment the most appropriate site for their care. The Medicare program
reimburses general acute care hospitals for their cost of providing these
services, which includes the Company's management fee as well as allocated
overhead costs to the facility, and allows reimbursement for partial
hospitalization and home health services that permit the patient to be treated
in the most cost-effective environment. The Company has developed particular
expertise in developing specialized psychiatric programs for the elderly, in
operating such programs, and in assisting hospitals to receive approval for
inpatient programs as distinct part units ("DPUs") under Medicare. Approval of
an inpatient program as a DPU is significant to client hospitals because
services provided in DPUs are exempt from predetermined reimbursement rates and
are reimbursed by Medicare on an actual cost basis, subject to certain
limitations.
The Company has developed and markets a proprietary mental health
outcome measurement system, CQI+ Outcomes Measurement System, (the "CQI+
System"), which provides outcome information regarding the effectiveness of a
hospital's mental health programs. The availability of such information enables
a hospital to demonstrate to third-party payors whether patients are improving
as a result of the treatment provided and allows a hospital to refine its
clinical treatment programs and to market such programs to patients and
providers. In addition, it provides the Company with a valuable tool in
demonstrating clinical results of the mental health programs managed by the
Company and in marketing such management services to other hospitals. The
Company provides outcome measurement services not only to client hospitals but
also to other hospitals, health care providers and third-party payors. The Joint
Commission on Accreditation of Healthcare Organizations ("JCAHO"), as part of
its hospital accreditation process, will require each hospital, by no later than
December 31, 1997, to select at least one
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acceptable measurement system and at least two clinical performance (outcome)
measures that together represent at least 20% of the hospital's patient
population. Each year, the requirements for the number of measures and the
percentage of the population will increase. The Company's CQI+ System has met
the initial criteria for inclusion in the future accreditation process and is
included on JCAHO's list of acceptable systems. The Company is committed to
meeting future criteria established by JCAHO. Since developing the CQI+ System
over three years ago, the Company has compiled a database containing outcome
measurement data on over 11,000 patients. With the growth of managed care and
the JCAHO accreditation requirement, the Company believes that its CQI+ System
will become an important component of the mental health services it provides.
PHYSICAL REHABILITATION SERVICES
The Company has successfully expanded the types of programs that it
manages for its client hospitals to include other related clinical services.
Horizon's recent acquisition of Specialty expanded the Company's operations to
include the contract management of physical rehabilitation programs. The Company
believes that many of the same factors driving demand in mental health programs
are also driving significant demand for physical rehabilitation programs. The
Company provides contract management for a full range of physical rehabilitation
services. In addition to acute and sub-acute physical therapy and rehabilitation
services, the Company also provides contract management for a comprehensive
outpatient rehabilitation facility program. Outpatient rehabilitation services
are dominated by the treatment of sports and work related injuries, but also
provide the continuum of rehabilitative care necessary to meet the medical needs
of a post-acute care patient following a disabling illness or traumatic injury.
Pressure from payors to move inpatients to the lowest-cost appropriate treatment
setting has helped fuel growth in these outpatient services.
OTHER MENTAL HEALTH SERVICES AND EMPLOYEE ASSISTANCE PROGRAMS
With the acquisition of Florida Professional Psychological Services,
Inc., also known as Professional Psychological Services, Inc. ("Florida PPS"),
in August 1996, the Company expanded its services to include provision of full
risk, capitated managed care mental health services for health maintenance
organizations ("HMOs") and self-insured employers and the operation of employee
assistance programs for employers. The mental health care services are provided
by mental health care professionals that are employed by the Company or are
under contract with the Company as independent providers. The Company believes
that its existing relationships with health care providers and its expertise in
the provision of mental health care services provide it with the capability to
establish, operate and manage the network of health care professionals necessary
to economically furnish such services. Employee assistance programs, which are
usually provided by employers as a benefit at no cost to employees, give
employees the opportunity to have consultations with a health care provider to
identify and discuss problems that may be affecting the work performance of the
employee and a course of action or treatment to address such problems. The
Company believes that an opportunity exists for the contract management of
employee assistance programs offered by community-based general acute care
hospitals. As with its other products, the Company intends to market such
programs as an additional service it can offer new and existing client
hospitals.
SERVICES
MENTAL HEALTH SERVICES
The Company has the expertise to manage a broad range of clinical
mental health programs, including geropsychiatric, general adult, substance
abuse and adolescent programs. The programs use a treatment team concept, with
the admitting physician, team psychologist, social workers, nurses, therapists
and counselors coordinating each phase of therapy. The programs include crisis
intervention, individual therapy, group and family therapy, recreational
therapy, occupational therapy, lifestyle education, social services and
substance abuse counseling. Family involvement is encouraged. Each treatment
program is individually tailored as much as practicable to meet the needs of
the patients, the client hospital, physicians and payor groups. Mental health
services represented 177 of the Company's 195 management contracts at August
31, 1997.
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Elements of the Continuum of Care
The mental health treatment programs managed by the Company are
designed to provide a continuum of mental health services, consisting of
inpatient, partial hospitalization (or day treatment), outpatient and home
health services.
Inpatient Services. Inpatient services are generally provided to
patients needing the most intensive mental health treatment and who frequently
have accompanying medical care needs. The patient is admitted to the client
hospital and remains there on a 24-hour per day basis throughout the course of
the inpatient treatment, which is continued until the patient can be stabilized
and moved to another level in the continuum of mental health services.
Partial Hospitalization. Partial hospitalization services are provided
for limited periods per day at established intervals with the patient returning
home at the conclusion of each day's treatment. Partial hospitalization services
are designed to be both an alternative to inpatient hospitalization services and
a key component of care following inpatient hospitalization.
Outpatient Services. Outpatient services consist generally of
consultative sessions which can be rendered in a variety of individual or group
settings at various locations, including hospitals, clinics or the offices of
the service provider. Outpatient service providers can also serve as gatekeepers
for persons being evaluated for treatment. Once an individual is assessed for
treatment in an outpatient environment, the individual is provided the
appropriate level of service in relation to the diagnosis.
Home Health Services. Home health services are provided in the
patient's home. Typically, these services are provided on a periodic basis by an
experienced psychiatric nurse working under the direct supervision of a
psychiatrist. The nurse may provide medication management, vital sign
monitoring, individual and family therapy, and other related clinical services.
Patients utilizing home health services include individuals whose clinical
conditions make it difficult or impossible to leave their homes due to
psychiatric illness or a combination of psychiatric and medical illness. Home
health service patients also include patients without access to transportation.
Patients over the age of 65 often use psychiatric home health services.
CQI+ Outcomes Measurement System
The Company began offering its CQI+ Outcomes Measurement System in
1994. The CQI+ System provides a qualitative and quantitative tool for the
clinical staff to evaluate the clinical effectiveness of treatment programs and
to make adjustments in the programs in order to improve quality and
appropriateness of care. In addition, the CQI+ System enables client hospitals
to demonstrate to third-party payors the effectiveness of the treatment programs
and provides a valuable tool to the hospital in marketing to patients and
providers. The CQI+ System also assists the hospitals in complying with the
increasing demands of regulatory and accrediting bodies for quality assessment
of their mental health programs. JCAHO, as part of its accreditation process,
will require each hospital, by no later than December 31, 1997, to select at
least one acceptable measurement system and at least two clinical performance
(outcome) measures that together represent at least 20% of the hospital's
patient population. Each year, the requirements for the number of measures and
the percentage of the population will increase. The Company's CQI+ System has
met the initial criteria for inclusion in the future accreditation process and
is included on JCAHO's list of acceptable systems. The Company is committed to
meeting future criteria established by JCAHO. At August 31, 1997, 84 of the
Company's management contracts included the CQI+ System. The CQI+ System
provides the Company with a valuable tool in demonstrating clinical results of
the mental health programs managed by the Company and in marketing such
management services to other hospitals.
Since offering CQI+ System, the Company has compiled a database
containing outcome measurement data on over 11,000 patients. Sample data is
collected from randomly selected patients at admission, discharge and 90 to 120
days after discharge. Semi-annual outcome reports include a summary of patient
characteristics and outcome measures. A multidisciplinary committee reviews and
analyzes the data in order to identify specific areas for program improvement. A
regional clinical consultant then prepares an implementation plan. Program
improvements implemented through this process are evaluated for use at other
treatment programs managed by the Company. The
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Company trains and supervises on-site personnel to ensure the collection of
accurate outcome measurement data. Price Waterhouse LLP provides an annual
written examination of the CQI+Systems to insure that stated data sampling and
analytical procedures are followed and that the data collection process adheres
to the Company's procedures and patient and client confidentiality policies.
Each client is provided a copy of the attestation report.
PHYSICAL REHABILITATION SERVICES
The Company provides contract management for a broad range of physical
rehabilitation programs including (i) acute physical medicine and
rehabilitation, (ii) subacute physical therapy and rehabilitation, and (iii)
comprehensive outpatient rehabilitation. Physical rehabilitation services
represented 18 of the Company's 195 management contracts at August 31, 1997.
Acute Physical Therapy and Rehabilitation. The physical therapy and
rehabilitation program incorporates a variety of treatments and services aimed
at maximizing an individual's capabilities following a disabling illness or
traumatic injury. The treatment program is provided by an interdisciplinary team
of health care professionals including physicians, physical, recreational,
occupational and speech therapists, rehabilitation nurses, social workers and
psychologists. The Company attempts to tailor an acute physical therapy and
rehabilitation program for a health care facility to satisfy unmet community and
medical staff needs, while maximizing utilization of the facility.
Sub-acute Physical Therapy and Rehabilitation. Rapidly changing
reimbursement issues have challenged health care providers to seek alternative
services to meet the needs of their patient population requiring lower cost and
intensity physical medicine and rehabilitation services. Comprehensive physical
medicine and rehabilitation services at the subacute level offer an attractive
alternative for acute care hospitals and skilled nursing facilities to meet
these needs. The Company evaluates the feasibility of a health care facility
providing rehabilitation services at the sub-acute level by analyzing a
facility's discharge data, conducting a market analysis of services offered in a
facility's community, assessing medical staff needs and evaluating financial
viability.
Comprehensive Outpatient Rehabilitation. A comprehensive outpatient
rehabilitation facility ("CORF") program serves as an adjunct to inpatient
physical therapy and rehabilitation programs at the acute and/or sub-acute
levels. The program provides the continuum of rehabilitative care necessary to
meet the medical needs of a post-acute care patient following a disabling
illness or traumatic injury. The Company has developed a CORF program in
compliance with Medicare regulations which functions as a non-residential day
facility to provide diagnostic, therapeutic and restorative services to
outpatients at a single fixed location under the supervision of a qualified
physician.
OTHER MENTAL HEALTH CARE SERVICES AND EMPLOYEE ASSISTANCE PROGRAMS
The Company began offering mental health care services to HMOs and
employee assistance programs to self-insured employers with the acquisition of
Florida PPS in 1996. The Company contracts with HMOs to provide the mental
health care component of the general health plans offered by such entities. The
contracts are on a full risk, capitated basis under which the Company is paid a
set fee per month for each member of the respective health plan. In the
Tampa-St. Petersburg area, such services are generally provided by the Company's
employees, but elsewhere they are provided by independent providers. The Company
reimburses the independent professionals and institutions on a discounted
fee-for-service basis. As of August 31, 1997, the Company provided mental health
care services for approximately 264,217 total members of various health plans
with which it had contracted.
The Company utilizes the same network to operate employee assistance
programs for employers. Employee assistance programs, which are usually provided
by employers as a benefit at no cost to employees, generally give employees and
their dependents the opportunity to have four to six consultations annually with
a health care provider to discuss problems that may be affecting their ability
to work. Such problems frequently relate to matters unrelated to mental health
care. The purpose of the consultation is to help the employee identify the
problem and to recommend a course of action or treatment to address the problem.
Often the employee is referred by the employer after observing a change in work
performance. The Company frequently provides training to employer personnel for
identifying troubled employees. The Company believes that such early
identification,
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consultation and treatment can frequently minimize the likelihood that the
problem will develop into a serious debilitating event requiring extensive
treatment. The Company is paid a set fee per month per employee for its
services. As of August 31, 1997, the employee assistance programs operated by
the Company covered approximately 12,239 employees.
On October 31, 1997, the Company acquired all the outstanding capital
stock of Acorn Behavioral HealthCare Management Corporation, a Pennsylvania
corporation ("Acorn"), for approximately $12.7 million in cash (the "Acorn
Acquisition"). Acorn offers employee assistance programs and related services
only to self-insured employers. Most of the contracts are on a capitated basis
under which employees and their dependents are entitled to receive a specified
number of consultations per contract year with behavioral health specialists.
Acorn is paid a set fee per month per employee for such services. Under some
contracts, Acorn also provides certain specified outpatient mental health
benefits for the capitated fee. A few contracts also provide for mental health
services on a discounted fee-for-service basis. Acorn also provides
pre-admission certification, utilization review, case management, hospital bill
review, claims adjudication and related services as requested by the client
usually under the capitated fee but sometimes on a separate fee basis. At
October 1, 1997, Acorn had a total of 122 contracts with employers covering over
246,000 employees and, under most of its contracts, the dependents of the
employees.
OPERATIONS
GENERAL
The Company operates mental health management contracts through a
regional structure with offices in the Boston, Chicago, Dallas, Los Angeles and
Tampa metropolitan areas. The structure is designed to keep key operating
employees of the Company in direct contact with clients. Each of the five
regional offices is staffed to have the capacity to supervise up to 40 mental
health management contract locations. Each regional office is under the
supervision of a vice president who in turn supervises regional directors, each
of whom has direct responsibility over eight to ten mental health management
contract locations. Other regional office personnel include clinical and other
specialists, who are available to provide assistance to the local programs and
client hospital personnel. Presently, the Company's physical rehabilitation
management contracts are operated in the same manner out of its Dallas office
with plans to develop a comparable regional structure as it expands that area of
its operations.
The Company develops and operates its outcomes measurement system
primarily out of its Dallas office. Program personnel are responsible for the
completion of the data input forms concerning the various treatment programs.
The data is inputted into the national database from which reports are
developed, reviewed and analyzed by the CQI+ System staff of 11 employees.
At August 31, 1997, the Company had approximately 983 program employees
at its contract locations and approximately 150 employees at its regional and
national support center offices.
Florida PPS has 39 administrative employees and employs 25 health care
professionals, all of which are located in the Tampa-St. Petersburg area. In
addition, Florida PPS has contracted with approximately 756 independent mental
health care professionals and institutions for the provider network that furnish
the mental health care and employee assistance program services.
Acorn is headquartered in the Philadelphia metropolitan area and
employs 52 employees, all of which are located in its corporate offices. It
provides the mental health and other services through a network of independent
health care professionals and institutions. At October 1, 1997, Acorn had
contracts with approximately 7,000 individual providers located throughout the
United States.
MANAGEMENT CONTRACTS
The Company provides its management services under contracts with its
client hospitals. Each contract is tailored to address the differing needs of
the client hospital and its community. The Company and the client hospital
determine the programs and services to be offered by the hospital and managed by
the Company, which may consist
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of one or more treatment programs offering inpatient, partial hospitalization,
outpatient or home health services. Under the contracts, the hospital is the
actual provider of the mental health or physical rehabilitation services and
utilizes its own facilities (including beds for inpatient programs), nursing
staff and support services (such as billing, dietary and housekeeping) in
connection with the operation of its programs.
While each of the Company's management contracts is tailored to the
specific needs of the client hospital, substantially all of the Company's
contracts contain non-compete and confidentiality provisions. In addition, the
Company's management contracts typically prohibit the client hospital from
soliciting the employment of the Company employees during the contract term and
for a specified period thereafter.
Contracts are frequently renewed prior to or at their stated expiration
dates. Some contracts are terminated prior to their stated expiration dates
pursuant to agreement of the parties or early termination provisions included in
the contracts. As of August 31, 1995, 1996 and 1997, the Company had
successfully retained 74%, 80% and 78%, respectively, of the management
contracts in existence at the beginning of such fiscal years. The Company
believes the most frequent reason client hospitals do not renew a contract is
that they desire to manage such programs themselves.
Under each contract, the Company receives a fee for its management
services from the client hospital. Management fees may be either a variable fee
related in part to patient census at the program or a fixed fee with
reimbursement for direct program costs. The management fee is frequently subject
to periodic adjustments as a result of changes in the consumer price index or
other economic factors. A significant number of the Company's management
contracts require the Company to refund some or all of its fee if either
Medicare reimbursement for services provided to patients of the programs is
denied or the fee paid to the Company is denied as a reimbursable cost. During
the fiscal year ended August 31, 1997, the Company refunded approximately
$219,294 of its fees in relation to these denials.
Program Development
The Company assists in the development of each clinical program as
requested by the client hospital, including such matters as licensing,
accreditation, certificate of need approvals and Medicare certification. The
Company also develops and implements a marketing plan for the clinical programs
to be offered by the hospital. Each program is marketed locally with an emphasis
on the hospital addressing the needs of the local community. The Company markets
the clinical programs in the community in the name of the client hospital. The
Company's name is not used and its role is not publicly emphasized in the
operation of the clinical programs offered by its client hospitals. Each patient
is admitted by the medical staff of the client hospital, and all charges for
clinical services provided to the patient accrue directly to the client hospital
or treating physician.
The Company also develops and maintains standardized policy and
procedure manuals, initial and ongoing staff training and education, and
comprehensive quality assurance procedures. Each local program director receives
ongoing support from the National Support Center and regional support staff in
all areas including recruiting, finance, reimbursement, development, marketing
and quality assurance.
Each operating region is responsible for training new employees,
including formalized instruction and on-the-job training. Continuing education
programs are also provided to employees. In addition, the Company has a
centralized orientation program for new program directors and an annual
conference for all program directors.
Program Staffing
Each mental health program has a psychiatric medical director, a
program director who is usually a psychologist or a social worker, a community
relations coordinator and additional social workers or therapists as needed.
Each physical rehabilitation program has an independent medical director, a
program director, and additional clinical staff tailored to meet the needs of
the program and the client hospital, which may include physical and occupational
therapists, a speech pathologist, a social worker and other appropriate
supporting personnel. Each medical director has a contract with the Company
under which on-site administrative services needed to administer
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the program are provided. These contracts generally include nondisclosure,
nonsolicitation and noncompetition covenants pursuant to which the medical
director agrees not to solicit the Company employees for specified periods,
disclose confidential information of the Company or render certain
administrative or management services within specified time periods and
geographic areas to any enterprise in competition with the Company or the
programs it manages. Except for the nursing staff, which is typically provided
by the hospital, the other program personnel are employees of the Company. At
August 31, 1997, the Company had an average of five employees per contract
location.
Program Marketing
Because the treatment programs managed by the Company are offered by
general acute care hospitals, most patients are referred by the client
hospital's medical staff or result from relationships that the client hospital
has in the community. Each contract location has an outreach coordinator who
works with a referral development committee consisting of Company and hospital
personnel to identify prospective referral sources. The outreach coordinator
informs physicians and other health professionals and nursing homes in the
community of the treatment programs that are available at the client hospital.
The outreach coordinator also designs and offers community educational programs
regarding various health issues.
Internal Clinical Audits
The Company has established a comprehensive internal clinical audit
process for its mental health programs. The Company's regional mental health
clinical specialists review the services and clinical documentation of the
treatment programs to ensure compliance with client hospital, federal and state
standards. The Company also has an internal clinical auditor who makes
unannounced visits to contract locations on a periodic basis. The auditor
reviews medical records and marketing programs, and conducts interviews with
physicians, referral sources and client hospital staff members. Results of the
audits are reported directly to the senior management of the Company, rather
than through the normal operating organization.
Contract Locations
At August 31, 1997, the Company had a total of 195 management contracts
with general acute care hospitals located in 38 states, as shown below:
<TABLE>
<CAPTION>
STATE NUMBER OF STATE NUMBER OF
CONTRACTS CONTRACTS
<S> <C> <C> <C>
Alabama............ 4 Missouri................. 7
Arizona............ 4 Nebraska................. 1
Arkansas........... 10 Nevada................... 3
California......... 19 New Hampshire............ 2
Colorado........... 2 New Jersey............... 4
Connecticut........ 1 New Mexico............... 1
Florida............ 12 New York................. 3
Georgia............ 9 North Carolina........... 5
Illinois........... 6 Ohio..................... 9
Indiana............ 3 Oklahoma................. 7
Iowa............... 2 Oregon................... 3
Kansas............. 1 Pennsylvania............. 11
Kentucky........... 3 South Carolina........... 3
Louisiana.......... 3 Tennessee................ 16
Maine.............. 1 Texas.................... 12
Maryland........... 1 Vermont.................. 2
Massachusetts...... 9 Virginia................. 1
Michigan........... 6 Washington............... 4
Mississippi........ 4 Wisconsin................ 1
</TABLE>
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Client Hospitals
The Company's clients are primarily small to medium sized hospitals and
include some large tertiary care hospitals. At August 31, 1997, 43.1% of the
Company's management contracts were with proprietary hospitals. The remainder
are with primarily community not-for-profit hospitals.
At August 31, 1997, the Company had management contracts with 39
hospitals directly or indirectly owned by Columbia/HCA Healthcare Corporation
("Columbia/HCA"). These 39 contracts accounted for 19.1% of the Company's
revenues for the year ended August 31, 1997. In the aggregate, including both
contracts in effect on August 31, 1997 and contracts that terminated during the
fiscal year ended August 31, 1997, revenues generated by hospitals directly or
indirectly owned by Columbia/HCA accounted for 20.3% of the Company's revenues
for the year ended August 31, 1997. Of the 39 Columbia/HCA contracts at August
31, 1997, 14 contracts contain a provision limiting the number of contracts
which Columbia/HCA can cancel without cause to 33.3% during any calendar year.
The termination or non-renewal of all or a substantial part of the management
contracts with hospitals owned by Columbia/HCA could have a material adverse
effect on the Company's business, financial condition or results of operations.
SALES AND MARKETING
At August 31, 1997, the Company employed five full-time regional
managers of development for mental health management contracts and one manager
of development for physical rehabilitation management contracts. The Company
compiles information from numerous databases to identify prospective clients.
The Company has developed profiles of over 5,000 hospitals in the United States,
with numerous financial and operating characteristics for each hospital.
Potential clients include hospitals without existing mental health, physical
rehabilitation, employee assistance programs or other programs as well as
hospitals with existing programs of which the Company could assume management. A
select list of candidates is systematically and regularly updated based on
criteria indicating which hospitals are the most likely potential clients. A
regional manager of development, who typically acts as the point person on the
sales team for such region, directly contacts the prospective clients and, where
appropriate, presents a detailed proposal to key decision-makers. The proposal
often contains detailed financial projections of the proposed programs. The
Company works with the potential client to develop contract terms responsive to
the client's specific needs. The typical sales cycle for a management contract
is approximately nine months, during which time the Company's Vice President of
Sales will assist the regional manager of development and will sometimes assume
the role of point person for the sales effort. In addition, the Company's
Executive Vice President of Sales and Development will generally become involved
at the end of the sales process and negotiate the final terms of the management
contract. The Company believes it can increase sales of rehabilitation
management contracts by applying its expertise in winning mental health
management contracts to the solicitation of rehabilitation management contracts.
In addition, the Company believes it has substantial opportunity to cross-sell a
broad range of services to client hospitals and is pursuing the development of
such opportunities as a primary part of its business strategy.
The CQI+ System is marketed primarily through the regional staff
personnel working together with the CQI+ corporate staff.
Florida PPS markets its mental health services and employee assistance
programs through the administrative staff personnel located in its Tampa
offices.
COMPETITION
The health care industry is highly competitive and subject to continual
changes in the method in which services are provided and the types of companies
providing such services. The Company competes with several national competitors
and many regional and local competitors, some of which have greater resources
than the Company. In addition, hospitals could elect to manage their own mental
health and physical rehabilitation programs.
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Competition among contract managers for hospital-based mental health
and physical rehabilitation programs is generally based upon reputation for
quality, price, the ability to provide financial and other benefits for the
hospital, and the management expertise necessary to enable the hospital to offer
mental health and physical rehabilitation programs that provide the full
continuum of mental health and physical rehabilitation services in a quality and
cost-effective manner. The pressure to reduce health care expenditures has
emphasized the need to manage the appropriateness of mental health and physical
rehabilitation services provided to patients. As a result, competitors without
management experience covering the various levels of the continuum of mental
health and physical rehabilitation services may not be able to compete
successfully. The Company believes that its reputation and management expertise
will enable it to compete successfully in this rapidly changing market.
In addition, general acute care hospitals offering mental health and
physical rehabilitation programs managed by the Company compete for patients
with other providers of mental health care services, including other general
acute care hospitals, freestanding psychiatric hospitals, independent
psychiatrists and psychologists, and with other providers of physical
rehabilitation services, including other general acute care hospitals,
freestanding rehabilitation facilities and outpatient facilities.
The Company also competes with hospitals, nursing homes, clinics,
physicians' offices and contract therapy companies for the services of physical,
occupational and speech therapists. These specialists are in short supply and
there can be no assurance that the Company will be able to attract a sufficient
number of therapists for its growing needs.
GOVERNMENT REGULATION
The Company's business is affected by federal, state and local laws and
regulations concerning, among other matters, mental health and physical
rehabilitation facilities and reimbursement for mental health and physical
rehabilitation services. These regulations impact the development and operation
of mental health and physical rehabilitation programs managed by the Company for
its client hospitals. Licensing, certification, reimbursement and other
applicable government regulations vary by jurisdiction and are subject to
periodic revision. The Company is not able to predict the content or impact of
future changes in laws or regulations affecting the mental health or physical
rehabilitation industries.
FACILITY USE AND CERTIFICATION
Hospital facilities are subject to various federal, state and local
regulations, including facilities use, licensure and inspection requirements,
and licensing or certification requirements of federal, state and local health
agencies. Many states also have certificate of need laws intended to avoid the
proliferation of unnecessary or under-utilized health care services and
facilities. The mental health and physical rehabilitation programs which the
Company manages are also subject to licensure and certification requirements.
The Company assists its client hospitals in obtaining required approvals for new
programs. Some approval processes may lengthen the time required for programs to
commence operations. In granting and renewing a facility's licenses,
governmental agencies generally consider, among other factors, the physical
condition of the facility, the qualifications of administrative and professional
staff, the quality of professional and other services, and the continuing
compliance of such facility with the laws and regulations applicable to its
operations. The Company believes that the mental health and physical
rehabilitation programs it manages and the facilities of the client hospitals
used in the operation of such programs comply in all material respects with
applicable licensing and certification requirements.
MEDICARE AND MEDICAID; REIMBURSEMENT FOR SERVICES
Most of the Company's client hospitals receive reimbursement under one
or more of the Medicare or Medicaid programs for mental health and physical
rehabilitation services provided in programs managed by the Company. The Company
is paid directly by its client hospitals for the management services it
provides. While fees paid to the Company by its client hospitals are not subject
to or based upon reimbursement under the Medicare or Medicaid programs or from
any other third-party payor, under many of its management contracts the Company
is
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obligated to refund a portion of its fee if Medicare denies reimbursement for
an individual patient treatment or all of its fee if the fee paid to the Company
is denied by Medicare as a reimbursable cost. Since a substantial portion of the
patients of the programs managed by the Company are covered by Medicare, any
changes which limit or reduce Medicare reimbursement levels could have a
material adverse effect on the Company's client hospitals and, in turn, on the
Company.
The Company is not a provider reimbursed by Medicare or Medicaid but
provides contract management services to such providers. As such, the Company
could be considered subject to such federal and state laws. While the Company
believes that its relationships with its client hospitals, medical directors and
other providers and the fee arrangements with its client hospitals are
consistent with Medicare and Medicaid criteria, those criteria are often vague
and subject to interpretation. The federal government has been actively
investigating health care providers for potential abuses. There can be no
assurance that aggressive anti-fraud enforcement actions will not adversely
affect the business of the Company.
The Medicare program was enacted in 1965 to provide a nationwide,
federally funded health insurance program for the elderly. The program is
divided in Part A and Part B, each of which has separate rules and requirements
and separate funding sources. Medicare Part A, the Hospital Insurance Program
(42 U.S.C., sec. 1395c et seq.) is financed primarily through mandatory taxes
on workers' wages. Part A pays for hospital, skilled nursing, home health
agency, hospice, and dialysis services determined to be medically necessary for
the individual patient. Medicare Part B, the Supplementary Medical Insurance
program (42 U.S.C., sec. 1395j et seq.), is a voluntary medical benefits plan
in which eligible individuals can enroll to receive benefits in addition to
those available under Part A. Under Part B, each beneficiary must pay a monthly
premium, meet a deductible towards the cost of covered items and services
determined to be medically necessary, and pay 20 percent of the Medicare
allowable charge as coinsurance on most covered items. Non-institutional
services, including physician services, outpatient hospital services, durable
medical equipment, and laboratory services, among others, are paid under
Medicare Part B. In addition, the Balanced Budget Act adds a new Medicare Part
C, which provides Medicare beneficiaries with additional health plan choices,
such as managed care plans and medical savings accounts.
The Medicare program is administered by the Health Care Financing
Administration ("HCFA") of the U.S. Department of Health and Human Services
("HHS"). HCFA adopts regulations and issues interpretive memoranda and program
manuals providing detailed explanation of the Medicare program. The payment
operations of the Medicare program are handled by intermediaries (under Part A)
and carriers (under Part B) who are insurance companies and Blue Cross/ Blue
Shield plans which contract with the Secretary of HHS (the "Secretary") to make
Medicare payments to providers in a particular geographic region. Individual
intermediaries and carriers issue transmittals, bulletins, notices, and general
instructions to providers and suppliers in their respective areas to facilitate
the administration of the Medicare program, but are required to follow the
Medicare statute, HCFA regulations, HCFA transmittals, and the program manuals.
Within these requirements, intermediaries and carriers are granted broad
discretion to establish particular guidelines and procedures for making Medicare
coverage determinations and payments, including prior approval, utilization
limits, and specific documentation.
The Medicaid program is a joint federal-state cooperative arrangement
established for the purpose of enabling states to furnish medical assistance on
behalf of aged, blind, or disabled individuals, or members of families with
dependent children, whose income and resources are insufficient to meet the
costs of necessary medical services. The federal and state governments share the
costs of such aid pursuant to statutory formulae. The Secretary has primary
federal responsibility for administering the Medicaid program. The
responsibility has been delegated to HCFA, whose Medicaid Bureau carries out
this delegation. States are not required to participate in the Medicaid program.
States which choose to participate, however, must administer their Medicaid
programs in accordance with federal law, the implementing regulations and
policies of the Secretary and their approved state plans. A state becomes
eligible to receive federal funds by submitting to the Secretary a state plan
for medical assistance. The federal Medicaid statute establishes minimum
standards for state plans in such area as administration, eligibility, coverage
of services, quality and provision of services, and payment for services. States
have significant latitude, within these standards, to determine the mix of
services and structure of their state Medicaid programs. The state plan must be
amended by appropriate submission to the Secretary whenever
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necessary to reflect changes in federal statutes, regulations, policies, court
decisions, or material changes in any phase of state law, policy, or operations.
In order to receive reimbursement under the Medicare or Medicaid
programs, each client hospital or facility must meet applicable requirements
promulgated by HHS relating to the type of facility, personnel, standards of
patient care and compliance with all state and local laws, rules and
regulations. The Company believes that the programs it manages comply in all
material respects with applicable Medicare and Medicaid requirements.
In the mid-1980's, changes in reimbursement rates and procedures
included the creation of the prospective payment system ("PPS") using
predetermined reimbursement rates for diagnosis related groups ("DRGs"). The DRG
system established fixed payment amounts per discharge for diagnoses generally
provided by acute care hospitals. Mental health services provided by acute care
hospitals which qualify for an exemption are deemed to be DPUs and are not
included in the DRG system. Services provided by DPUs are reimbursed on an
actual cost basis, subject to certain limitations. The mental health programs
managed by the Company which are eligible for reimbursement by the Medicare
program currently meet the applicable requirements for designation as DPUs and
are exempt from the DRG system. In the future, however, it is possible that
Medicare reimbursement for mental health services, including those provided by
programs managed by the Company, could be under the DRG system or otherwise
altered. At August 31, 1997, of the 291 mental health treatment programs managed
by the Company, 197 were geropsychiatric programs for which a substantial
majority of the patients are covered by Medicare. Recent amendments to the
Medicare regulations established maximum reimbursement amounts on a per case
basis for both inpatient mental health and physical rehabilitation services.
Effective as of October 1, 1997, regulations promulgated pursuant to these
amendments establish a ceiling on the rate of increase in operating costs per
case for mental health and physical rehabilitation services furnished to
Medicare beneficiaries. Prior to these amendments, the reimbursement amounts
were tied to each hospital's mental health or physical rehabilitation unit cost
during such unit's first year of operations, subject to adjustment. The new
regulations establish a nationwide cap limiting the reimbursement target amount
on a per case basis for mental health and physical rehabilitation services to
$10,547 and $19,250, respectively, subject to adjustments based on market
indices and on costs for other similar units. There can be no assurance that
such limitation will not result in the decline of amounts reimbursed to the
Company's client hospital and will not have an adverse effect on the business,
operations and financial condition of the Company.
Qualified outpatient rehabilitation services are exempt from PPS. Acute
rehabilitation units within acute-care hospitals are eligible to obtain an
exemption from PPS, generally after the first year of operation, upon
satisfaction of specified federal criteria. Such criteria include the operation
for a full 12 months under PPS and the completion of an initial exemption
survey. The exemption survey measures compliance with certain criteria
applicable to exempt units generally, including approval to participate as a
Medicare provider, admission standards, recordkeeping, compliance with state
licensure laws, segregation of beds, accounting standards and certain specific
standards applicable to rehabilitation units, including staffing, medical care
and patient mix. Upon successful completion of the survey, Medicare payments for
rehabilitation services provided in inpatient units are made under a cost-based
reimbursement system. As of August 31, 1997, 17 of the Company's managed
physical rehabilitation programs were exempt from PPS. The remaining program
will apply for exemption as soon as it is eligible. A recently enacted amendment
to the Medicare statutes provides for a gradual phase-out of cost-based
reimbursement for physical rehabilitation services over a three-year period
commencing on October 1, 2000. The resulting phase-in of reimbursement for
physical rehabilitation services based on PPS could significantly lower Medicare
reimbursements to hospitals and thus have a material adverse effect on the
business, operations and financial results of the Company.
The Medicare and Medicaid programs are subject to statutory and
regulatory changes, retroactive and prospective rate adjustments, administrative
rulings and funding restrictions, any of which could have the effect of limiting
or reducing reimbursement levels to general acute care hospitals for mental
health and physical rehabilitation services provided by programs managed by the
Company. The Company cannot predict whether any changes to such government
programs will be adopted or, if adopted, the effect, if any, such changes will
have on the Company. In addition, a significant number of the Company's
management contracts require the Company to refund a portion of its fee if
Medicare reimbursement to the client hospital is disallowed for a patient
treated in a program managed by the Company or all of its fee if the fee paid to
the Company is disallowed as a reimbursable
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cost. During the fiscal year ended August 31, 1997, the Company refunded
approximately $219,294 of its fees in relation to these denials. Also, Medicare
retrospectively audits cost reports of client hospitals upon which Medicare
reimbursement for services rendered in the programs managed by the Company is
based. Accordingly, at any time, the Company could be subject to refund
obligations to client hospitals for prior year cost reports that have not been
audited and settled at the date hereof. Any significant decrease in Medicare
reimbursement levels, the imposition of significant restrictions on
participation in the Medicare program, or the disallowance by Medicare of any
significant portion of the client hospital's costs, including the fee to the
Company, where the Company has a reimbursement denial repayment obligation could
adversely affect the Company. Numerous amendments have recently been made to the
regulations promulgated under the Medicare statutes effective October 1, 1997.
These amendments affect, among other things, Medicare reimbursement to
psychiatric and rehabilitation distinct units in hospitals by imposing ceilings
on reimbursable amounts, and could have a material adverse effect on the
business, operations and financial results of the Company. In addition, there
can be no assurance that hospitals which offer mental health or physical
rehabilitation programs now or hereafter managed by the Company will satisfy the
requirements for participation in the Medicare or Medicaid programs.
Payors, including Medicare and Medicaid, are attempting to manage
costs, resulting in declining amounts paid or reimbursed to hospitals for the
services provided. As a result, the Company anticipates that the number of
patients served by general acute care hospitals on a per diem, episodic or
capitated basis will increase in the future. There can be no assurance that if
amounts paid or reimbursed to hospitals decline, it will not adversely affect
the Company.
Medicare regulations limit reimbursement for mental health, physical
rehabilitation and other health care charges paid to related parties. A party is
considered "related" to a provider if it is deemed to be controlled by the
provider. One test for determining control for this purpose is whether the
percentage of the total revenues of the party received from services rendered to
the provider is so high that it effectively constitutes control. Although the
Company believes that it does not receive sufficient revenues from any customer,
including Columbia/HCA, that would make it a related party, it is possible that
such regulations could limit the number of management contracts that the Company
could have with Columbia/HCA or any other client.
Federal law contains certain provisions designed to ensure that
services rendered by hospitals to Medicare and Medicaid patients are medically
necessary and meet professionally recognized standards. These provisions include
a requirement that admissions of Medicare and Medicaid patients to hospitals
must be reviewed in a timely manner to determine the medical necessity of the
admissions. In addition, these provisions state that a hospital may be required
by the federal government to reimburse the government for the cost of
Medicare-reimbursed services that are determined by a peer review organization
to have been medically unnecessary. The Company and its client hospitals have
developed and implemented quality assurance programs and procedures for
utilization review and retrospective patient care evaluation intended to meet
these requirements.
PATIENT REFERRAL LAWS
Various state and federal laws regulate the relationships between
health care providers and referral sources, including federal and state fraud
and abuse laws prohibiting individuals and entities from knowingly and willfully
offering, paying, soliciting or receiving remuneration in order to induce
referrals for the furnishing of health care services or items. These federal
laws generally apply only to referrals for items or services reimbursed under
the Medicare or Medicaid programs or any state health care program. The
objective of these laws is generally to ensure that the purpose of a referral is
quality of care and not monetary gain by the referring party. Violations of such
laws can result in felony criminal penalties, civil sanctions and exclusion from
participation in the Medicare and Medicaid programs.
The Medicare and Medicaid anti-kickback statute, 42 U.S.C. sec.
1320a-7b, prohibits the knowing and willful solicitation or receipt of any
remuneration "in return for" referring an individual, or for recommending or
arranging for the purchase, lease, or ordering, of any item or service
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for which payment may be made under Medicare or a state health care program. In
addition, the statute prohibits the offer or payment of remuneration "to induce"
a person to refer an individual, or to recommend or arrange for the purchase,
lease, or ordering of any item or service for which payment may be made under
the Medicare or state health care programs. The statute contains exceptions for
certain discounts, group purchasing organizations, employment relationships,
waivers of coinsurance by community health centers, health plans, and practices
defined in regulatory safe harbors.
Under a significant number of its management contracts, the Company
receives a variable fee related in part to average daily patient census of the
mental health or physical rehabilitation program. In addition, the Company has
entered into agreements with physicians to serve as medical directors at the
mental health and physical rehabilitation programs and facilities managed by the
Company, which generally provide for payments to such persons by the Company as
compensation for their administrative services. These medical directors also
generally provide professional services at such programs and facilities. In
1991, regulations were issued under federal fraud and abuse laws creating
certain "safe harbors" for relationships between health care providers
andreferral sources. Any relationship that satisfies the terms of the safe
harbor is considered permitted. Failure to satisfy a safe harbor, however, does
not mean that the relationship is prohibited. Although the contracts and
relationships between the Company and its client hospitals and medical directors
are not within the safe harbors, the Company believes that such contracts and
relationships comply with applicable laws. There can be no assurance, however,
that the Company's activities will not be challenged by regulatory authorities.
The Omnibus Budget Reconciliation Act of 1993 contains provisions
("Stark II") prohibiting physicians from referring Medicare and Medicaid
patients to an entity with which the physician has a "financial relationship"
for the furnishing of a list of "designated health services" including physical
therapy, occupational therapy, home health services, and others. If a financial
relationship exists, the entity is generally prohibited from claiming payment
for such services under the Medicare or Medicaid programs. Compensation
arrangements are generally exempted from the Stark provisions if, among other
things, the compensation to be paid is set in advance, does not exceed fair
market value and is not determined in a manner that takes into account the
volume or value of any referrals or other business generated between the
parties.
Other provisions in the Social Security Act authorize other penalties,
including exclusion from participation in Medicare and Medicaid, for various
billing-related offenses. HHS can also initiate permissive exclusion actions for
such improper billing practices as submitting claims "substantially in excess"
of the provider's usual costs or charges, failure to disclose ownership and
officers, or failure to disclose subcontractors and suppliers. Executive Order
12549 prohibits any corporation or facility from participating in federal
contracts if it or its principals have been disbarred, suspended or are
ineligible, or have been voluntarily excluded, from participating in federal
contracts. A principal has been defined as an officer, director, owner, partner,
key employee or other person with primary management or supervisory
responsibilities.
Additionally, the Health Insurance Portability and Accountability Act
of 1996 granted expanded enforcement authority to HHS and the U.S. Department of
Justice ("DOJ"), and provided enhanced resources to support the activities and
responsibilities of the Office of Inspector General ("OIG") of HHS and DOJ by
authorizing large increases in funding for investigating fraud and abuse
violations relating to health care delivery and payment. On January 24, 1997,
the OIG issued guidelines for the Fraud and Abuse Control Program as mandated by
the Act, and on February 19, 1997 issued an interim final rule establishing
procedures for seeking advisory opinions on the application on the anti-kickback
statute and certain other fraud and abuse laws. The recently-enacted Balanced
Budget Act also includes numerous health fraud provisions, including: new
exclusion authority for the transfer of ownership or control interest in an
entity to an immediate family or household member in anticipation of, or
following, a conviction, assessment, or exclusion; increased mandatory exclusion
periods for multiple health fraud convictions, including permanent exclusion for
those convicted of three health care-related crimes; authority of the Secretary
to refuse to enter into Medicare agreements with convicted felons; new civil
money penalties for contracting with an excluded provider or violating the
Medicare and Medicaid antikickback statute; new surety bond and information
disclosure requirements for certain providers and suppliers; and an expansion of
the mandatory and permissive exclusions added by the Health Insurance
Portability and Accountability Act of 1996 to any federal health care program
(other than the Federal Employees Health Benefits Program).
In addition, federal and some state laws impose restrictions on
referrals for certain designated health services by physicians and, in a few
states, psychologists and other mental health care professionals to entities
with
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which they have financial relationships. The Company believes that its
operations comply with these restrictions to the extent applicable, although no
assurance can be given regarding compliance in any particular factual situation.
Federal legislation has been considered to expand current law from its
application to Medicare and Medicaid business to all payors and to additional
health services. Certain states are considering adopting similar restrictions or
expanding the scope of existing restrictions. There can be no assurance that the
federal government or other states in which the Company operates will not enact
similar or more restrictive legislation or restrictions that could under certain
circumstances impact the Company's operations.
MENTAL HEALTH CARE PATIENT RIGHTS
Many states have adopted "patient bill of rights" regulations which set
forth standards for least restrictive treatment, patient confidentiality,
patient access to mail and telephones, patient access to legal counsel and
requirements that patients be treated with dignity. There are also laws and
regulations relating to the civil commitment of patients to mental health
programs, disclosure of information concerning patient treatments and related
matters.
HEALTH CARE REFORM
The Clinton Administration and various federal legislators have
considered health care reform proposals intended to control health care costs
and to improve access to medical services for uninsured individuals. These
proposals included proposed cutbacks to the Medicare and Medicaid programs and
steps to permit greater flexibility in the administration of Medicaid. In
addition, some states in which the Company operates are considering various
health care reform proposals. It is uncertain at this time what legislation on
health care reform may ultimately be enacted or whether other changes in the
administration or interpretation of governmental health care programs will
occur. There can be no assurance that future health care legislation or other
changes in the administration or interpretation of governmental health care
programs will not have a material adverse effect on the Company's business,
financial condition or results of operations.
LICENSING REQUIREMENTS
Certain of the services provided by Florida PPS and Acorn may be
subject to certain licensing requirements in some states. Neither Florida PPS
nor Acorn hold any licenses in states other than Florida and Pennsylvania,
respectively. If the business operations of such entities are determined to
require licenses in other states, then obtaining such licenses or the inability
to obtain such licenses could adversely affect the business operations of such
entities. In addition, several states have laws that prohibit business
corporations from providing, or holding themselves out as providers of, medical
care. While the Company has no reason to believe that it is in violation or has
violated such statutes, these laws vary from state to state and have seldom been
interpreted by the courts or regulatory agencies.
EMPLOYEES
At August 31, 1997, the Company employed 1,208 people, including 974
full-time employees, 197 part-time employees, and 37 temporary employees. The
Company has no collective bargaining agreements with any unions and believes
that its overall relations with its employees are good. In addition, at August
31, 1997, the Company had administrative services contracts with 251 physicians
to serve as medical directors for the clinical programs managed by the Company.
INSURANCE
The Company carries general liability, comprehensive property damage,
malpractice, workers' compensation and other insurance coverages that management
considers adequate for the protection of the Company's assets and operations.
There can be no assurance, however, that the coverage limits of such policies
will be adequate. A successful claim against the Company in excess of its
insurance coverage could have a material adverse effect on the Company.
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ITEM 2. PROPERTIES
In September 1996, the Company leased a building consisting of
approximately 40,000 square feet for its National Support Center in Lewisville,
Texas under a lease term expiring on September 26, 2001. In addition, at August
31, 1997 the Company leased an aggregate of 11,058 square feet of space for four
regional offices in the Boston, Chicago, Los Angeles and Tampa metropolitan
areas, with lease terms expiring from May 1998 to August 2000. Except for one
partial hospitalization program operating in approximately 3,150 square feet of
space, the space required for the clinical programs managed by the Company is
provided by the client hospitals either within their existing facilities or at
other locations owned or leased by the hospitals.
The Company leases approximately 13,665 square feet of office space in
the Tampa metropolitan area with lease terms expiring from June 1998 to October
2002 for the operations of Florida PPS.
Resulting from the acquisition of Acorn Behavioral HealthCare
Management Corporation, effective October 31, 1997 the Company leases 12,835
square feet of office space in the Philadelphia metropolitan area with a lease
term expiring on October 31, 1999.
ITEM 3. LEGAL PROCEEDINGS
The Company is, and may be in the future, party to litigation arising
in the course of its business. While the Company has no reason to believe that
any pending claims are material, there can be no assurance that the Company's
insurance coverage will be adequate to cover all liabilities arising out of such
claims or that any such claims will be covered by the Company's insurance. Any
material claim which is not covered by insurance may have an adverse effect on
the Company's business. Claims against the Company, regardless of their merit or
outcome, may also have an adverse effect on the Company's reputation and
business.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
A Special Meeting of Stockholders of the Company was held on August 11, 1997.
At the Special Meeting of Stockholders, the stockholders approved the issuance
by the Company of up to 1,400,000 shares of the Company's Common Stock in
exchange for all of the outstanding shares of common stock of Specialty,
pursuant to a Share Exchange Reorganization Agreement dated as of April 25,
1997, as amended by amendment dated as of July 2, 1997, by and among the
Company, Specialty and the stockholders of Specialty (the "Exchange
Agreement"). At the meeting, a total of 4,004,205 votes were cast for this
proposal, a total of 4,673 votes were cast against this proposal, a total of
5,419 shares abstained from voting on this proposal, and there were a total of
480,102 broker non-votes with respect to this proposal. As a reslt of the
adoption of this proposal, upon closing under the Exchange Agreement Specialty
became a wholly-owned subsidiary of the Company.
At the Special Meeting of Stockholders, the stockholders also approved
an amendment to the Certificate of Incorporation of the Company to change its
corporate name to "Horizon Health Corporation." At the meeting, a total of
4,450,531 votes were cast for this proposal, a total of 1,635 votes were cast
against this proposal, a total of 937 shares abstained from voting on this
proposal, and there were a total of 41,296 broker non-votes with respect to this
proposal.
EXECUTIVE OFFICERS OF THE REGISTRANT
Pursuant to General Instructions G(3) of Form 10-K, set forth below is
certain information regarding the executive officers of the Company:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
James Ken Newman...... 53 Chief Executive Officer and Chairman of
the Board of Directors
Robert A. Lefton...... 41 President and Chief Operating Officer
James W. McAtee....... 52 Executive Vice President -- Finance &
Administration, Chief Financial Officer,
Treasurer and Secretary; Director
Gary A. Kagan......... 46 Executive Vice President -- Development
John F. DeVaney....... 45 Senior Vice President -- Rehab Operations
</TABLE>
James Ken Newman has been the Chief Executive Officer of the Company
since July 1989 and Chairman since February 1992. From July 1989 until September
1997, he served as President of the Company. Mr. Newman currently serves as a
director of United Dental Care, Inc. and Telecare Corporation.
Robert A. Lefton has been President and Chief Operating Officer since
September 1, 1997. He formerly served as Executive Vice President, Operations
from September 1996 to August 1997. He was a Senior Regional Vice President of
the Company from March 1995 until September 1996. He served as a Regional Vice
President of the Company from November 1991 to March 1995.
James W. McAtee has been Executive Vice President -- Finance &
Administration of the Company since February 1992 and Chief Financial Officer,
Treasurer and Secretary of the Company since September 1990. He has been a
director of the Company since July 1995. He was a Senior Vice President of the
Company from September 1990 to February 1992.
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<PAGE> 20
Gary A. Kagan has been Executive Vice President -- Development of the
Company since January 1992. From April 1990 to December 1991, he served as
President of the subsidiary of the Company engaged in the contract management
business.
John F. DeVaney has been Senior Vice President -- Rehab Operations
since September 1997 in charge of the physical rehabilitation contract
management business of the Company. From September 1996 to August 1997 he was an
Executive Vice President, Operations of the Company. He was a Senior Regional
Vice President of the Company from August 1994 until September 1996. He served
as a Regional Vice President of the Company from September 1992 to August 1994.
Officers of the Company are elected by the Board of Directors of the
Company and serve at the pleasure of the Board of Directors until their
respective successors are elected and qualified.
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<PAGE> 21
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company completed an initial public offering of its Common Stock in
March 1995. The Common Stock of the Company was originally listed on the
American Stock Exchange and was traded under the symbol "HMH". On May 7, 1996,
the Common Stock of the Company began trading on the Nasdaq National Market
under the symbol "HMHM". On August 12, 1997, the Nasdaq trading symbol for the
Company was changed to "HORC" following the change of its corporate name from
Horizon Mental Health Management, Inc.
The following table sets forth the high and low sale prices per share
for the Common Stock of the Company as reported by the American Stock Exchange
or the Nasdaq National Market, as applicable, for the periods indicated:
<TABLE>
<CAPTION>
High Low
<S> <C> <C>
FISCAL YEAR ENDED AUGUST 31, 1996(1):
September 1, 1995 -- November 30, 1995......................... $12.67 $ 9.50
December 1, 1995 -- February 29, 1996.......................... 12.67 10.67
March 1, 1996 -- May 31, 1996......................... 15.00 12.75
June 1, 1996 -- August 31, 1996................................ 19.50 14.17
FISCAL YEAR ENDED AUGUST 31, 1997(1):
September 1, 1996 -- November 30, 1996......................... 18.67 14.67
December 1, 1996 -- February 28, 1997.......................... 19.67 16.33
March 1, 1997 -- May 31, 1997.................................. 20.00 15.38
June 1, 1997 -- August 31, 1997................................ 26.12 18.00
</TABLE>
(1) Adjusted to reflect three-for-two stock split effected by the Company
as a 50% stock dividend on January 31, 1997.
The reported last sale price per share of the Common Stock as reported
by the Nasdaq National Market on November 18, 1997 was $23.375. As of November
18, 1997, the Company had 7,000,262 shares of Common Stock outstanding. As of
November 18, 1997, there were 43 stockholders of record of the Common Stock of
the Company.
The Company has not paid or declared any cash dividends on its capital
stock since its inception. The Company currently intends to retain all future
earnings for use in the expansion and operation of its business. Future
borrowings may limit the Company's ability to pay dividends. The payment of any
future cash dividends will be determined by the Board of Directors in light of
conditions then existing, including the Company's earnings, financial condition
and capital requirements, restrictions in financing agreements, business
conditions and other factors. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity and Capital
Resources."
Pursuant to the Exchange Agreement, the Company issued in the aggregate
1,400,000 shares of the Company's Common Stock to the stockholders of Specialty
on August 11, 1997, in consideration for all of the outstanding shares of common
stock of Specialty. The nature of the transaction consummated under the Exchange
Agreement was a tax-free "reorganization" within the meaning of Section 368 of
the Internal Revenue Code of 1986, as amended, with the result that Specialty
became a wholly-owned subsidiary of the Company and, based upon the number of
shares of Common Stock of the Company issued and outstanding on July 7, 1997,
the Specialty
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<PAGE> 22
stockholders held approximately 20.1% of the total issued and outstanding shares
of the Company's Common Stock immediately after the exchange (approximately
17.4% on a fully-diluted basis).
In connection with the offer and sale of its securities pursuant to the
Exchange Agreement, the Company relied upon the exemption from registration set
forth in Section 4(2) of the Securities Act of 1933, as amended (the
"Securities Act"). Such exemption was available to the Company because, among
other things, of the limited number of offerees (8 total Specialty
stockholders), no general solicitation or advertising was undertaken by the
Company, each of the offerees were provided with adequate information regarding
the Company, its Common Stock and the exchange transaction, and the Company
exercised reasonable care to assure that the Specialty stockholders were not
underwriters, within the meaning of Section 2(11) of the Securities Act.
Page 22
<PAGE> 23
ITEM 6. SELECTED CONSOLIDATED FINANCIAL INFORMATION AND STATISTICAL DATA
The selected historical consolidated financial data presented below for
the fiscal years ended August 31, 1995, 1996 and 1997, and at August 31, 1996
and August 31, 1997, are derived from the audited Consolidated Financial
Statements of the Company included elsewhere in this Report. The selected
historical consolidated financial data presented below for the fiscal years
ended August 31, 1993 and 1994, and at August 31, 1993, 1994 and 1995, are
derived from the audited consolidated financial statements of the Company not
included herein. Effective August 11, 1997, Horizon acquired Specialty in a
share exchange transaction with the stockholders of Specialty which was
accounted for as a pooling of interests. The Consolidated Financial Statements
of the Company give effect to the Specialty exchange by combining (a) the
financial statements of Horizon for the years ended August 31, 1995 and 1996
with the financial statements of Specialty for the years ended December 31, 1995
and 1996 and (b) the results of operations of Horizon for the year ended August
31, 1997 with the results of operations of Specialty for the twelve month period
ended August 31, 1997, in each case on a pooling of interests basis. Specialty
was a division of National Medical Enterprises, Inc. during the year ended
December 31, 1994. The operations of Specialty for the four month period ended
December 31, 1996 resulting in net revenues and net income of $10.8 million and
$849,000, respectively, have been included in the restated statement of
operations for both the year ended August 31, 1996 and the year ended August 31,
1997. The effect of including Specialty's net income for the four months in both
periods is eliminated in stockholders' equity in the Consolidated Financial
Statements of the Company. The selected financial information presented below
should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and with the Consolidated
Financial Statements of the Company and Notes thereto included elsewhere in this
Report.
Page 23
<PAGE> 24
<TABLE>
<CAPTION>
FISCAL YEAR ENDED AUGUST 31,
-------------------------------------------------------------------------------
1993 1994(1) 1995(1) 1996 1997
---- ------ ------ ---- ----
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Contract management revenues ............ $ 20,960 $ 24,962 $ 68,721 $ 95,244 $ 102,263
Other(2) ................................... $ 7,770 5,297 634 995 7,004
--------- --------- --------- --------- ---------
Total Revenues ...................... 28,730 30,259 69,355 96,239 109,267
Operating expenses:
Salaries and benefits ................... 16,031 16,814 40,083 55,810 60,048
Purchased services ...................... 4,398 4,731 10,794 13,880 16,466
Provision for bad debts ................. 359 312 1,680 1,435 3,034
Other ...................................... 5,703 5,745 9,189 11,848 12,796
Depreciation and amortization ........... 585 560 1,133 1,812 2,201
Merger expenses ......................... -- -- -- -- 3,528
--------- --------- --------- --------- ---------
Operating income ........................... 1,654 2,097 6,476 11,454 11,194
Interest and other income (expense), net ... (1,111) (1,005) (1,003) (67) 120
--------- --------- --------- --------- ---------
Income before income taxes ................. 543 1,092 5,473 11,387 11,314
Income tax expense (benefit) ............... 44 (20) 1,695 4,609 4,518
--------- --------- --------- --------- ---------
Income before equity in net earnings of
Horizon LLC and minority interest ......... 499 1,112 3,778 6,778 6,796
Equity in net earnings of Horizon LLC ...... -- 364 1,568 -- --
--------- --------- --------- --------- ---------
Minority interest .......................... -- -- -- (2) (140)
--------- --------- --------- --------- ---------
Net income ................................. $ 499 $ 1,476 $ 5,346 $ 6,776 $ 6,656
========= ========= ========= ========= =========
Net income per common share (3) ............ $ 0.13 $ 0.35 $ 0.85 $ 0.86 $ 0.83
========= ========= ========= ========= =========
Weighted average common shares and
common equivalent shares
outstanding (3) .......................... 3,738 4,184 6,308 (4) 7,872 (4) 8,062 (4)
========= ========= ========= ========= =========
BALANCE SHEET DATA (AT END OF PERIOD):
Cash and short-term investments ............ $ 1,633 $ 2,144 $ 3,249 $ 8,346 $ 5,517
Working capital ............................ 1,950 162 4,394 8,751 5,064
Intangible assets (net) (5) ................ 8,031 7,676 14,998 19,887 26,005
Total assets ............................... 14,216 15,079 33,587 45,214 48,728
Total debt ................................. 13,732 12,121 3,216 3,576 --
Stockholders' equity (deficit) ............. (2,936) (1,434) 17,225 25,149 31,682
</TABLE>
<TABLE>
<CAPTION>
AUG.31, NOV.30, FEB.29, MAY 31, AUG.31, NOV.30, FEB.28, MAY 31, AUG.31,
1995 1995 1996 1996 1996 1996 1997 1997 1997
---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
STATISTICAL DATA:
Number of Contract Locations (6):
Contract locations in operation ............ 146 150 145 162 163 162 162 176 181
Contract locations signed and unopened ..... 15 16 13 19 16 22 10 18 14
---- ---- ---- ---- ---- ---- ---- ---- ----
Total contract locations ................... 161 166 158 181 179 184 172 194 195
==== ==== ==== ==== ==== ==== ==== ==== ====
SERVICES COVERED BY CONTRACTS (6):
Inpatient .................................. 138 142 137 155 156 152 157 164 166
Partial hospitalization .................... 64 69 70 78 84 84 86 101 104
Outpatient ................................. 15 16 18 25 20 29 28 21 24
Home health ................................ 1 3 6 7 13 14 13 15 17
CQI+ ....................................... 46 48 55 60 64 67 71 78 86
TYPES OF TREATMENT PROGRAMS (6):
Geropsychiatric ............................ 102 111 117 125 144 145 153 183 197
Adult psychiatric .......................... 81 84 81 87 82 83 80 74 75
Substance abuse ............................ 9 9 9 24 20 22 21 16 10
Other mental health ........................ 2 2 2 6 5 7 8 4 9
Physical rehabilitation .................... 23 24 22 23 22 22 22 22 20
</TABLE>
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<PAGE> 25
- --------------
(1) Effective August 1, 1994, the Company and Mental Health Management, Inc.
("MHM") formed Horizon Mental Health Management Company, L.L.C., a Delaware
limited liability company ("Horizon LLC"). Horizon LLC assumed
management responsibility for all of the then existing management contracts
of the Company and MHM. Certain provisions of the limited liability company
agreement which required the consent of MHM for certain transactions
prevented the Company from having the ability to control Horizon LLC under
generally accepted accounting principles and therefore Horizon LLC was not
consolidated with Horizon for accounting purposes through February 28, 1995.
As a result, the revenues and expenses of Horizon LLC for the period August
1, 1994 through February 28, 1995 are not included in the revenues and
expenses of the Company; instead, for such periods the Company accounted for
its investment in Horizon LLC by the equity method and reflected its share
of Horizon LLC's net income for the period in question as "Equity in Net
Earnings of Horizon LLC." Effective with the acquisition of the minority
interest in Horizon LLC of MHM on March 20, 1995, the MHM contracts were
assigned to the Company and Horizon LLC became a wholly owned subsidiary of
Horizon. Horizon LLC was consolidated with the Company effective March 1,
1995. The Company's share of Horizon LLC's net earnings was $364,000 through
August 31, 1994 and $1,567,720 from September 1, 1994 through February 28,
1995. The Horizon LLC agreement stipulated that MHM, as a member of Horizon
LLC, would be allocated the first $1,750,000 of Horizon LLC net earnings in
each of the fiscal years ending August 31, 1995 and 1996. $1,750,000 was
allocated to MHM during the six months ended February 28, 1995.
(2) Other revenues for the fiscal years ended August 31, 1993, 1994, 1995 and
1996 consist primarily of revenues earned from a psychiatric hospital
formerly operated by the Company, patient services and physician contract
management fees, or subsequent adjustments for Medicare settlements
recognized during the respective period. The Company subleased the
operations of the hospital to a third party effective July 31, 1994. For
fiscal 1997, other revenues consisted of revenues from mental health
services and employee assistance programs conducted through Florida PPS.
(3) Adjusted to reflect a three-for-two stock split effected by the Company
as a 50% stock dividend on January 31, 1997.
(4) Adjusted for the Specialty transaction based on historical share amounts,
converting each outstanding share of Specialty Common Stock into 147.4616
shares of Horizon Common Stock.
(5) The Company recorded additional goodwill of $4,498,038 and $714,672 and
additional management contract values of $507,948 and $141,066, as a result
of the acquisitions on March 15, 1997 of Geriatric Medical Care, Inc., a
Tennessee corporation ("Geriatric"), and Clay Care, Inc.,a Texas corporation
("Clay Care"), respectively. On August 1, 1996, the Company purchased 80% of
the outstanding common stock of Florida PPS. Due to this purchase,
$3,298,885 was recorded as goodwill during 1996 and 1997. On April 1, 1996,
the Company purchased all of the outstanding capital stock of the Parkside
Company. In connection with this purchase, approximately $1,400,000 was
recorded as goodwill and $2,100,000 as management contracts. Effective
January 3, 1995, the Company acquired the net assets and operations of
National Medical Management Services, a division of National Medical
Enterprises, Inc. Due to this purchase, $120,350 was recorded as goodwill
and $1,000,000 as management contracts. On March 20, 1995, $9,683,467 of the
net proceeds to the Company from its initial public offering were used to
purchase MHM's minority interest in Horizon LLC. The purchase transaction
eliminated $2,794,715 of MHM's equity interest in Horizon LLC and recognized
an increase in intangible assets of $2,355,000 based upon the value of
Horizon LLC management contracts. The remaining purchase price of $4,533,752
was recorded as goodwill. The recorded goodwill was increased by $376,639 in
March, 1996 based on a final valuation of MHM's minority interest. In each
such acquisition, the increase in contract value will be amortized over
seven years and the goodwill over forty years.
(6) Represents combined information for both Horizon and Specialty.
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<PAGE> 26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The Company provides contract management of clinical and related
services for general acute care hospitals and is currently the leading manager
of mental health programs offered by general acute care hospitals in the United
States. The Company has grown both internally and through acquisitions,
increasing both the number of its management contracts and the variety of its
treatment programs and services. The Company was formed in July 1989 as the
successor to Horizon Health Management Company, which had been engaged in the
mental health contract management business since 1981. During the period from
1989 to 1994, the Company grew primarily from its internal sales efforts as it
focused its business operations entirely on the contract management of mental
health programs. In 1995, the Company began to pursue acquisitions as an
additional source of growth. Over the last five years, the Company has increased
its management contracts from 43 to a total of 195 as of August 31, 1997, and
currently operates in 38 states. Of those management contracts, 177 related to
mental health programs and 18 related to physical rehabilitation programs. The
195 management contracts cover 311 various treatment programs. The Company has
also developed a proprietary mental health outcomes measurement system known as
CQI+ and at August 31, 1997 provided outcome measurement services at 86 hospital
locations.
The Company's strategy is to enhance its position as the leader in the
contract management of mental health programs and to further expand the range of
services which it offers to its existing and new client hospitals to include
other clinical and related services and programs. A significant challenge in
obtaining clinical management contracts from hospitals is overcoming the initial
reservations that many hospital administrators have with outsourcing key
clinical services. The Company believes its expertise in working with hospital
administrations, its reputation in the industry and its existing relationships
with 195 hospitals nationwide provide it with a significant advantage in
obtaining new contracts. The Company also believes it has substantial
opportunities to cross-sell a broad range of mental health services and physical
rehabilitation services to existing client hospitals by marketing and selling
its mental health services to client hospitals for which the Company currently
manages only physical rehabilitation programs, and by marketing and selling its
physical rehabilitation services to client hospitals for which the Company
currently manages only mental health programs. The Company is pursuing the
development of such opportunities as a primary part of its business strategy.
The Company has successfully expanded the breadth of management services it
offers to hospitals to include the full continuum of mental health services,
including mental health outcome measurement services, and physical
rehabilitation services and its contracts increasingly provide for multiple
services. In addition, the Company capitalizes on its expertise in managing the
delivery of mental health services to offer mental health services and employee
assistance programs directly to businesses and managed care organizations.
REVENUES
The primary factors affecting revenues in any period are the number of
management contracts with treatment programs in operation in the period and the
number of services covered by each such management contract. The Company
provides its management services under contracts with terms generally ranging
from three to five years. Each contract is tailored to address the differing
needs of each client hospital and its community and increasingly cover multiple
treatment programs and services. The Company and the client hospital determine
the programs and services to be offered by the hospital and managed by the
Company, which may consist of one or more mental health or physical
rehabilitation treatment programs offering inpatient, partial hospitalization,
outpatient or home health services. Under the contracts, the hospital is the
actual provider of the mental health or physical rehabilitation services and
utilizes its own facilities (including beds for inpatient programs), nursing
staff and support services (such as billing, dietary and housekeeping) in
connection with the operations of its programs. As the Company has expanded the
breadth of treatment programs it offers to hospitals, it has moved from managing
one treatment program under a single contract with a hospital to managing
multiple treatment programs under such contract.
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<PAGE> 27
Contracts are frequently renewed prior to or at their stated expiration
dates. Some contracts are terminated prior to their stated expiration dates
pursuant to agreement of the parties or early termination provisions included in
the contracts. As of August 31, 1995, 1996 and 1997, the Company had
successfully retained 74%, 80% and 78%, respectively, of the management
contracts in existence at the beginning of such fiscal years. The Company
believes the most frequent reason its client hospitals do not renew their
contracts with the Company is that the hospitals decide to manage such programs
themselves.
Under each contract, the Company receives a fee for its management
services from the client hospital. Management fees may be either a variable fee
related in part to patient volume, a fixed monthly fee or reimbursement for
direct program costs plus a fixed fee. The management fee is frequently subject
to periodic adjustments as a result of changes in the consumer price index or
other economic factors. Payors, including Medicare and Medicaid, are attempting
to manage costs, resulting in declining amounts paid or reimbursed to hospitals
for the services provided. As a result, the Company anticipates that the number
of patients served by general acute care hospitals on an inpatient basis will
decrease and, as an alternative, the number of patients served on a per diem,
episodic or capitated basis will increase in the future.
Over the past three years, the Company has increased revenues through
acquisitions (discussed below) and through internal growth by adding services,
price escalators and volume increases at existing contract locations. During
that period, the Company has generated a net increase of 20 additional
management contracts achieved through its internal sales effort. Of these
contracts, 4 were added in fiscal 1995, 11 in fiscal 1996 and 5 in fiscal 1997.
In fiscal 1997, the average quarterly year-over-year increase in same site
revenues was 7.0%. The Company has increased prices for its contract services
over the last three years. This has primarily been due to the increased range of
services offered per contract and the increased demand for geropsychiatric
services as general hospitals have sought to enter this market. An additional
factor in the pricing strategy has been the Company's policy of establishing a
minimum direct margin threshold for its management contracts. Because the
pooling with Specialty occurred on August 11, 1997, fiscal 1997 margins do not
reflect the integration or the elimination of Specialty's executive,
administrative, accounting and personnel functions and information systems, the
closing of two Specialty office facilities and other synergies which management
believes should result in improved margins in fiscal 1998.
The Company's mix of programs has changed over the last three years
reflecting the increased interest in geropsychiatric programs by general
hospitals. Geropsychiatric programs as a percentage of the Company's total
mental health programs have increased from approximately 51% to 68% during that
period.
Most of the Company's client hospitals receive reimbursement under one
or more of the Medicare or Medicaid programs for mental health and physical
rehabilitation services provided in programs managed by the Company. The Company
is paid directly by its client hospitals for the management services it
provides. Under many of its management contracts the Company is obligated to
refund all or a portion of its fee if either Medicare denies reimbursement to
the client hospital for individual patient treatment or if the fee paid to the
Company is denied by Medicare as a reimbursable cost. During the fiscal years
ended August 31, 1997 and 1996, the Company refunded approximately $219,294 and
$429,849, respectively, of its fees as a result of these denials.
Recent amendments to the Medicare regulations established maximum
reimbursement amounts on a per case basis for both inpatient mental health and
physical rehabilitation services. Effective as of October 1, 1997, regulations
promulgated pursuant to these amendments establish a ceiling on the rate of
increase in operating costs per case for mental health and physical
rehabilitation services furnished to Medicare beneficiaries. Prior to these
amendments, the reimbursement amounts were tied to each hospital's mental health
or physical rehabilitation unit cost during such unit's first year of
operations, subject to adjustment. The new regulations establish a nationwide
cap limiting the reimbursement target amount on a per case basis for mental
health and physical rehabilitation services to $10,547 and $19,250,
respectively, subject to adjustments based on market indices. There can be no
assurance that such limitation will not result in the decline in amounts
reimbursed to the Company's client hospitals and will not have an adverse effect
on the business, operations and financial condition of the Company.
Page 27
<PAGE> 28
A recently enacted amendment to the Medicare statutes provides for a
gradual phase-out of cost-based reimbursement for physical rehabilitation
services over a three-year period commencing on October 1, 2000. The resulting
phase-in of reimbursement for physical rehabilitation services based on PPS
could significantly lower Medicare reimbursements to hospitals and thus have a
material adverse effect on the business, operations and financial results of the
Company.
OPERATING EXPENSES
The primary factor affecting operating expenses in any period is the
number of management contracts with programs in operation in the period. The
Company's operating expenses consist primarily of salaries and benefits paid to
its therapists and supporting personnel. Each mental health program managed by
the Company has a psychiatric medical director, a program director who is
usually a psychologist or a social worker, a community relations coordinator and
additional social workers or therapists as needed. Each physical rehabilitation
program managed by the Company has an independent medical director, a program
director, and additional clinical staff tailored to meet the needs of the
program and the client hospital, which may include physical and occupational
therapists, a speech pathologist, a social worker and other appropriate
supporting personnel. Each medical director has a contract with the Company
under which on-site administrative services needed to administer the program are
provided. Except for the nursing staff, which is typically provided by the
hospital, the other personnel are employees of the Company. At August 31, 1997,
the Company had an average of five employees per contract location.
Purchased services includes payments to independent health care
professionals providing services under the capitated mental health services
contracts and employee assistance programs offered by the Company. Operating
expenses for the Company's other mental health services and employee assistance
programs are comprised of approximately 49% salaries and benefits and
approximately 42% purchased services from network providers. Other costs and
expenses include items such as marketing costs and expenses, accounting and
legal fees and expenses, employee relocation expenses, rent, utility and
property taxes.
ACQUISITIONS
On October 31, 1997, the Company acquired all of the outstanding
capital stock of Acorn for approximately $12.7 million in cash. Acorn provides
employee assistance programs and other related services to self-insured
employers. See Note 15 to Notes to Consolidated Financial Statements of the
Company included elsewhere in this Report.
On August 11, 1997, Horizon acquired Specialty in a transaction
accounted for as a pooling of interests, resulting in a restatement of the
Company's financial results for the fiscal years ended August 31, 1995, 1996 and
1997. Included in the Company's financial statements for the fiscal years ended
August 31, 1995 and 1996 are the financial results of Specialty for the years
ended December 31, 1995 and 1996, respectively. Included in the Company's
financial statements for the fiscal year ended August 31, 1997 are the financial
results of Specialty for the twelve months ended August 31, 1997.
As a result, in the Company's financial statements for the fiscal year
ended August 31, 1995, the financial results of Specialty are included for
twelve months although Specialty, which began operations in January 1995, was
only in operation for eight months of the Company's fiscal year. In addition,
the financial results of Specialty for the four months of September 1, 1996
through December 31, 1996 are included in the Company's financial statements for
both fiscal 1996 and 1997. The operations of Specialty for the four months ended
December 31, 1996, resulted in net revenues and net income of $10.8 million and
$849,000, respectively. As a result, an adjustment was made to stockholders'
equity in the consolidated financial statements of the Company to eliminate the
effect of including Specialty's net income for the four months in both periods.
Additionally, the consolidated statement of cash flows was adjusted to reflect
the cash flows of Specialty for the four months ended December 31, 1996. The
treatment of the Specialty acquisition as a pooling of interests resulted in the
Company recognizing
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<PAGE> 29
merger-related expenses of approximately $3,528,000 and an offsetting tax
benefit of approximately $1,340,000, which taken together resulted in a one-time
charge to earnings of $.27 per share.
Other acquisitions during the last three years have significantly affected the
Company's results of operation and financial condition. The Company acquired 39
management contracts from Mental Health Management, Inc. ("MHM") on March 20,
1995, 19 management contracts from Parkside on April 1, 1996 and 23 management
contracts with the acquisition of Geriatric and Clay Care on March 15, 1997. In
addition, on August 1, 1996 the Company acquired Florida PPS, a company
specializing in providing mental health services under capitated contracts,
which had approximately $5.7 million in revenues for the year ended August 31,
1997.
Due to the structure of the acquisition of the 39 management contracts
from MHM, the Company reported virtually no revenues or expenses for the six
months ended February 28, 1995, other than revenues and expenses of Specialty as
restated due to the pooling of interests transaction with Specialty as
previously discussed.
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RESULTS OF OPERATIONS
The following table sets forth for the fiscal years ended August 31,
1995, 1996 and 1997, the percentage relationship to total net revenues of
certain costs, expenses and income and the number of management contracts in
operation at the end of each fiscal year.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED AUGUST 31,
----------------------------
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Revenues:
Contract management revenues............................ 99.1 % 99.0 % 93.6 %
Other................................................... 0.9 1.0 6.4
----- ----- -----
Total revenues............................................ 100.0 100.0 100.0
Operating expenses
Salaries and benefits.................................. 57.8 58.0 55.0
Purchased services..................................... 15.6 14.4 15.1
Provision for bad debts................................ 2.4 1.5 2.8
Other.................................................. 13.2 12.3 11.7
Depreciation and amortization.......................... 1.7 1.9 2.0
Merger expenses........................................ -- -- 3.2
----- ----- -----
Total operating expenses.................................. 90.7 88.1 89.8
----- ----- -----
Operating income.......................................... 9.3 11.9 10.2
----- ----- -----
Interest and other income (expense), net.................. (1.4) (0.1) 0.1
----- ----- -----
Income before taxes....................................... 7.9 11.8 10.3
Income tax expense........................................ 2.5 4.8 4.1
----- ----- -----
Income before equity in net earnings of Horizon
LLC and minority interest.............................. 5.4 7.0 6.2
Equity in net earnings of Horizon LLC..................... 2.3 -- --
Minority interest......................................... -- -- 0.1
----- ----- -----
Net income................................................ 7.7 % 7.0 % 6.1 %
===== ===== =====
Number of contracts in operation, end of year............. 146 163 181
</TABLE>
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<PAGE> 31
FISCAL YEAR ENDED AUGUST 31, 1997 COMPARED TO FISCAL YEAR ENDED
AUGUST 31, 1996
Revenue. Revenues for the fiscal year ended August 31, 1997 were $109.3
million representing an increase of $13.0 million, or 13.5%, as compared to
revenues of $96.3 million for the prior fiscal year. Approximately $3.0 million
(3.1%) of the revenue increase for the year was attributable to a 9.4% increase
in the number of contract locations in operation, from a daily average of 156.0
contract locations in operation during the year ended August 31, 1996 to a daily
average of 170.7 contract locations in operation during the year ended August
31, 1997. Approximately $4.8 million (5.0%) of the revenue increase resulted
from a 7.0% increase in same site revenues on an average quarterly
year-over-year basis at contract locations in operation throughout each
comparison period, which in the aggregate represented approximately 66.7% of
fiscal 1997 revenues. Approximately $5.2 million (5.4%) of the revenue increase
resulted from the operations of Florida PPS, of which twelve months of results
were included in fiscal 1997 versus one month in fiscal 1996 following its
acquisition on August 1, 1996.
Salaries and Benefits. Salaries and benefits for the fiscal year ended
August 31, 1997 were $60.0 million representing an increase of $4.2 million, or
7.6%, as compared to salaries and benefits of $55.8 million for the prior fiscal
year. Salary and benefits cost per full time equivalent for the year ended
August 31, 1997 were $56,821 representing an increase of $3,430 per full time
equivalent, or 6.4%, as compared to salary and benefits cost of $53,391 per full
time equivalent for the prior fiscal year. The number of full time equivalents
for the year ended August 31, 1997 was approximately 1,057, representing an
increase of 11.5, or 1.1%, as compared to approximately 1,045 full time
equivalents in the prior fiscal year. The increase in the number of full time
equivalents of 1.1% was less than the 9.4% increase in the number of contract
locations in operation because the contract locations terminated during fiscal
1997 were mature programs which typically employ more personnel per location
than the newly signed and acquired contract locations during fiscal 1997.
Depreciation and Amortization. Depreciation and amortization expenses
for the fiscal year ended August 31, 1997 were $2.2 million representing an
increase of $389,000, or 21.5%, as compared to depreciation and amortization
expenses of $1.8 million for the prior fiscal year. $277,000 of the increase
resulted from additional depreciation and amortization arising from the
acquisitions of Florida PPS, Parkside, Geriatric and Clay Care. The remainder of
the increase resulted from the depreciation expense associated with the
operation of additional contract locations and the equipment and furniture
purchased for the Company's new national support center which opened in
September 1996.
Other Operating Expenses (Including Purchased Services and Provision
for Bad Debts). Other operating expenses for the fiscal year ended August 31,
1997 were $32.3 million representing an increase of $5.1 million, or 18.8%, as
compared to other operating expenses of $27.2 million for the previous fiscal
year. A major factor in the increase in other operating expense resulted from
the 9.4% increase in the number of contract locations in operation for the
fiscal year ended August 31, 1997, as compared to the prior fiscal year. $1.7
million of the increase resulted from an increase in bad debt expense due to the
write-off of the receivable associated with a contract location which closed on
April 30, 1997. Purchased services increased by $2.6 million, of which $1.8
million was due primarily to the inclusion of Florida PPS in the Company's
consolidated financial statements for the entire twelve months in fiscal 1997
versus only one month in fiscal 1996 following its acquisition on August 1,
1996.
Merger Expenses. Merger expenses were $3.5 million for the fiscal
year ended August 31, 1997. The Company did not have merger expenses for the
prior fiscal year.
Interest and Other Income (Expense), Net. Interest income, interest
expense and other income for the fiscal year ended August 31, 1997 was $122,000,
as compared to net interest expense and other income of negative $66,000 for the
prior fiscal year. The increase in interest income was due to the investment of
the positive cash flow from earnings.
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Income Tax Expense. Income tax expense for the fiscal year ended August
31, 1997 was $4.5 million representing a decrease of $92,000, or 2.0%, as
compared to income tax expense of $4.6 million for the prior fiscal year. The
small decrease in income tax expense was largely due to a small decrease in
pre-tax earnings.
FISCAL YEAR ENDED AUGUST 31, 1996 COMPARED TO FISCAL YEAR ENDED
AUGUST 31, 1995
During the first six months of fiscal 1995, Horizon LLC had management
responsibility for substantially all of the management contract business of the
Company. Certain provisions of the limited liability company agreement of
Horizon LLC required the consent of the other member for certain transactions
preventing the Company from having the ability to control Horizon LLC under
generally accepted accounting principles, and therefore, Horizon LLC was not
consolidated with the Company for accounting purposes. As a result, the revenues
and expenses of Horizon LLC for the period August 1, 1994 through February 28,
1995 are not included in the revenues and expenses of the Company; instead, for
such periods the Company accounted for its investment in Horizon LLC by the
equity method and reflected its share of Horizon LLC's net income for the period
in question as "Equity in Net Earnings of Horizon LLC." Therefore, the operating
results of the Company for the year ended August 31, 1996, during which all of
the management contract business of the Company was consolidated for accounting
purposes, has changed materially as compared to the year ended August 31, 1995.
The historical financial results of the Company for the year ended August 31,
1995 are of limited value for the purpose of comparison to the results of the
Company for the year ended August 31, 1996. In particular the significant
increases in revenues and salaries and benefits are primarily due to the
consolidation in 1996 of the operations conducted by Horizon LLC for the first
six months in the 1995 fiscal year which were not consolidated.
Revenue. Revenues for the year ended August 31, 1996 were $96.2 million
representing an increase of $26.9 million, or 38.8%, as compared to the revenues
of $69.3 million for the prior fiscal year.
Salaries and Benefits. Salaries and benefits expenses for the year
ended August 31, 1996 were $55.8 million, representing an increase of $15.7
million, or 39.2%, as compared to salaries and benefits expenses of $40.1
million for the prior fiscal year.
Depreciation and Amortization. Depreciation and amortization expenses
for the year ended August 31, 1996 were $1.8 million, representing an increase
of $679,000, or 60.0% as compared to depreciation and amortization expenses of
$1.1 million for the prior fiscal year. $230,000 of this increase resulted from
recording a full year of expenses in 1996 of the amortization of goodwill and
contract value resulting from the acquisition of 110 contracts from Horizon LLC
effective March 1, 1995.
Other Operating Expenses (Including Purchase Services and Provision for
Bad Debts). Other operating expenses for the year ended August 31, 1996 were
$27.2 million, representing an increase of $5.5 million, or 25.3%, as compared
to other operating expenses of $21.7 million for the prior fiscal year.
Interest and Other Income (Expense), Net. Interest expense net of
interest and other income for the year ended August 31, 1996 was $66,000,
representing a decrease of $934,000, or 93.4%, as compared to $1.0 million in
net interest expense for the prior fiscal year. This net decrease resulted from
a combination of higher interest income earned as a result of an increase in
cash from operations and the proceeds of the Company's equity offering in March,
1995.
Income Tax Expense (Benefit). Income tax expense for the year ended
August 31, 1996 was $4.6 million, representing an increase of $2.9 million from
$1.7 million for the prior fiscal year. This increase resulted from higher
pre-tax earnings and the use of the Company's remaining net operating loss
carryforward in the year ended August 31, 1995.
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<PAGE> 33
LIQUIDITY AND CAPITAL RESOURCES
Effective September 29, 1995, the Company established with Texas
Commerce Bank, N.A. ("TCB") an $11.0 million revolving credit facility which was
increased to $14.0 million on October 16, 1997. The purpose of the facility is
to provide funds to be used for working capital needs and future acquisitions.
The facility is for a three year term with extension provisions. As of August
31, 1997, there were no borrowings outstanding under the revolving credit
facility and the Company had the ability to borrow $10.1 million thereunder.
On October 13, 1997, the Company entered into a commitment letter dated
October 8, 1997 (the "Commitment Letter") with TCB and Chase Securities Inc.
("Chase"), under which Chase agreed to act as exclusive advisor and arranger for
a senior secured credit facility in an aggregate amount of up to $50.0 million
(the "New Credit Facility") and TCB committed to provide up to $20.0 million of
the facility and to act as administrative agent. The New Credit Facility would
consist of a $10.0 million revolving credit facility to fund ongoing working
capital requirements (the "Revolving Credit Facility") and a $40.0 million
advance term loan facility to finance future acquisitions by the Company (the
"Advance Term Loan Facility"). The New Credit Facility will replace the
Company's existing $14.0 million revolving credit facility with TCB and it is
currently anticipated that the New Credit Facility will be put in place by early
December, 1997.
The following summary of certain material provisions of the Commitment
Letter does not purport to be complete, and is subject to, and qualified in its
entirety by reference to, the Commitment Letter, a copy of which was filed as
Exhibit 10.3 to the Company's Current Report on Form 8-K, dated September 1,
1997 and filed with the Commission on October 21, 1997, and is available from
the Company upon request. Because the terms, conditions and covenants of the New
Credit Facility are subject to the negotiation, execution and delivery of the
definitive loan documents, certain of the actual terms, conditions and covenants
thereof may differ from those described below.
The Company will be the borrower under the New Credit Facility which
will be unconditionally guaranteed by all material domestic subsidiaries of the
Company. The Revolving Credit Facility will have a term of three years from
closing and the Advance Term Loan Facility will have a term of five years from
closing, with drawdowns available for two years. Once a drawdown is made under
the Advance Term Loan Facility, the commitment thereunder will be reduced by the
amount funded. Each acquisition will require a separate note (the "Acquisition
Note") that will provide for quarterly principal payments, beginning at the end
of the two-year advance period, based upon a five year amortization schedule.
Principal outstanding under the New Credit Facility will bear interest at the
"Base Rate" (the greater of the Agent's "prime rate" or the federal funds rate
plus --%) plus 0% to .50% (depending on the Company's Indebtedness to EBITDA
Ratio as defined in the Commitment Letter) or the "Eurodollar Rate" plus .75% to
1.50% (depending on the Indebtedness to EBITDA Ratio), as selected by the
Company in accordance with the terms of the facility. The Company will incur
quarterly commitment fees ranging from .25% to .375% per annum (depending on the
Indebtedness to EBITDA Ratio) on the unused portion of the Revolving Credit
Facility and unused portion of the Advance Term Loan Facility.
The Company will be subject to certain covenants under the agreements
which will govern the New Credit Facility, including prohibitions against (i)
incurring additional debt or liens, except specified permitted debt or permitted
liens, (ii) certain material acquisitions, other than specified permitted
acquisitions (including any single acquisition not greater than $10.0 million or
cumulative acquisitions not in excess of $20.0 million during any four
consecutive quarterly periods), (iii) certain mergers, consolidations or asset
dispositions by the Company or changes of control of the Company, (iv) certain
management vacancies at the Company, and (v) material change in the nature of
business conducted. In addition, the terms of the New Credit Facility will
require the Company to satisfy certain ongoing financial covenants. The New
Credit Facility will be secured by a first lien or first priority security
interest in and/or pledge of all of the assets of the Company and of all present
and future subsidiaries of the Company.
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<PAGE> 34
Effective September 1996, the Company entered into a lease agreement
with a term of five years for a building which had been constructed to the
Company's specifications for its National Support Center. In connection with the
lease transaction, the Company guaranteed a loan of approximately $900,000. The
loan was by a financial institution to the owner. The Company also agreed to
purchase the leased building for approximately $4.5 million at the end of the
lease term in September 2001 if either the building is not sold to a third party
or the Company does not extend its lease.
The Company believes that its cash flow from operations, cash of $5.5
million at August 31, 1997 and $14.0 million currently available under the
revolving credit facility will be sufficient to cover all cash requirements over
the next twelve months, including the recently completed Acorn Acquisition of
approximately $12.7 million and estimated capital expenditures of $1.2 million.
The Company generated $9.3 million in net cash from operations during the year
ended August 31, 1997. The Company is likely to require additional capital to
fund any further acquisitions.
On October 31, 1997, the Company acquired all the outstanding capital
stock of Acorn for approximately $12.7 million. To fund the acquisition, the
Company utilized approximately $1.7 million of existing cash and incurred debt
of approximately $11.0 million under the revolving credit facility. The Company
believes that its cash flow from operations and the remaining availability under
its revolving credit facility will be sufficient for remaining cash requirements
in fiscal 1998.
Horizon acquired Specialty on August 11, 1997. Specialty was a contract
manager of mental health and physical rehabilitation treatment programs for
general acute care hospitals. At August 11, 1997, Specialty had 44 management
contracts. In the Specialty transaction, 1,400,000 shares of Horizon common
stock were issued and exchanged for all outstanding shares of Speciality capital
stock. The 1,400,000 shares represented approximately 20.1% of the Company's
common stock outstanding after the acquisition. The Company accounted for the
transaction as a pooling of interests, which resulted in the Company recognizing
merger-related expenses of approximately $3,528,000 and an offsetting tax
benefit of approximately $1,341,000, which taken together resulted in a one-time
charge to earnings of $.27 per share. Upon the acquisition, the Specialty
outstanding bank indebtedness of approximately $3.2 million was paid in full.
Effective March 15, 1997, the Company purchased all of the outstanding
capital stock of Geriatric. Geriatric is a contract manager of mental health
programs for general acute care hospitals and, at March 15, 1997, had 18
management contracts. The purchase price was approximately $4.6 million, and was
paid from existing cash.
Also effective March 15, 1997, the Company purchased all of the
outstanding capital stock of Clay Care. Clay Care is a contract manager of
mental health programs for general acute care hospitals and, at March 15, 1997
had five management contracts. The purchase price was $1.0 million, and was paid
from existing cash.
In July 1996, the Company acquired 80% of the outstanding common stock
of Florida PPS. The Company accounted for the acquisition of Florida PPS by the
purchase method as required by generally accepted accounting principles. Florida
PPS has been consolidated with the Company as of August 1, 1996. Based in
Clearwater, Florida, Florida PPS specializes in full risk, capitated managed
mental health programs and employee assistance programs. The purchase price for
80% of the outstanding capital stock was approximately $3.3 million, based
primarily on a 6.25 multiple of the 1996 pre-tax income of Florida PPS, and was
paid from existing cash. In addition, the Company obtained an option to acquire
the remaining 20% of the outstanding Florida PPS common stock at a future date.
The sellers, constituting all the shareholders of Florida PPS, also obtained the
right to put to the Company such shares on certain dates. The option and put
prices for the remaining Florida PPS shares are based on a multiple of the
pre-tax income of Florida PPS in future years.
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Specialty acquired the assets of National Medical Management Services
effective January 1, 1995. In the transaction, Specialty paid approximately
$3.95 million in cash and a note of approximately $731,000 payable to NME as
payment for the assets. Specialty also issued to NME a warrant to acquire common
stock of Specialty, which warrant was subsequently exercised as part of
Horizon's acquisition of Specialty in August 1997. The NME promissory note was
paid in January 1996. In April, 1996 Specialty acquired The Parkside Company, a
contract manager of mental health programs, in a merger in which common stock
was issued and approximately $2.6 million was paid in cash which was financed
under a bank credit facility.
INFLATION
The Company's management contracts generally provide for annual
adjustments in the Company's fees based upon various inflation indexes, thus
mitigating the effect of inflation. During the last three years, inflation has
had little effect on the Company's business.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the Consolidated Financial Statements of the
Company and the Notes thereto appearing at page F-1 to F-26 attached hereto, all
of which information is incorporated by reference into this Item 8.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The Company will file with the Commission a definitive proxy statement
with respect to the annual meeting of stockholders of the Company to be held on
January 23, 1998 (the "Proxy Statement"). The Company hereby incorporates into
this Item 10 by reference to the Proxy Statement the information required by
this Item 10 that will appear in the Proxy Statement under the caption ELECTION
OF DIRECTORS.
The information called for by this Item 10 and Item 401 of Regulation
S-K with respect to executive officers of the Company appears under the caption
EXECUTIVE OFFICERS OF THE REGISTRANT following Item 4 of Part I of this Report,
and is incorporated by reference into this Item 10.
ITEM 11. EXECUTIVE COMPENSATION
The Company hereby incorporates into this Item 11 by reference to the
Proxy Statement the information required by this Item 11 that will appear in the
Proxy Statement under the caption EXECUTIVE COMPENSATION.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The Company hereby incorporates into this Item 12 by reference to the
Proxy Statement the information required by this Item 12 that will appear in the
Proxy Statement under the caption SECURITY OWNERSHIP BY MANAGEMENT AND PRINCIPAL
STOCKHOLDERS.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company hereby incorporates into this Item 13 by reference to the
Proxy Statement the information required by this Item 13 that will appear in the
Proxy Statement under the caption CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K
(a) (1) Reference is made to the Index to Consolidated Financial
Statements appearing at page F-1 of this report.
(2) Reference is made to the Index to Financial Statement
Schedules appearing at page S-1 of this report.
(3) Exhibits.
NUMBER EXHIBIT
2.1 - Stock Purchase Agreement, dated October 20, 1997, among the
Company, Dr. Melvyn S. Goldsmith, Ph.D., Barbara C. Goldsmith
and Acorn Behavioral HealthCare Management Corporation
(incorporated herein by reference to Exhibit 2.1 to the
Company's Current Report on Form 8-K dated September 1, 1997).
3.1 - Certificate of Incorporation of the Company, as amended
(incorporated herein by reference to Exhibit 3.1 to the
Company's Current Report on Form 8-K dated August 11, 1997).
3.2 - Amended and Restated Bylaws of the Company, as amended
(incorporated herein by reference to Exhibit 3.2 to Amendment
No. 2 as filed with the Commission on February 16, 1995
("Amendment No. 2") to the Company's Registration Statement on
Form S-1 filed with the Commission on January 6, 1995
(Registration No. 33-88314) (the "Form S-1").
4.1 - Specimen certificate for the Common Stock, $.01 par value of
the Company (incorporated herein by reference to Exhibit 4.1
to the Company's Current Report on Form 8-K dated August
11, 1997).
4.2 - Rights Agreement, dated February 6, 1997, between the Company
and American Stock Transfer & Trust Company, as Rights Agent
(incorporated by reference to Exhibit 4.1 to the Company's
Registration Statement on Form 8-A, Registration No.
000-22123, as filed with the Commission on February 7, 1997).
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<PAGE> 39
10.1 - Lease dated as of December 15, 1990 between Charter Hospital
of Fort Collins, Inc. and HHG Colorado, Inc. (incorporated
herein by reference to Exhibit 10.12 to the Company's Form S-1).
10.2 - Sublease Agreement dated as of July 31, 1997 between HHG
Colorado, Inc. and MHM of Colorado, Inc. (incorporated herein by
reference to Exhibit 10.13 to the Company's Form S-1).
10.3 - Employment Agreement dated as of August 21, 1990 between Horizon
Health Management Company, Inc. and Gary A. Kagan (incorporated
herein by reference to Exhibit 10.44 to the Company's Form S-1).
10.4 - Letter dated November 23, 1992 between Horizon Mental Health
Services, Inc. and Robert A. Lefton regarding severance
arrangements (incorporated herein by reference to Exhibit 10.45
to the Company's Form S-1).
10.5 - Agreed Permanent Injunction and Final Judgment dated December 8,
1994 (incorporated herein by reference to Exhibit 10.32 to the
Company's Form S-1).
10.6 - Loan Agreement dated September 29, 1995 among Horizon Mental
Health Management, Inc., a Delaware corporation, Horizon Mental
Health Management, Inc., a Texas corporation, Mental Health
Outcomes, Inc., a Delaware corporation, and Texas Commerce Bank
National Association (incorporated herein by reference to
Exhibit 10.45 to the Company's Annual Report on Form 10-K for
the fiscal year ended August 31, 1995).
10.7 - First Amendment to Loan Agreement dated as of December 20, 1995
among Horizon Mental Health Management, Inc., a Delaware
corporation, Horizon Mental Health Management, Inc., a Texas
corporation, Mental Health Outcomes, Inc., a Delaware
corporation, and Texas Commerce Bank National Association
("TCB") (incorporated herein by reference to Exhibit 10.2 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
November 30, 1995 as filed with the Commission on January 16,
1996 (the "November 1995 Form 10-Q")).
10.8 - Fifth Amendment to Loan Agreement, by and among TCB, the
Company, Horizon Mental Health Management, Inc. and Mental
Health Outcomes, Inc., dated as of October 16, 1997
(incorporated herein by reference to Exhibit 10.1 to the
Company's Current Report on Form 8-K dated September 1, 1997).
10.9 - Amended and Restated Revolving Credit Note, dated October 16,
1997, made by the Company, Horizon Mental Health Management,
Inc. and Mental Health Outcomes, Inc. in the principal sum of up
to $14,000,000 and payable to TCB (incorporated herein by
reference to Exhibit 10.2 to the Company's Current Report on
Form 8-K dated September 1, 1997).
10.10 - Horizon Health Corporation Senior Secured Credit Facility
Commitment Letter, dated as of October 8, 1997, among the
Company, TCB and Chase Securities, Inc. (incorporated herein by
reference to Exhibit 10.3 to the Company's Current Report on
Form 8-K dated September 1, 1997).
10.11 - Letter Loan Agreement dated December 20, 1995 among North
Central Development Company, as borrower, TCB, as lender, and
Horizon Mental Health Management, Inc., a Delaware corporation,
Horizon Mental Health Management, Inc., a Texas corporation, and
Mental Health Outcomes, Inc., a Delaware corporation, as
guarantors (incorporated herein by reference to Exhibit 10.7 to
the November 1995 Form 10-Q).
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<PAGE> 40
10.12 - Lease Agreement dated as of December 20, 1995 between North
Central Development Company and Horizon Mental Health
Management, Inc., a Delaware corporation (incorporated herein by
reference to Exhibit 10.8 to the November 1995 Form 10-Q).
10.13 - Horizon Health Group, Inc. 1989 Stock Option Plan, as amended
(incorporated herein by reference to Exhibit 10.52 of Amendment
No. 2 to the Company's Form S-1).
10.14 - Horizon Mental Health Management, Inc. 1995 Stock Option Plan
(incorporated herein by reference to Exhibit 10.11 to the
November 1995 Form 10-Q).
10.15 - Horizon Mental Health Management, Inc. Amended and Restated 1995
Stock Option Plan for Eligible Outside Directors (incorporated
herein by reference to Exhibit 10.12 to the November 1995 Form
10-Q).
10.16 - Amendments to 1989 Stock Option Plan and 1995 Stock Option Plan
(incorporated herein by reference to Exhibit 10.5 to the
Company's Current Report on Form 8-K dated September 1, 1997).
10.17 - Amendments to 1995 Stock Option Plan and 1995 First Amended and
Restated Stock Option Plan for Eligible Outside Directors
(incorporated herein by reference to Exhibit 10.6 to the
Company's Current Report on Form 8-K dated September 1, 1997).
10.18 - Horizon Mental Health Management Bonus Plan Fiscal 1996
(incorporated herein by reference to Exhibit 10.13 to the
November 1995 Form 10-Q).
10.19 - Horizon Mental Health Management Bonus Plan Fiscal 1997
(incorporated herein by reference to Exhibit 10.36 to Amendment
No. 1 to the Company's Annual Report on Form 10-K/A for the
fiscal year ended August 31, 1996 (the "1996 Form 10-K/A")).
10.20 - Horizon Mental Health Management Contingent Bonus Plan
(incorporated herein by reference to Exhibit 10.37 to the
Company's 1996 Form 10-K/A).
10.21 - Horizon Health Corporation Bonus Plan Fiscal 1998
(filed herewith).
10.22 - Stock Purchase Agreement among Horizon Mental Health Management,
Inc., as purchaser, and Joseph R. Bona, M.D., Nancy J. Simons,
Ph.D., John G. Toms, Ph.D., William H. Kale, Ph.D., and David E.
Stenmark, Ph.D. as sellers, dated July 31, 1996 (incorporated
herein by reference to Exhibit 10.25 to the Company's 1996
Form 10-K/A).
10.23 - Amendment dated February 10, 1997 between the Company and the
stockholders of Florida Professional Psychological Services,
Inc. (incorporated herein by reference to the Company's
Quarterly Report on Form 10-Q for the quarter ended February
28, 1997, as filed with the Commission on March 31, 1997 (the
"February 1997 Form 10-Q)).
10.24 - Stock Purchase Agreement dated as of February 24, 1997, among
the Company and Geriatric Medical Care, Inc. and its
stockholders, as amended (incorporated herein by reference to
Exhibit 10.1 to the Company's February 1997 Form 10-Q).
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<PAGE> 41
10.25 - Share Exchange Reorganization Agreement dated as of April 25,
1997, among the Company, Howard B. Finkel, John Harrison, Larry
Reiff, Argentum Capital Partners, L.P., Denise Dailey, Ken
Dorman, G. Phillip Woellner, and Michael S. McCarthy, and
Specialty Healthcare Management, Inc., as amended by a First
Amendment to Share Exchange Reorganization Agreement dated as of
July 2, 1997 (incorporated herein by reference to Appendix A to
the definitive Proxy Statement filed with the Commission by the
Company on July 11, 1997, relating to a Special Meeting of
Stockholders of the Company to be held on August 11, 1997).
10.26 - Post-Closing Escrow Agreement dated August 11, 1997 between the
Company and Howard B. Finkel, as Agent (incorporated herein by
reference to Exhibit 10.2 to the Company's Current Report on Form
8-K dated August 11, 1997).
10.27 - Registration Rights Agreement dated August 11, 1997, between the
Company and Howard B. Finkel, et al. (incorporated herein by
reference to Exhibit 10.3 to the Company's Current Report on
Form 8-K dated August 11, 1997).
10.28 - Executive Retention Agreement effective September 1, 1997,
between the Company and James Ken Newman (incorporated herein by
reference to Exhibit 10.4 to the Company's Current Report on Form
8-K dated September 1, 1997).
11.1 - Statement Regarding Computation of Per Share Earnings (filed
herewith).
21.1 - List of Subsidiaries of the Company (filed herewith).
23.1 - Consent of Price Waterhouse LLP (filed herewith).
27.1 - Financial Data Schedule (incorporated herein by reference to
Exhibit 27.1 to the Company's Registration Statement on Form S-3
filed with the Commission on October 21, 1997 (Registration No.
333-38421)).
(b) The Company filed the following report on Form 8-K during the last
quarter of the period covered by this report:
Current Report on Form 8-K dated August 11, 1997 and filed with the
Commission on August 25, 1997, which included Item 2 relating to
the acquisition of Specialty and Item 5 relating to the change of
the Company's corporate name and trading symbol and the election of
two additional directors and a new President of the Company.
Unaudited Pro Forma Condensed Combined Financial Statements of the
Company and Specialty and Consolidated Financial Statements of
Specialty were filed with such Form 8-K.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
DATE: NOVEMBER 21, 1997
HORIZON HEALTH CORPORATION
BY: /s/ JAMES KEN NEWMAN
----------------------------------
JAMES KEN NEWMAN
CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the Company
and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE CAPACITY DATE
--------- -------- ----
<S> <C> <C>
/s/ JAMES KEN NEWMAN
- ---------------------------- Director, Chairman of the Board and November 21, 1997
James Ken Newman Chief Executive Officer
(Principal Executive Officer)
/s/ JAMES W. MCATEE
- ---------------------------- Director, Executive Vice President, November 21, 1997
James W. McAtee Finance & Administration,
Chief Financial Officer and Treasurer
(Principal Financial Officer)
/s/ CLIFF W. GARDNER
- ---------------------------- Vice President--Controller, November 21, 1997
Cliff W. Gardner (Principal Accounting Officer)
/s/ JACK R. ANDERSON
- ---------------------------- Director November 21, 1997
Jack R. Anderson
/s/ GEORGE E. BELLO
- ---------------------------- Director November 21, 1997
George E. Bello
/s/ WILLIAM H. LONGFIELD
- ---------------------------- Director November 21, 1997
William H. Longfield
/s/ JAMES E. BUNCHER
- ---------------------------- Director November 21, 1997
James E. Buncher
/s/ DONALD E. STEEN
- ---------------------------- Director November 21, 1997
Donald E. Steen
/s/ HOWARD B. FINKEL
- ---------------------------- Director November 21, 1997
Howard B. Finkel
</TABLE>
<PAGE> 43
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
<S> <C>
Report of Independent Accountants...............................................F-2
Consolidated Balance Sheets at August 31, 1996 and 1997.........................F-3
Consolidated Statements of Income
For the Years Ended August 31, 1995, 1996, and 1997...........................F-4
Consolidated Statements of Changes in Stockholders' Equity (Deficit)
For the Years Ended August 31, 1995, 1996, and 1997...........................F-5
Consolidated Statements of Cash Flows
For the Years Ended August 31, 1995, 1996, and 1997...........................F-6
Notes to Consolidated Financial Statements......................................F-7
</TABLE>
F - 1
<PAGE> 44
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
and Stockholders of
Horizon Health Corporation
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, of changes in stockholders' equity (deficit)
and of cash flows present fairly, in all material respects, the financial
position of Horizon Health Corporation and its subsidiaries at August 31, 1996
and 1997, and the results of their operations and their cash flows for each of
the three years in the period ended August 31, 1997, in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Dallas, Texas
October 13, 1997
F - 2
<PAGE> 45
HORIZON HEALTH CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
AUGUST 31,
--------------------------
1996 1997
----------- -----------
<S> <C> <C>
CURRENT ASSETS:
Cash and short-term investments........................... $ 8,346,373 $ 5,516,575
Accounts receivable less allowance for uncollectible
accounts of $2,387,622 and $1,357,423 at August 31, 1996
and 1997, respectively.................................. 12,720,429 11,995,254
Receivable from employees................................. 89,126 63,303
Prepaid expenses and supplies............................. 173,131 182,208
Income taxes receivable................................... 96,210 951,256
Other receivables......................................... 89,383 51,877
Other current assets...................................... 71,940 170,154
Current deferred taxes.................................... 2,116,582 1,687,512
----------- -----------
TOTAL CURRENT ASSETS............................... 23,703,174 20,618,139
----------- -----------
PROPERTY AND EQUIPMENT:
Equipment................................................. 2,704,225 3,694,717
Building improvements..................................... 109,467 255,406
----------- -----------
2,813,692 3,950,123
Less accumulated depreciation............................. 1,729,440 2,208,083
----------- -----------
1,084,252 1,742,040
Restricted cash............................................. 344,404 --
Goodwill, net of accumulated amortization of $1,564,195 and
$2,078,177 at August 31, 1996 and 1997, respectively...... 15,330,555 21,553,594
Management contracts, net of accumulated amortization of
$1,991,093 and $2,744,666 at August 31, 1996 and 1997,
respectively.............................................. 4,555,985 4,451,426
Other assets................................................ 195,630 363,208
----------- -----------
TOTAL ASSETS....................................... $45,214,000 $48,728,407
=========== ===========
CURRENT LIABILITIES:
Accounts payable.......................................... $ 2,687,805 $ 1,747,393
Employee compensation and benefits........................ 5,276,659 6,233,477
Income taxes payable...................................... 84,942 --
Accrued expenses (Note 5)................................. 5,721,827 7,572,929
Payable to Health Insurance Program....................... 661,248 --
Current debt maturities................................... 519,600 --
----------- -----------
TOTAL CURRENT LIABILITIES.......................... 14,952,081 15,553,799
Other liabilities......................................... 724,511 355,803
Long-term debt, net of current debt maturities............ 3,056,714 --
Deferred income taxes..................................... 1,322,635 987,704
----------- -----------
TOTAL LIABILITIES.................................. 20,055,941 16,897,306
----------- -----------
Commitments and contingencies (Note 9)
Minority interest........................................... 8,755 148,648
STOCKHOLDERS' EQUITY:
Preferred stock, $.10 par value, authorized 500,000
shares; none issued or outstanding...................... -- --
Common stock, $.01 par value, 10,000,000 and 40,000,000
shares authorized at August 31, 1996 and 1997,
respectively; 6,702,305 shares issued and 6,696,849
shares outstanding at August 31, 1996 and 6,966,762
shares issued and outstanding at August 31, 1997........ 67,023 69,668
Additional paid-in capital................................ 16,046,163 16,739,425
Retained earnings......................................... 9,066,399 14,873,360
Deferred compensation..................................... (25,000) --
Treasury stock, at cost................................... (5,281) --
----------- -----------
25,149,304 31,682,453
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY......... $45,214,000 $48,728,407
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE> 46
HORIZON HEALTH CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE YEARS ENDED AUGUST 31,
------------------------------------------
1995 1996 1997
----------- ----------- ------------
<S> <C> <C> <C>
REVENUES:
Contract management revenue....................... $68,720,645 $95,244,454 $102,263,283
Other............................................. 634,238 994,512 7,003,512
----------- ----------- ------------
Total revenues............................ 69,354,883 96,238,966 109,266,795
----------- ----------- ------------
EXPENSES:
Salaries and benefits............................. 40,083,239 55,809,614 60,048,345
Purchased services................................ 10,794,068 13,880,426 16,466,115
Provision for bad debts........................... 1,680,396 1,435,049 3,033,693
Other............................................. 9,188,828 11,848,384 12,795,910
Depreciation and amortization..................... 1,132,604 1,811,790 2,201,450
Merger expenses (Note 3).......................... -- -- 3,527,671
----------- ----------- ------------
Operating expenses................................ 62,879,135 84,785,263 98,073,184
----------- ----------- ------------
Operating Income.................................... 6,475,748 11,453,703 11,193,611
----------- ----------- ------------
Other income (expense)
Interest expense -- related party................. (1,190,680) (24,298) --
Interest expense -- other......................... (221,439) (395,123) (402,003)
Interest income and other......................... 409,047 353,231 523,877
Loss on sale of equipment......................... -- -- (1,888)
----------- ----------- ------------
Income before income taxes.......................... 5,472,676 11,387,513 11,313,597
Income tax expense.................................. 1,694,534 4,609,360 4,517,688
----------- ----------- ------------
Income before equity in net earnings of Horizon LLC
and minority interest............................. 3,778,142 6,778,153 6,795,909
Equity in net earnings of Horizon LLC............... 1,567,720 -- --
Minority interest................................... -- (2,397) (139,893)
----------- ----------- ------------
Net income.......................................... $ 5,345,862 $ 6,775,756 $ 6,656,016
=========== =========== ============
Earnings per common share:
Net income per common share....................... $ 0.85 $ 0.86 $ 0.83
=========== =========== ============
Weighted average common shares and common equivalent
shares outstanding................................ 6,307,633 7,872,251 8,061,879
=========== =========== ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 47
HORIZON HEALTH CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED AUGUST 31, 1995, 1996 AND 1997
<TABLE>
<CAPTION>
COMMON SHARES ADDITIONAL RETAINED
------------------- PAID-IN EARNINGS DEFERRED TREASURY
SHARES AMOUNT CAPITAL (DEFICIT) COMPENSATION STOCK, AT COST TOTAL
--------- ------- ----------- ----------- ------------ -------------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at August 31, 1994........ 3,565,680 $35,657 $ 1,586,359 $(3,055,219) $ -- $ -- $(1,433,203)
Net income...................... -- -- -- 5,345,862 -- -- 5,345,862
Initial public offering......... 2,100,000 21,000 11,978,528 -- -- -- 11,999,528
Issuance of shares in
conjunction with purchase of
the net assets of NMMS........ 530,419 5,304 883,700 -- -- -- 889,004
Issuance of warrants in
conjunction with purchase..... -- -- 389,350 -- -- -- 389,350
Sale of common shares........... 5,456 55 24,610 -- -- -- 24,665
Acquisition of treasury
shares........................ (5,456) -- -- -- -- (5,281) (5,281)
Notes receivable for purchase of
shares........................ -- -- (75,000) -- -- -- (75,000)
Deferred compensation for
issuance of stock............. -- -- -- -- (75,000) -- (75,000)
Amortization of deferred
compensation.................. -- -- -- -- 25,000 -- 25,000
Tax benefit associated with
stock options................. -- -- 2,313 -- -- -- 2,313
Exercise of stock options....... 118,575 1,186 120,249 -- -- -- 121,435
Sale of rights to purchase
options....................... -- -- 16,750 -- -- -- 16,750
--------- ------- ----------- ----------- -------- ------- -----------
Balance at August 31, 1995........ 6,314,674 63,202 14,926,859 2,290,643 (50,000) (5,281) 17,225,423
Net income...................... -- -- -- 6,775,756 -- -- 6,775,756
Sale of common shares........... 55,298 553 59,446 -- -- -- 59,999
Issuance of shares in
conjunction with purchase of
the Parkside Company.......... 192,437 1,924 868,076 -- -- -- 870,000
Payments on notes receivable.... -- -- 50,000 -- -- -- 50,000
Amortization of deferred
compensation.................. -- -- -- -- 25,000 -- 25,000
Tax benefit associated with
stock options................. -- -- 37,717 -- -- -- 37,717
Exercise of stock options....... 134,440 1,344 104,065 -- -- -- 105,409
--------- ------- ----------- ----------- -------- ------- -----------
Balance at August 31, 1996........ 6,696,849 67,023 16,046,163 9,066,399 (25,000) (5,281) 25,149,304
Net income...................... -- -- -- 6,656,016 -- -- 6,656,016
Adjustment applicable to
transition period (Note 3).... -- -- -- (849,055) -- -- (849,055)
Amortization of deferred
compensation.................. -- -- -- -- 25,000 -- 25,000
Retirement of treasury shares... -- (55) (5,226) -- -- 5,281 --
Payment on note receivable...... -- -- 25,000 -- -- -- 25,000
Exercise of warrants............ 179,178 1,793 (1,793) -- -- -- --
Tax benefit associated with
stock options................. -- -- 511,949 -- -- -- 511,949
Exercise of stock options....... 90,735 907 163,332 -- -- -- 164,239
--------- ------- ----------- ----------- -------- ------- -----------
Balance at August 31, 1997........ 6,966,762 $69,668 $16,739,425 $14,873,360 $ -- $ -- $31,682,453
========= ======= =========== =========== ======== ======= ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 48
HORIZON HEALTH CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED AUGUST 31, 1995, 1996 AND 1997
<TABLE>
<CAPTION>
1995 1996 1997
------------ ----------- -----------
<S> <C> <C> <C>
Operating Activities:
Net income................................................ $ 5,345,862 $ 6,775,756 $ 6,656,016
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation and amortization........................... 1,132,604 1,811,790 2,201,450
Loss on sale of equipment............................... -- -- 1,888
Minority interest....................................... -- 2,397 139,893
Horizon LLC investment income........................... (1,567,720) -- --
Deferred income taxes................................... 84,230 9,909 94,139
Non-cash expenses....................................... 535,000 25,000 25,000
Changes in net assets and liabilities:
Decrease (increase) in restricted cash.................. (582,689) (205,857) 218,606
Decrease (increase) in accounts receivable.............. 4,832,797 (1,307,286) 1,143,322
Decrease (increase) in other receivables................ (118,035) 285,346 264,589
Decrease (increase) in prepaid expenses and supplies.... 483,751 (80,875) (599,553)
Decrease (increase) in other assets..................... 171,329 (127,188) (144,101)
Increase in accounts payable, accrued expenses, and
other liabilities..................................... 1,922,276 1,450,473 1,031,381
Increase (decrease) in income taxes payable............. -- 75,344 (272,649)
Decrease in payable to health insurance program......... (1,126,208) -- (661,248)
Increase (decrease) in other liabilities................ 243,423 151,872 (749,532)
------------ ----------- -----------
Net cash provided by operating activities................... 11,356,620 8,866,681 9,349,201
------------ ----------- -----------
Investing Activities:
Purchase of property and equipment........................ (621,201) (393,703) (1,412,441)
Proceeds from sale of equipment........................... -- -- 13,485
Payment for purchase of minority interest in Horizon LLC,
net of cash acquired.................................... (9,196,249) -- --
Cash contributed to Horizon LLC........................... (620,000) -- --
Increase in goodwill and management contracts............. (37,916) (123,222) --
Payment for purchase of the Parkside Company, net of cash
acquired................................................ -- (2,600,000) --
Payment for purchase of net assets of National Medical
Management Services..................................... (3,946,849) (302,817) --
Payment for purchase of Professional Psychological
Services, Inc., net of cash acquired.................... -- (786,767) (1,898,230)
Payment for purchase of Clay Care, Inc., net of cash
acquired................................................ -- -- (913,634)
Payment for purchase of Geriatric Medical Care, Inc., net
of cash acquired........................................ -- -- (4,577,970)
------------ ----------- -----------
Net cash used in investing activities....................... (14,422,215) (4,206,509) (8,788,790)
------------ ----------- -----------
Financing activities:
Payments on long-term debt................................ (11,931,242) (3,108,047) (4,114,862)
Payment on notes receivable for purchase of common
stock................................................... -- 50,000 25,000
Proceeds from long term borrowings........................ 3,203,000 3,291,820 --
Net proceeds from issuance of common stock................ 12,879,351 165,408 164,239
Sale of rights to purchase options........................ 16,750 -- --
Tax benefit related to stock option exercise.............. 2,313 37,717 511,949
------------ ----------- -----------
Net cash provided by (used in) financing activities......... 4,170,172 436,898 (3,413,674)
------------ ----------- -----------
Change in cash during transition period..................... -- -- 23,465
Net Increase (decrease) in cash and short term
investments............................................... 1,104,577 5,097,070 (2,829,798)
Cash and short-term investments at beginning of year........ 2,144,726 3,249,303 8,346,373
------------ ----------- -----------
Cash and short-term investments at end of year.............. $ 3,249,303 $ 8,346,373 $ 5,516,575
============ =========== ===========
Supplemental disclosure of cash flow information
Cash paid during the period for:
Interest................................................ $ 1,412,119 $ 419,421 $ 402,003
============ =========== ===========
Income taxes............................................ $ 2,188,363 $ 4,930,499 $ 4,584,015
============ =========== ===========
Supplemental disclosure on non-cash investing activities:
Purchase of minority interest in Horizon LLC and the net
assets of National Medical Management Services during
fiscal year 1995; the acquisition of 80% of the common
stock of Professional Psychological Services, Inc. and
100% of the common stock of the Parkside Company during
fiscal year 1996; and the acquisition of Geriatric
Medical Care, Inc., Clay Care, Inc., and additional
payments for the acquisition of 80% of the common stock
of Professional Psychological Services, Inc. during
fiscal year 1997.
Fair value of assets acquired........................... $ 24,038,476 $ 5,815,535 $ 9,004,431
Cash paid............................................... (13,630,316) (3,825,000) (7,524,968)
Conversion of equity investment......................... (4,351,737) -- --
Common stock exchanged.................................. -- (870,000) --
------------ ----------- -----------
Liabilities assumed..................................... $ 6,056,423 $ 1,120,535 $ 1,479,463
============ =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE> 49
HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
Horizon Health Corporation (the "Company"), formerly known as Horizon
Mental Health Management, Inc., is a contract manager of clinical and
related services, primarily of mental health programs, offered by general
acute care hospitals in the United States. These management contracts are
generally for terms ranging from three to five years, the majority of
which have automatic renewal provisions. The Company currently has
offices in the Dallas, Texas; Los Angeles, California; Chicago, Illinois;
Tampa, Florida; and Boston, Massachusetts metropolitan areas. The
Company's National Support Center is in Lewisville, Texas.
The Company was formed in July 1989 for the purpose of acquiring all the
assets of two companies. One of these companies, known as Horizon Health
Management Company, had been formed in 1981 and since that time had been
engaged in the mental health contract management business. The other
company owned a freestanding psychiatric hospital in California.
Effective March 1, 1990, the assets constituting the contract management
business and the psychiatric hospital of the two companies were
transferred to the Company. On January 3, 1995, the Company acquired the
net assets and operations of National Medical Management Services, a
division of National Medical Enterprises, Inc.
On March 13, 1995, the Company's initial public offering of 3,120,000
shares of common stock at an offering price to the public of $6.67 per
share was declared effective by the Securities and Exchange Commission.
Of the 3,120,000 shares of common stock offered, 1,981,850 shares were
offered by the Company and 1,138,150 shares were offered by a stockholder
of the Company. On March 20, 1995, the Company completed the initial
public offering, issued the common stock and received net proceeds of
$11,324,141 (after deducting underwriting discounts and IPO costs of
$1,888,189).
On April 11, 1995, the Company sold an additional 118,150 shares of
common stock at the initial offering price of $6.67 per share pursuant to
the exercise of the overallotment option granted to the underwriters in
the initial public offering. Net proceeds of $675,387 (after deducting
underwriting discounts and IPO costs of $112,283) were received by the
Company.
On April 1, 1996, the Company acquired the Parkside Company ("Parkside"),
a contract manager of mental health services for acute care hospitals.
Parkside has been consolidated with the Company as of April 1, 1996. On
July 31, 1996, the Company acquired eighty percent (80%) of the
outstanding common stock of Florida Professional Psychological Services,
Inc., also known as Professional Psychological Services, Inc. ("PPS") and
PPS has been consolidated with the Company as of August 1, 1996.
Effective March 15, 1997, the Company purchased all of the outstanding
capital stock of Geriatric Medical Care, Inc., a Tennessee corporation
("Geriatric"), and Clay Care, Inc., a Texas corporation ("CCI"), and they
have been consolidated with the Company as of March 15, 1997 (see Note
3).
F-7
<PAGE> 50
HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
On August 11, 1997, the Company exchanged 1,400,000 shares of its common
stock for all of the outstanding common stock of Specialty Healthcare
Management, Inc. ("Specialty"). Specialty was a privately held contract
manager of mental health and physical rehabilitation treatment programs
for general acute care hospitals. The exchange has been accounted for
under the pooling of interests method. Accordingly, all financial
statements presented have been restated to include the results of
Specialty (see Note 3).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND SHORT-TERM INVESTMENTS: Cash and short-term investments include
securities with original maturities of three months or less when
purchased.
RESTRICTED CASH: Restricted cash represents amounts set aside for the
Supplemental Executive Retirement Plan (SERP) and Deferred Compensation
Plan of Specialty Healthcare Management, Inc., which were terminated in
connection with the pooling of interests transaction.
PROPERTY AND EQUIPMENT: Property and equipment are recorded at cost.
Depreciation expense is recorded on the straight-line basis over the
assets' estimated useful lives. The useful lives of furniture and
fixtures and computer equipment are estimated to be five years and three
years, respectively. Building improvements are recorded at cost and
amortized over the estimated useful lives of the improvements or the
terms of the underlying lease, whichever is shorter. Routine maintenance,
repair items, and customer facility and site improvements are charged to
current operations.
MANAGEMENT CONTRACTS: Management contracts represent the fair value of
contracts purchased and are being amortized using the straight-line
method over seven years.
GOODWILL: Goodwill represents the excess of cost over fair value of net
assets acquired and is being amortized using the straight-line method
over 40 years.
LONG-LIVED AND INTANGIBLE ASSETS: The Company has adopted Statement of
Financial Accounting Standards ("SFAS") No. 121, "Accounting for the
Impairment of Long-lived Assets and Assets to be Disposed of". Under SFAS
121, the Company recognizes impairment losses on property and equipment
and intangible assets whenever events or changes in circumstances
indicate that the carrying amount of long-lived assets, on an individual
property basis, may not be recoverable through undiscounted future cash
flows. Such losses are determined using estimated fair value or by
comparing the sum of the expected future discounted net cash flows to the
carrying amount of the asset. Impairment losses are recognized in
operating income as they are determined.
REVENUE: Contract management revenue is reported at the estimated net
realizable amounts from contracted hospitals for contract management
services rendered. Adjustments are accrued on an estimated basis in the
period the related services are rendered and adjusted in future periods
as final settlement is determined. Contract management revenue is based
on a per diem calculation using patients per day, a fixed fee,
admissions, discharges, direct expenses, or any combination of the
preceding depending on a specific contract.
F-8
<PAGE> 51
HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Other revenue is primarily generated by capitated managed behavioral
health and employee assistance programs. The fees are defined by contract
and are calculated on a per-member/per-month fee, fixed fee and/or a fee
for service basis. Other revenue is accrued in the same manner as
contract management revenue.
Some management contracts include a clause which states that the Company
will indemnify the hospital for any third-party payor denials, including
Medicare. At the time the charges are denied, an allowance for 100% of
the disputed amount is recorded by the Company. Management believes it
has adequately provided for any potential adjustments that may result
from final settlement of these denials.
The customers of the Company are not concentrated in any specific
geographic region, but are concentrated in the health care industry. At
August 31, 1997, the Company had management contracts with 39 hospitals
directly or indirectly owned by Columbia/HCA Healthcare Corporation
("Columbia/HCA"), of which 36 had programs in operation. These 36
contracts accounted for 19.1% of the Company's net revenues for the year
ended August 31, 1997. In the aggregate, including terminated contracts,
revenues generated by hospitals directly or indirectly owned by
Columbia/HCA accounted for 15.6%, 20.3%, and 20.3% of the Company's net
revenues for the years ended August 31, 1995, 1996, and 1997. Of the 39
Columbia/HCA contracts at August 31, 1997, 14 contracts contain a
provision limiting the number of contracts which Columbia/HCA can cancel
without cause to 33.3% during any calendar year. The termination or
non-renewal of all or a substantial part of the management contracts with
hospitals owned by Columbia/HCA could have a material adverse effect on
the Company's business, financial condition or results of operations. In
recent months, Columbia/HCA and its business practices have been under
intense widespread review by governmental agencies. Because the Company
has a significant number of management contracts with Columbia/HCA which
could also be subject to review, the governmental scrutiny of
Columbia/HCA could directly or indirectly affect the Company or its
relationship with Columbia/HCA.
At August 31, 1996 and 1997, accounts receivable from hospitals directly
or indirectly owned by Columbia/HCA were approximately $1,966,000 and
$2,089,000, respectively. The Company generally does not require
collateral to support outstanding accounts receivable.
INCOME TAXES: The Company has adopted SFAS No. 109, "Accounting for
Income Taxes." SFAS 109 generally requires an asset and liability
approach and requires recognition of deferred tax assets and liabilities
resulting from differing book and tax bases of assets and liabilities. It
requires that deferred tax assets and liabilities be determined using the
tax rate expected to apply to taxable income in the periods in which the
deferred tax asset or liability is expected to be realized or settled.
Under this method, future financial results will be impacted by the
effect of changes in income tax rates on cumulative deferred income tax
balances.
F-9
<PAGE> 52
HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NET INCOME PER SHARE: Net income per common share is calculated using the
weighted average number of common shares and common equivalent shares
outstanding during the respective periods. Dilutive common equivalents
consist of stock options and warrants calculated using the treasury stock
method. Pursuant to the requirements of the Securities and Exchange
Commission, common shares and common equivalent shares issued at prices
below the public offering price during the twelve months immediately
preceding the date of the initial filing of the Registration Statement
have been included in the calculation of common shares and common
equivalent shares, using the treasury stock method, as if they were
outstanding for all periods presented. All shares and per share data,
except par value per share, have been retroactively adjusted to reflect a
three for two stock split effected as a 50% stock dividend by the
Company.
SALE OF RIGHTS TO PURCHASE OPTIONS: During the year ended August 31,
1995, the Company issued rights to purchase nonstatutory stock options to
purchase 168,000 shares of common stock. Certain of these options
required payment of $0.67 per option by the recipient prior to issuance
of the option. The Company recognized these payments as an addition to
Additional Paid-in Capital.
HEALTH INSURANCE PROGRAM REIMBURSEMENT: Services were provided by the
Company to patients who are eligible for coverage under Title XVIII
(Medicare) Health Insurance Programs. Amounts received are generally less
than the standard billing rates of the hospital and receivables are
recorded in the consolidated balance sheet at the estimated amount to be
reimbursed. Amounts due to/from Health Insurance Programs under Medicare
are subject to final determination through an audit by a fiscal
intermediary. All amounts due were finalized in fiscal 1997.
FINANCIAL INSTRUMENTS: Financial instruments consist of cash and
short-term investments, restricted cash, accounts receivable, current
liabilities and long-term debt obligations. The carrying amounts reported
in the balance sheets for these financial instruments approximate fair
value.
USE OF ESTIMATES: The Company has made a number of estimates and
assumptions relating to the reporting of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period to prepare these financial statements in
conformity with generally accepted accounting principles. Actual results
could differ from those estimates.
RECLASSIFICATIONS: Certain prior year amounts have been reclassified to
conform to the current year presentation.
NEW ACCOUNTING STANDARDS: In February 1997, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No.
128, "Earnings Per Share", which establishes new standards for computing
and presenting earnings per share. SFAS No. 128 is effective for the
Company for periods ending after December 15, 1997, and requires
restatement of all prior-period earnings per share amounts. If the
Company had computed net earnings per share in accordance with the
provisions of SFAS No. 128, the basic and diluted earnings per share for
the three years ended August 31, 1995, 1996 and 1997 would have been
$1.04 and $0.85, $1.03 and $0.86, and $0.99 and $0.83, respectively
(unaudited).
F-10
<PAGE> 53
HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 130, "Reporting Comprehensive
Income," which establishes standards for reporting and display of
comprehensive income and its components. SFAS No. 130 is effective for
the Company for fiscal years beginning after December 15, 1997, and
requires reclassification of financial statements in earlier periods for
comparative purposes. Adoption of this Statement is not expected to have
a material impact on the presentation of the Company's financial
statements.
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 131, "Disclosures About Segments of
an Enterprise and Related Information", which establishes standards for
the way that public business enterprises report information about
operating segments in interim and annual financial statements. SFAS No.
131 is effective for the Company for fiscal years beginning after
December 15, 1997, and requires comparative information for earlier years
to be restated. Management has not yet completed its assessment of how
this Statement will impact segment disclosures.
3. ACQUISITIONS
SPECIALTY HEALTHCARE MANAGEMENT, INC.
On August 11, 1997, the Company exchanged 1,400,000 shares of its common
stock for all of the outstanding common stock of Specialty Healthcare
Management, Inc. The exchange has been accounted for under the pooling of
interests method. Accordingly, all financial statements presented have
been restated to include the results of Specialty. Prior to the exchange
Specialty prepared its financial statements on a December 31 calendar
year end which has subsequently been changed to conform to the Company's
fiscal year end.
For purposes of recording the pooling of interests combination,
Specialty's financial statements for the twelve months ended December 31,
1995 and 1996 were combined with Horizon Health Corporation's ("Horizon")
financial statements for the twelve months ended August 31, 1995 and
1996. Specialty's results of operations for the twelve months ended
August 31, 1997 have been combined with Horizon's results of operations
for the same period. The operations of Specialty for the four months
ended December 31, 1996, resulting in net revenues and net income of
$10.8 million and $849,055, respectively, have been included in the
statement of income for both the year ended August 31, 1996 and 1997. As
a result, an adjustment was made to stockholders' equity in the
consolidated financial statements of the Company to eliminate the effect
of including Specialty's net income for the four months in both periods.
Additionally, the consolidated statement of cash flows was adjusted to
reflect the cash flows of Specialty for the four months ended December
31, 1996.
F-11
<PAGE> 54
HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Combined and separate results of Horizon and Specialty during periods
preceding the exchange were as follows (in thousands):
<TABLE>
<CAPTION>
Nine months
Twelve months Twelve months ended
ended ended May 31, 1997
August 31, 1995 August 31, 1996 (unaudited)
------------------------ ----------------------- ----------------------
<S> <C> <C> <C>
Revenues:
Horizon $29,350 $62,445 $57,894
Specialty 40,005 (a) 33,794 (b) 23,286
Combined 69,355 96,239 81,180
Net Income:
Horizon $ 3,946 $ 5,564 $ 5,483
Specialty 1,400 (a) 1,212 (b) 871
Combined 5,346 6,776 6,354
</TABLE>
(a) For the fiscal year ended December 31, 1995.
(b) For the fiscal year ended December 31, 1996.
Merger expenses of $3,527,671, before a related tax benefit of
$1,340,515, include legal, investment banking and accounting fees.
GERIATRIC MEDICAL CARE, INC.
Effective March 15, 1997, the Company purchased all of the outstanding
capital stock of Geriatric Medical Care, Inc., a Tennessee corporation,
and Geriatric has been consolidated with the Company as of March 15,
1997. The Company accounted for the acquisition of Geriatric by the
purchase method as required by generally accepted accounting principles.
Geriatric is a contract manager of mental health services for acute care
hospitals. Geriatric had total revenues of approximately $5.7 million in
1996 and, at March 15, 1997, had 18 management contract locations, of
which three were not yet in operation. The purchase price of
approximately $4.6 million, of which approximately $4.3 million was paid
at closing from existing cash of the Company, included retiring
essentially all of Geriatric's outstanding debt. The final purchase price
payment of $270,000 was made on April 16, 1997. The purchase price
exceeded the fair value of Geriatric's tangible net assets by $5,005,986,
of which $4,498,038 is recorded as goodwill and $507,948 as management
contracts. Tangible assets acquired and liabilities assumed totaled
$1,042,683 and $1,421,931, respectively. Pro forma financial data is not
presented because the impact of this acquisition is not material to the
Company's results of operations for any period presented.
F-12
<PAGE> 55
HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
CLAY CARE, INC.
Also effective March 15, 1997, the Company purchased all of the
outstanding capital stock of Clay Care, Inc., a Texas corporation, and
CCI has been consolidated with the Company as of March 15, 1997. The
Company accounted for the acquisition of CCI by the purchase method as
required by generally accepted accounting principles. CCI is a contract
manager of mental health services for acute care hospitals. At March 15,
1997, CCI had management contracts with five hospitals of which four were
in operation and one of which opened in April 1997. CCI had total
revenues of approximately $1.3 million in 1996. A total of $475,000 of
the $1,000,000 purchase price was paid at the closing from existing cash
of the Company. The remaining $525,000 of the total purchase price was
paid by the Company in April 1997 and June 1997. The purchase price
exceeded the fair value of CCI's tangible net assets by $855,738, of
which $714,672 is recorded as goodwill and $141,066 as management
contracts. Tangible assets acquired and liabilities assumed totaled
$201,794 and $57,532, respectively. Pro forma financial data is not
presented because the impact of this acquisition is not material to the
Company's results of operations for any period presented.
INVESTMENT IN PPS
On July 31, 1996, the Company acquired eighty percent (80%) of the
outstanding common stock of Florida Professional Psychological Services,
Inc., also known as Professional Psychological Services, Inc., and PPS
has been consolidated with the Company as of August 1, 1996. The Company
accounted for the acquisition of PPS by the purchase method as required
by generally accepted accounting principles. Based in Clearwater,
Florida, PPS specializes in full risk, capitated managed behavioral
health programs and employee assistance programs. The final purchase
price of $3,324,310 was based primarily on a multiple of the 1996 pre-tax
income of PPS. The purchase price exceeded the fair value of PPS' net
assets by $3,298,885 which is recorded as goodwill. Assets acquired and
liabilities assumed totaled $540,960 and $515,535, respectively. Cash
payments for the purchase of PPS, net of cash acquired, were $786,767 and
$1,898,230 during 1996 and 1997, respectively. The final payment of
$200,985 was made on September 30, 1997.
In addition, the Company also obtained an option to acquire the remaining
twenty percent (20%) of the outstanding PPS common stock at a future
date. The sellers, constituting all the shareholders of PPS, also
obtained the right to put to the Company such shares on certain dates.
The option and put prices for the remaining PPS shares are based on a
multiple of the pre-tax income of PPS in future years.
The following table presents the revenue of PPS for fiscal years 1995 and
1996. PPS's effect on the Company's net income and earnings per share has
been deemed negligible for the periods and not presented.
<TABLE>
<CAPTION>
For the year ended
August 31,
----------------------------
1995 1996
----------- -----------
<S> <C> <C>
Historical Revenues (unaudited) $ 4,475,000 $ 5,050,000
</TABLE>
For the year ended August 31, 1997, PPS generated $5,682,323 in gross revenues,
and net income of $699,467.
F-13
<PAGE> 56
HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
PARKSIDE COMPANY
Effective April 1, 1996, the Company purchased all of the outstanding
capital stock of the Parkside Company, and Parkside has been consolidated
with the Company as of April 1, 1996. The Company accounted for the
acquisition of Parkside by the purchase method as required by generally
accepted accounted principles. Parkside is a contract manager of mental
health services for acute care hospitals. The purchase price of $3.5
million included approximately $2,600,000 in cash and 192,437 shares of
the Company's common stock. The purchase price exceeded the fair value of
Parkside's tangible net assets by $3,500,000, of which $1,400,000 is
recorded as goodwill and $2,100,000 as management contracts.
NATIONAL MEDICAL MANAGEMENT SERVICES
Effective January 3, 1995, the Company acquired the net assets and
operations of National Medical Management Services, a division of
National Medical Enterprises, Inc. (the "Division") and the Division has
been consolidated with the Company as of January 3, 1995 (see Note 10).
The Company accounted for the acquisition by the purchase method as
required by generally accepted accounting principles. The purchase price
exceeded the fair value of the net assets acquired by $1,120,350, of
which $120,350 is recorded as goodwill and $1,000,000 as management
contacts. Tangible assets acquired and liabilities assumed totaled
$6,755,415 and $2,808,566, respectively.
4. INVESTMENT IN HORIZON LLC
On August 1, 1994 the Company signed a contract with Horizon Mental
Health Management LLC ("Horizon LLC") to have it manage all of the
Company's then existing management contract obligations for a 72.5%
interest in Horizon LLC. Prior to March 20, 1995, the remaining 27.5%
interest in Horizon LLC was held by Mental Health Management, Inc.
("MHM"). Prior to the Company's acquisition of the minority interest of
MHM in Horizon LLC, as discussed below, certain provisions of the limited
liability company agreement of Horizon LLC which required the consent of
MHM for certain transactions prevented the Company from having the
ability to control Horizon LLC under generally accepted accounting
principles, and therefore Horizon LLC was not consolidated with the
Company and the Company accounted for its investment in Horizon LLC by
the equity method through the six months ended February 28, 1995.
Upon completion of its initial public offering of common stock on March
13, 1995, the Company became contractually obligated to acquire the
minority interest of MHM in Horizon LLC. Effective March 20, 1995,
$9,683,467 of the $11,324,141 in net proceeds to the Company from its
initial public offering were used to purchase MHM's minority interest in
Horizon LLC. The purchase transaction eliminated MHM's equity interest in
Horizon LLC ($2,794,715) and recognized an increase in intangible assets
based upon the value of Horizon LLC management contracts ($2,355,000).
The remaining purchase price was recorded as goodwill ($4,533,752). As
such, Horizon LLC became a wholly-owned subsidiary of the Company.
Horizon LLC has been consolidated with the Company effective March 1,
1995 through August 31, 1995. Effective September 1, 1995, Horizon LLC
was dissolved and its operations combined with the Company.
F-14
<PAGE> 57
HORIZON HEALTH CORPORATION
Notes to Consolidated Financial Statements - (Continued)
Summarized financial information for Horizon LLC is as follows:
<TABLE>
<CAPTION>
Six Months
ended
February 28, 1995
-----------------
(Unaudited)
<S> <C>
Net revenues $ 26,869,535
Operating expenses 23,566,024
Other income 44,507
-------------
Income before income taxes 3,348,018
Income tax expense 30,298
-------------
Net income $ 3,317,720
=============
</TABLE>
The Company's share of Horizon LLC's net earnings was $1,567,720 for the
six months ended February 28, 1995. Horizon LLC contract stipulated that
MHM was allocated the first $1,750,000 of Horizon LLC net earnings for
the fiscal year ending August 31, 1995.
5. ACCRUED EXPENSES
Accrued expenses consisted of the following at August 31, 1996 and 1997:
<TABLE>
<CAPTION>
August 31,
------------------------
1996 1997
----------- -----------
<S> <C> <C>
Reserve for contract adjustments $ 1,036,084 $ 1,287,664
Health insurance 396,926 936,639
Other 4,288,817 5,348,626
----------- -----------
$ 5,721,827 $ 7,572,929
=========== ===========
</TABLE>
F-15
<PAGE> 58
HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
6. LONG-TERM DEBT
At August 31, 1996 and 1997, the Company had the following long-term
debt:
<TABLE>
<CAPTION>
August 31, August 31,
1996 1997
---------- ----------
<S> <C> <C>
Note payable, bearing interest at the Citibank, N.A. $ 637,800 $ --
base rate plus 2% per annum with interest and principal
payments due monthly through January 1, 1998
Revolving line of credit, bearing interest at the Citibank N.A. 2,938,514 --
base rate plus 2% per annum, with interest payable monthly
and any outstanding borrowing due January 1, 1998
Texas Commerce Bank-Revolving Credit Facility -- --
---------- ----------
3,576,314 --
---------- ----------
Less current maturities (519,600) --
---------- ----------
$3,056,714 $ --
========== ==========
</TABLE>
During 1995, the Company entered into a credit facility with Finova
Capital Corporation ("Finova") that provided for a $700,000 term loan and
a line of credit up to the lesser of $4,300,000 or an amount equal to 70%
of the net amount of eligible receivables. During 1996, the Company
increased the total credit facility to $6,000,000, which provides for a
$1,027,500 term loan and a line of credit up to the lesser of $4,972,500
or an amount equal to 75% of the net amount of eligible receivables.
Borrowings under the credit facility bear interest as described above
with the Company being subject to an annual minimum interest charge of
$120,000. In addition, the Company pays an annual credit facility fee of
0.25% on the amount of the total facility. The credit facility agreement
also requires the Company to meet certain financial ratios on leverage,
debt service coverage, net worth, etc., and contains certain covenants
which restrict capital expenditures and the incurrence of additional
indebtedness. Substantially all of the Company's assets were pledged as
collateral.
On August 11, 1997, the Company paid $3,732,110 for the balance of the
term loan and line of credit plus accrued interest and executed a
termination agreement and mutual general release with Finova.
Effective September 29, 1995, the Company entered into a loan agreement
with Texas Commerce Bank (TCB) for a revolving line of credit with
maximum advance commitment of $11,000,000. As of August 31, 1997, the
Company has no borrowings outstanding against the available line of
credit and has $10.1 million available for advances under the revolving
credit facility. On October 16, 1997, the Company increased its
existing revolving line of credit from TCB from $11.0 million to $14.0
million.
F-16
<PAGE> 59
HORIZON HEALTH CORPORATION
Notes to Consolidated Financial Statements - (Continued)
The line of credit bears interest at (1) the lesser of the Floating Base
Rate, as defined, or (2) the lesser of the LIBOR Rate plus LIBOR Margin,
as defined. The LIBOR margin varies depending on the debt coverage ratio
of the Company.
The original maturity date of this line of credit is December 15, 1998;
however, it may be extended to December 15, 2000 if certain debt coverage
ratios are met.
On October 13, 1997, the Company entered into a commitment letter with
Texas Commerce Bank, N.A. ("TCB") and Chase Securities, Inc. ("CSI")
under which they committed to provide $20,000,000 of a proposed
$50,000,000 credit facility. The facility would consist of a $10,000,000
Revolving Credit Facility and a $40,000,000 Advance Term Loan Facility
for which CSI would act as the exclusive agent in arranging for a
syndicate of banks to participate in providing the credit for the
remainder of the facilities. The proposed terms and conditions are normal
for a credit facility of this type and size, with the transaction
expected to close by early December 1997.
7. STOCK OPTIONS
In accordance with the Company's 1989 and 1995 Stock Option Plans, as
amended, 1,931,843 shares of common stock have been reserved for grant to
key employees. Management believes the exercise prices of the options
granted approximated or exceeded the market value of the common stock at
the date of the grant. The options generally vest ratably over five years
from the date of grant and terminate 10 years from the date of grant.
On April 28, 1995 the board of directors created the 1995 Stock Option
Plan For Eligible Outside Directors for outside directors owning less
than 5% of the stock of the Company. 150,000 shares of common stock are
reserved for issuance under this plan. This plan has been amended and
restated to provide for 3,000 option grants to each eligible director
each time he is re-elected to the board after having served as a director
for at least one year since his initial grant under the plan. Options
vest ratably over five years from the date of grant.
The 1989 and 1995 Stock Option Plans and the 1995 Stock Option Plan For
Eligible Outside Directors are collectively referred to as "The Plans."
F - 17
<PAGE> 60
The following table summarizes the status of the Plans:
<TABLE>
<CAPTION>
1996 1997
------------------------- ------------------------
Weighted Weighted
Average Average
Exercise Exercise
Options Price Options Price
---------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Outstanding at beginning of year 1,411,268 $ 2.33 1,521,328 $ 4.04
Granted 255,750 11.96 49,500 20.15
Exercised 130,690 0.79 90,735 1.81
Expired or canceled 15,000 6.40 28,250 9.72
Outstanding at end of year 1,521,328 $ 4.04 1,451,843 $ 4.62
Exercisable at end of year 532,452 $ 1.62 728,166 $ 1.98
Available for grant at end of year 304,500 -- 283,250 --
</TABLE>
F - 18
<PAGE> 61
HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The following table summarizes information about options outstanding under the
Plans at August 31, 1997.
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
--------------------------------------------------- --------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Number Contractual Exercise Number Exercise
Range of Exercise Price Outstanding Life Price Outstanding Price
- ----------------------- ----------- ----------- --------- ----------- --------
<S> <C> <C> <C> <C> <C>
$0.50 - $4.00 1,096,343 5.91 $ 2.13 701,353 $ 1.76
$7.4167 - $9.75 183,750 7.89 8.97 26,813 7.75
$14.1667 - $26.00 171,750 9.16 15.89 - -
</TABLE>
The Company applies APB 25 in accounting for the Plans and recognizes no
compensation cost in net earnings from the grant of options as options
are granted at exercise prices equal to the current stock price. Had
compensation cost been determined under the terms of SFAS 123, the
Company's pro forma 1996 and 1997 net earnings and earnings per share
would have been:
<TABLE>
<CAPTION>
1996 1997
----------- -----------
<S> <C> <C>
Net Earnings $ 6,775,756 $ 6,656,016
As reported $ 6,705,592 $ 6,549,799
Pro forma (unaudited)
Earnings per share:
As reported $ 0.86 $ 0.83
Pro forma (unaudited) $ 0.85 $ 0.81
</TABLE>
F - 19
<PAGE> 62
HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
In accordance with SFAS 123, the fair value of options at date of grant
was estimated using the Black-Scholes option-pricing model with the
following weighted average assumptions:
<TABLE>
<CAPTION>
1996 1997
---- ----
<S> <C> <C>
Risk Free interest rate 6.2% 6.3%
Expected life (years) 6.6 6.6
Expected volatility 33.2% 30.3%
Expected dividend yield 0.0% 0.0%
</TABLE>
The weighted average fair value of options granted during 1996 and
1997 was $4.43 and $7.28, respectively.
On April 1, 1996, the Company filed an S-8 registration statement which
registered 2,054,549 shares granted or eligible for granting to employees
and directors under the 1989 and 1995 stock option plans, as amended, and
the outside director stock option plan. This registration includes a
separate reoffer prospectus to allow any shares issued in the future and
most previously exercised shares under the 1989 and 1995 stock options to
be traded at any time without holding period or volume restrictions.
8. INCOME TAXES
Deferred taxes are provided for those items reported in different periods
for income tax and financial reporting purposes. Income tax expense
comprised the following components:
<TABLE>
<CAPTION>
Federal State Total
------- ----- -----
<S> <C> <C> <C>
Year Ended August 31, 1995
Current $1,915,529 $ 575,863 $2,491,392
Deferred (712,978) (83,880) (796,858)
---------- ---------- ----------
$1,202,551 $ 491,983 $1,694,534
========== ========== ==========
Year Ended August 31, 1996
Current $3,835,706 $ 770,743 $4,606,449
Deferred 2,606 305 2,911
---------- ---------- ----------
$3,838,312 $ 771,048 $4,609,360
========== ========== ==========
Year Ended August 31, 1997
Current $3,957,913 $ 465,636 $4,423,549
Deferred 84,230 9,909 94,139
---------- ---------- ----------
$4,042,143 $ 475,545 $4,517,688
========== ========== ==========
</TABLE>
F - 20
<PAGE> 63
HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The components of the net deferred tax asset at August 31, 1996 and 1997
were obtained using the liability method in accordance with SFAS No. 109
and are as follows:
<TABLE>
<CAPTION>
1996 1997
------------- -------------
<S> <C> <C>
Management contracts $ (1,613,132) $ (1,377,276)
Goodwill (198,761) (463,159)
------------- -------------
Deferred tax liabilities (1,811,893) (1,840,435)
------------- -------------
Accounts receivable 1,377,273 693,562
Vacation accruals 375,532 595,947
Miscellaneous accruals 422,678 398,004
Fixed assets/intangibles 188,600 332,015
Net operating loss carryforward 241,757 520,715
------------- -------------
Deferred tax assets 2,605,840 2,540,243
------------- -------------
Net deferred tax asset $ 793,947 $ 699,808
============= =============
</TABLE>
At August 31, 1997, the Company had available estimated, unused net
operating loss carryforwards for tax purposes of approximately
$1,400,000. These carryforwards may be utilized to offset future years'
income and will begin to expire during 2006 if unused prior to that date.
These carryforwards are subject to annual utilization limits in
accordance with IRC Section 382.
The following is a reconciliation of income taxes at the U.S. federal
income tax rate to the income taxes reflected in the Consolidated
Statements of Income:
<TABLE>
<CAPTION>
1995 1996 1997
-------------- -------------- --------------
<S> <C> <C> <C>
Federal income taxes based on 34% of book
income (including equity in net earnings
of Horizon LLC) $ 2,393,734 $ 3,871,753 $ 3,846,623
Meals and entertainment, goodwill
amortization and other permanent adjustments 153,712 249,236 198,464
Change in valuation allowance (1,389,299) -- --
State income taxes and other adjustments 536,387 488,371 472,601
-------------- -------------- --------------
$ 1,694,534 $ 4,609,360 $ 4,517,688
============== ============== ==============
</TABLE>
The change in the deferred tax asset valuation allowance is primarily due
to the utilization of net operating loss carryforwards in the year ended
August 31, 1995.
F - 21
<PAGE> 64
HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
9. COMMITMENTS AND CONTINGENCIES
The Company leases various office facilities and equipment under
operating leases. The following is a schedule of minimum rental payments
under these leases which expire at various dates:
<TABLE>
<CAPTION>
Year ended August 31,
<S> <C>
1998 $ 1,107,245
1999 904,595
2000 696,781
2001 576,546
2002 182,838
-----------
$ 3,468,005
===========
</TABLE>
Rent expense for the years ended August 31, 1995, 1996, and 1997 totaled
$857,794, $846,931, and $980,573, respectively.
The Company leases a building it occupies as its executive offices and
National Support Center in Lewisville, Texas. In connection with this
lease transaction, the Company guaranteed a loan of approximately
$900,000 by a financial institution to the building owner. The Company
also agreed to purchase the leased building for approximately $4.5
million at the end of the lease term if it is not sold to a third party,
or the Company does not extend its lease.
On July 31, 1996, the Company acquired eighty-percent (80%) of the
outstanding common stock of Florida Professional Psychological Services,
Inc. The owners of the minority interest (20%) have an option to put to
the Company their remaining interest through January 1998, 1999, or 2000,
based upon a multiple of pre-tax earnings of the preceding fiscal year.
The Company is insured for professional and general liability on a
claims-made policy, with additional tail coverage being obtained when
necessary. Management is unaware of any claims against the Company that
would cause the final expenses for professional and general liability to
vary materially from amounts provided.
The Company is involved in litigation arising in the ordinary course of
business, including matters involving professional liability. It is the
opinion of management that the ultimate disposition of such litigation
would not be in excess of any reserves or have a material adverse effect
on the Company's financial position or results of operations.
F - 22
<PAGE> 65
HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
10. COMMON STOCK AND WARRANTS
As part of the purchase of National Medical Management Services,
effective January 3, 1995, the Company issued warrants to National
Medical Enterprises, Inc. to purchase 171,793 shares of common stock at
an exercise price of $0.000558 per share. The warrants were exercisable
at any time subsequent to January 3, 1997 and the exercise price and
number of shares were adjustable to maintain proportional ownership of
the Company. The value of the warrants at the date of issuance was
determined to be $389,350. The remaining warrants of 179,178 at August
11, 1997 were exercised in connection with the Specialty exchange (see
note 3). In conjunction with the purchase transaction the Company issued
additional shares to existing management shareholders, other senior
management and an outside shareholder. The proceeds from the sale of
these shares were used in the purchase transaction. Certain management
acquired shares through note receivable arrangements and the outstanding
balance on these notes has been reflected as a reduction of shareholders'
equity in the statement of changes in stockholders' equity (deficit).
The Board of Directors of the Company approved a three-for-two stock
split effected in the form of a 50% stock dividend, pursuant to which one
additional share of Common Stock of the Company was issued on January 31,
1997 for every two shares of Common Stock held by stockholders of record
at the close of business on January 22, 1997. As a result of such stock
split/dividend, a total of $18,253 originally recorded as additional paid
in capital was reclassified as common stock. Such stock split/dividend
has been retroactively reflected in the consolidated financial statements
included in this report. Upon effecting the stock split/dividend, the
stock options and their related exercise prices were adjusted
proportionately.
In February 1997, the Certificate of Incorporation, as amended, of the
Company was amended to increase the number of authorized shares of Common
Stock, $.01 par value per share, of the Company from 10,000,000 shares to
40,000,000 shares.
In February 1997, the Company entered into a Rights Agreement pursuant to
which it approved the distribution of one Common Stock purchase right,
exercisable under certain conditions, for each outstanding share of
Common Stock of the Company.
F - 23
<PAGE> 66
HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
11. UNAUDITED PRO FORMA SUPPLEMENTAL INFORMATION
The following unaudited pro forma information for the year ended August
31, 1995 has been prepared as if the issuance of 1,981,849 shares of
common stock from the initial public offering, and the purchase of the
minority interest in Horizon LLC at a price equal to 1,561,850 times the
initial public offering price per share had occurred on September 1,
1994.
<TABLE>
<CAPTION>
For the year ended
August 31,
1995
------------------
(Unaudited)
<S> <C>
Net revenue $ 96,082,718
==================
Net income $ 5,182,890
==================
Share data:
Pro Forma earnings per share $ 0.69
==================
Weighted average shares outstanding 7,474,002
==================
</TABLE>
12. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following is a summary of unaudited quarterly financial data for
fiscal 1996 and 1997:
<TABLE>
<CAPTION> Operating Net Earnings
Revenues Income Income Per Share
-------------- ------------- ------------ ------------
<S> <C> <C> <C> <C>
Quarter Ended:
November 30, 1995 $ 22,278,883 $ 2,432,133 $ 1,467,121 $ 0.19
February 29, 1996 24,109,706 2,419,307 1,419,706 0.18
May 31, 1996 24,846,620 3,475,500 2,028,465 0.25
August 31,1996 25,003,757 3,126,763 1,860,464 0.23
Quarter Ended:
November 30, 1996 $ 26,879,954 $ 4,058,712 $ 2,382,979 $ 0.30
February 28, 1997 26,363,617 3,300,063 2,004,618 0.25
May 31, 1997 27,936,645 3,284,349 1,966,131 0.24
August 31, 1997 28,086,580 550,487 302,288 0.04
</TABLE>
(1) For the purposes of recording the pooling of interest combination,
Specialty's financial statements for the quarters ended March 31, 1996,
June 30, 1996, September 30, 1996 and December 31, 1996 were combined with
Horizon's Financial Statements for the quarters ended November 30, 1995,
February 29, 1996, May 31, 1996 and August 31, 1996. Specialty's results of
operations for the year ended August 31, 1997 have been combined with
Horizon's results for the same period.
F - 24
<PAGE> 67
HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
13. RETIREMENT PLAN
The Company sponsors a 401(k) plan that covers substantially all eligible
employees. The Company can elect to make matching contributions at its
discretion. For the years ended August 31, 1995, 1996 and 1997 the
Company recognized matching contributions of approximately $481,000,
$350,000, and $534,000 respectively.
14. MOUNTAIN CREST HOSPITAL
A subsidiary of the Company leased and began operating Mountain Crest
Hospital ("MCH") in December 1990. In July 1994, the Company subleased
MCH to MHM for a period commencing July 31, 1994 through December 31,
2000. The Company, which had previously guaranteed the obligations under
the primary lease, has provided the substitute guaranty of MHM to the
lessor. Management believes it has satisfied the conditions in the
primary lease for release of its guaranty. The sublease requires monthly
rental payments to the Company of 50% of operating cash flow, as defined,
subject to a minimum monthly payment of $20,000, not to exceed $1,200,000
in the aggregate over the sublease life which expires upon expiration of
the primary lease on December 31, 2000. As of August 31, 1997, the
Company has received $843,686 of the $1,200,000 resulting in future
receipts of $356,314 to be received on or before February 1, 1999
assuming minimum monthly payments of $20,000.
F - 25
<PAGE> 68
HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
15. ACQUISITION OF ACORN (UNAUDITED)
Effective October 31, 1997, the Company acquired all of the outstanding
capital stock of Acorn Behavioral HealthCare Management Corporation, a
Pennsylvania corporation. The Company accounted for the acquisition of
Acorn by the purchase method as required by generally accepted
accounting principles. Acorn provides employee assistance programs and
other related services to self-insured employers. Acorn had total
revenues of approximately $7.0 million in 1997. The purchase price of
approximately $12.7 million in cash was funded from $1.7 million of
working capital and $11.0 million from an advance under the Company's
existing revolving credit facility with Texas Commerce Bank, N.A. The
purchase price exceeded the fair value of Acorn's tangible net assets by
$12,652,106, of which $9,281,358 is recorded as goodwill and $3,370,748
as contracts. The unaudited pro forma combined condensed balance sheet
of the Company and Acorn as of August 31, 1997 after giving effect to
certain pro forma adjustments, is as follows:
ASSETS
<TABLE>
<CAPTION>
<S> <C>
Current assets $19,103,388
Property and equipment, net 1,793,788
Management contracts and
other assets 8,185,382
Goodwill 30,834,952
-----------
Total assets $59,917,510
===========
</TABLE>
LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
<S> <C>
Current liabilities $15,716,686
Other liabilities 1,518,371
Debt 11,000,000
Stockholders' Equity 31,682,453
------------
Total liabilities and stockholders'
equity $59,917,510
============
</TABLE>
The unaudited pro forma combined results of operations of the company
and Acorn for the year ended August 31, 1997 after giving effect to
certain pro forma adjustments are as follows:
<TABLE>
<CAPTION>
<S> <C>
Revenue $ 116,312,399
=============
Net income $ 6,942,088
=============
Net income per common share $ .86
=============
</TABLE>
F - 26
<PAGE> 69
INDEX TO FINANCIAL STATEMENT SCHEDULE
Report of Independent Accountants on Financial Statement Schedule..........S - 2
Schedule VIII Valuation and Qualifying Accounts............................S - 3
S - 1
<PAGE> 70
REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE
To the Board of Directors and Stockholders
of Horizon Health Corporation
Our audits of the consolidated financial statements referred to in our report
dated October 13, 1997 appearing on page F - 2 of this Annual Report on Form
10-K also included an audit of the Financial Statement Schedule as listed in
Item 14(a) of the Form 10-K. In our opinion, this Financial Statement Schedule
presents fairly, in all material respects, the information set forth therein
when read in conjunction with the related consolidated financial statements.
PRICE WATERHOUSE LLP
Dallas, Texas
October 13, 1997
S - 2
<PAGE> 71
HORIZON HEALTH CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
Additions
Balance at Charged to Uncollectible Balance
Beginning Costs and Accounts at end
Of Period Expenses Written off Adjustments of Period
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Year ended August 31, 1993:
Allowance for doubtful accounts $ 657,965 $ 415,166 $ (467,766) -- $ 605,365
Year ended August 31, 1994:
Allowance for doubtful accounts 605,365 312,176 (160,565) -- 756,976
Year ended August 31, 1995:
Allowance for doubtful accounts 756,976 1,680,396 (1,331,434) 249,099 (1,2) 1,355,037
Year ended August 31, 1996:
Allowance for doubtful accounts 1,355,037 1,435,049 (343,990) (58,474) (2) 2,387,622
Year ended August 31, 1997:
Allowance for doubtful accounts 2,387,622 3,033,693 (4,023,355) (40,537) (2) 1,357,423
</TABLE>
(1) As a result of Horizon's acquisition of the 27.5% minority interest of MHM
in the Horizon LLC effective March 20, 1995, the Horizon LLC was
consolidated with Horizon for accounting purposes as of March 1, 1995.
Amounts represent bad debt expenses of the Horizon LLC which were accounted
for as "Equity in Net Earnings of Horizon LLC" through February 28, 1995.
(2) Adjustment reflects reserves in which Horizon is aware that specific
hospitals have experienced treatment day denials and to which a
corresponding accounts receivable balance does not exist. These amounts are
accrued as a contingent liability.
S - 3
<PAGE> 72
INDEX TO EXHIBITS
NUMBER EXHIBIT
2.1 - Stock Purchase Agreement, dated October 20, 1997, among the
Company, Dr. Melvyn S. Goldsmith, Ph.D., Barbara C. Goldsmith and
Acorn Behavioral HealthCare Management Corporation (incorporated
herein by reference to Exhibit 2.1 to the Company's Current Report on
Form 8-K dated September 1, 1997).
3.1 - Certificate of Incorporation of the Company, as amended
(incorporated herein by reference to Exhibit 3.1 to the Company's
Current Report on Form 8-K dated August 11, 1997).
3.2 - Amended and Restated Bylaws of the Company, as amended
(incorporated herein by reference to Exhibit 3.2 to Amendment No. 2
as filed with the Commission on February 16, 1995 ("Amendment No. 2")
to the Company's Registration Statement on Form S-1 filed with the
Commission on January 6, 1995 (Registration No. 33-88314) (the "Form
S-1").
4.1 - Specimen certificate for the Common Stock, $.01 par value of the
Company (incorporated herein by reference to Exhibit 4.1 to the
Company's Current Report on Form 8-K dated August 11, 1997).
4.2 - Rights Agreement, dated February 6, 1997, between the Company and
American Stock Transfer & Trust Company, as Rights Agent
(incorporated by reference to Exhibit 4.1 to the Company's
Registration Statement on Form 8-A, Registration No. 000-22123, as
filed with the Commission on February 7, 1997).
10.1 - Lease dated as of December 15, 1990 between Charter Hospital of Fort
Collins, Inc. and HHG Colorado, Inc. (incorporated herein by
reference to Exhibit 10.12 to the Company's Form S-1).
10.2 - Sublease Agreement dated as of July 31, 1997 between HHG Colorado,
Inc. and MHM of Colorado, Inc. (incorporated herein by reference to
Exhibit 10.13 to the Company's Form S-1).
10.3 - Employment Agreement dated as of August 21, 1990 between Horizon
Health Management Company, Inc. and Gary A. Kagan (incorporated herein
by reference to Exhibit 10.44 to the Company's Form S-1).
10.4 - Letter dated November 23, 1992 between Horizon Mental Health
Services, Inc. and Robert A. Lefton regarding severance arrangements
(incorporated herein by reference to Exhibit 10.45 to the Company's
Form S-1).
10.5 - Agreed Permanent Injunction and Final Judgment dated December
8, 1994 (incorporated herein by reference to Exhibit 10.32 to the
Company's Form S-1).
10.6 - Loan Agreement dated September 29, 1995 among Horizon Mental
Health Management, Inc., a Delaware corporation, Horizon Mental
Health Management, Inc., a Texas corporation, Mental Health Outcomes,
Inc., a Delaware corporation, and Texas Commerce Bank National
Association (incorporated herein by reference to Exhibit 10.45 to the
Company's Annual Report on Form 10-K for the fiscal year ended August
31, 1995).
<PAGE> 73
10.7 - First Amendment to Loan Agreement dated as of December 20, 1995 among
Horizon Mental Health Management, Inc., a Delaware corporation,
Horizon Mental Health Management, Inc., a Texas corporation, Mental
Health Outcomes, Inc., a Delaware corporation, and Texas Commerce Bank
National Association ("TCB") (incorporated herein by reference to
Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the
quarter ended November 30, 1995 as filed with the Commission on
January 16, 1996 (the "November 1995 Form 10-Q")).
10.8 - Fifth Amendment to Loan Agreement, by and among TCB, the Company,
Horizon Mental Health Management, Inc. and Mental Health Outcomes,
Inc., dated as of October 16, 1997 (incorporated herein by reference
to Exhibit 10.1 to the Company's Current Report on Form 8-K dated
September 1, 1997).
10.9 - Amended and Restated Revolving Credit Note, dated October 16, 1997,
made by the Company, Horizon Mental Health Management, Inc. and Mental
Health Outcomes, Inc. in the principal sum of up to $14,000,000 and
payable to TCB (incorporated herein by reference to Exhibit 10.2 to
the Company's Current Report on Form 8-K dated September 1, 1997).
10.10 - Horizon Health Corporation Senior Secured Credit Facility
Commitment Letter, dated as of October 8, 1997, among the Company,
TCB and Chase Securities, Inc. (incorporated herein by reference to
Exhibit 10.3 to the Company's Current Report on Form 8-K dated
September 1, 1997).
10.11 - Letter Loan Agreement dated December 20, 1995 among North Central
Development Company, as borrower, TCB, as lender, and Horizon Mental
Health Management, Inc., a Delaware corporation, Horizon Mental
Health Management, Inc., a Texas corporation, and Mental Health
Outcomes, Inc., a Delaware corporation, as guarantors (incorporated
herein by reference to Exhibit 10.7 to the November 1995 Form 10-Q).
10.12 - Lease Agreement dated as of December 20, 1995 between North
Central Development Company and Horizon Mental Health Management,
Inc., a Delaware corporation (incorporated herein by reference to
Exhibit 10.8 to the November 1995 Form 10-Q).
10.13 - Horizon Health Group, Inc. 1989 Stock Option Plan, as amended
(incorporated herein by reference to Exhibit 10.52 of Amendment No. 2
to the Company's Form S-1).
10.14 - Horizon Mental Health Management, Inc. 1995 Stock Option Plan
(incorporated herein by reference to Exhibit 10.11 to the November
1995 Form 10-Q).
10.15 - Horizon Mental Health Management, Inc. Amended and Restated 1995
Stock Option Plan for Eligible Outside Directors (incorporated herein
by reference to Exhibit 10.12 to the November 1995 Form 10-Q).
10.16 - Amendments to 1989 Stock Option Plan and 1995 Stock Option Plan
(incorporated herein by reference to Exhibit 10.5 to the Company's
Current Report on Form 8-K dated September 1, 1997).
10.17 - Amendments to 1995 Stock Option Plan and 1995 First Amended and
Restated Stock Option Plan for Eligible Outside Directors
(incorporated herein by reference to Exhibit 10.6 to the Company's
Current Report on Form 8-K dated September 1, 1997).
10.18 - Horizon Mental Health Management Bonus Plan Fiscal 1996
(incorporated herein by reference to Exhibit 10.13 to the November
1995 Form 10-Q).
<PAGE> 74
10.19 - Horizon Mental Health Management Bonus Plan Fiscal 1997
(incorporated herein by reference to Exhibit 10.36 to Amendment No. 1
to the Company's Annual Report on Form 10-K/A for the fiscal year
ended August 31, 1996 (the "1996 Form 10-K/A")).
10.20 - Horizon Mental Health Management Contingent Bonus Plan
(incorporated herein by reference to Exhibit 10.37 to the Company's
1996 Form 10-K/A).
10.21 - Horizon Health Corporation Bonus Plan Fiscal 1998 (filed herewith).
10.22 - Stock Purchase Agreement among Horizon Mental Health Management,
Inc., as purchaser, and Joseph R. Bona, M.D., Nancy J. Simons, Ph.D.,
John G. Toms, Ph.D., William H. Kale, Ph.D., and David E. Stenmark,
Ph.D. as sellers, dated July 31, 1996 (incorporated herein by
reference to Exhibit 10.25 to the Company's 1996 Form 10-K/A).
10.23 - Amendment dated February 10, 1997 between the Company and the
stockholders of Florida Professional Psychological Services, Inc.
(incorporated herein by reference to the Company's Quarterly Report
on Form 10-Q for the quarter ended February 28, 1997, as filed with
the Commission on March 31, 1997 (the "February 1997 Form 10-Q)).
10.24 - Stock Purchase Agreement dated as of February 24, 1997, among the
Company and Geriatric Medical Care, Inc. and its stockholders, as
amended (incorporated herein by reference to Exhibit 10.1 to the
Company's February 1997 Form 10-Q).
10.25 - Share Exchange Reorganization Agreement dated as of April 25,
1997, among the Company, Howard B. Finkel, John Harrison, Larry
Reiff, Argentum Capital Partners, L.P., Denise Dailey, Ken Dorman, G.
Phillip Woellner, and Michael S. McCarthy, and Specialty Healthcare
Management, Inc., as amended by a First Amendment to Share Exchange
Reorganization Agreement dated as of July 2, 1997 (incorporated
herein by reference to Appendix A to the definitive Proxy Statement
filed with the Commission by the Company on July 11, 1997, relating
to a Special Meeting of Stockholders of the Company to be held on
August 11, 1997).
10.26 - Post-Closing Escrow Agreement dated August 11, 1997 between the
Company and Howard B. Finkel, as Agent (incorporated herein by
reference to Exhibit 10.2 to the Company's Current Report on Form 8-K
dated August 11, 1997).
10.27 - Registration Rights Agreement dated August 11, 1997, between the
Company and Howard B. Finkel, et al. (incorporated herein by
reference to Exhibit 10.3 to the Company's Current Report on Form 8-K
dated August 11, 1997).
10.28 - Executive Retention Agreement effective September 1, 1997, between
the Company and James Ken Newman (incorporated herein by reference to
Exhibit 10.4 to the Company's Current Report on Form 8-K dated
September 1, 1997).
11.1 - Statement Regarding Computation of Per Share Earnings (filed
herewith).
21.1 - List of Subsidiaries of the Company (filed herewith).
23.1 - Consent of Price Waterhouse LLP (filed herewith).
27.1 - Financial Data Schedule (incorporated herein by reference to Exhibit
27.1 to the Company's Registration Statement on Form S-3 filed with
the Commission on October 21, 1997 (Registration No. 333-38421)).
<PAGE> 1
EXHIBIT 10.21
HORIZON HEALTH CORPORATION
BONUS PLAN -- FISCAL 1998
Ken Newman: $23,000 in cash bonus for each $.01 of earnings per share in
excess of $1.26 that Horizon reports during fiscal 1998. The
maximum bonus to be no more than 100% of his average base salary
for fiscal 1998.
Jim McAtee: $12,000 in cash bonus for each $.01 of earnings per share in
excess of $1.26 that Horizon reports during discal 1998. The
maximum bonus to be no more than 60% of his average base salary
for fiscal 1998.
Bob Lefton: $13,000 in cash bonus for each $.01 of earnings per share in
excess of $1.26 that Horizon reports during fiscal 1998. The
maximum bonus to be no more than 75% of his average base salary
for fiscal 1998.
All bonuses to be paid on the first regular payroll date following
the receipt of Horizon audited financials for fiscal 1998.
Gary Kagan: $10,000 for each new mental health management contract signed
during fiscal 1998 in excess of eighteen. Bonus to be paid upon
the opening of the contract locations.
<PAGE> 1
EXHIBIT 11.1
HORIZON HEALTH CORPORATION
COMPUTATIONS OF EARNINGS PER SHARE
Year Ended August 31,
In Thousands, Except Per Share Amounts
<TABLE>
<CAPTION>
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
SIMPLE
Net income $5,346 $6,776 $6,656
Average outstanding shares 5,110 6,558 6,929
------ ----- ------
Simple net income per share $ 1.05 $ 1.03 $ 0.96
====== ====== ======
PRIMARY
Net income $5,346 $6,776 $6,656
Average outstanding shares 5,110 6,558 6,929
Common stock equivalents assuming
exercise of stock options 1,191 1,310 1,133
------ ------ ------
Shares for primary 6,301 7,868 8,062
====== ====== ======
Primary net income per share (1) $ 0.85 $ 0.86 $ 0.83
====== ====== ======
FULLY DILUTED
Net income $5,346 $6,776 $6,656
Average outstanding shares 5,110 6,558 6,929
Common stock equivalents assuming
exercise of stock options
1,203 1,331 1,139
------ ------ ------
Shares for fully diluted 6,313 7,889 8,068
------ ------ ------
Fully diluted net income per share (1) $ 0.85 $ 0.86 $ .83
------ ------ ------
</TABLE>
(I) The calculations for primary and fully diluted net income per share are
submitted in accordance with Regulation S-K Item 601(b)(11).
<PAGE> 1
EXHIBIT 21.1
SUBSIDIARIES OF THE COMPANY
1. Mental Health Outcomes, Inc., a Delaware corporation.
2. Horizon Mental Health Management, Inc., a Texas corporation formerly known
as Horizon Mental Health Services, Inc., is the successor by merger to
Horizon Mental Health Services, Inc., a Delaware corporation formerly
known as Horizon Health Management Company.
3. HHG Colorado, Inc., a Colorado corporation, d/b/a Mountain Crest Hospital,
Inc.
4. HHMC Partners, Inc., a Delaware corporation.
5. Florida Professional Psychological Services, Inc., a Florida corporation,
d/b/a Professional Psychological Services, Inc.
6. Geriatric Medical Care, Inc., a Tennessee corporation.
7. Clay Care, Inc., a Texas corporation.
8. Specialty Rehab Management, Inc., a Delaware corporation.
9. Psychiatric Management Services Company, a Delaware corporation.
(Dissolved 10/9/97)
10. Acorn Behavioral HealthCare Management Corporation, a Pennsylvania
corporation. Purchase date 10/31/97.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 333-2938) of Horizon Health Corporation and the
Registration Statement on Form S-8 (No. 333-36953) of Horizon Health
Corporation of our report dated October 13, 1997 appearing on page F - 2 of
this Form 10-K. We also consent to the incorporation by reference of our report
on the Financial Statement Schedule, which appears on page S - 2 of this Form
10-K.
PRICE WATERHOUSE LLP
Dallas, Texas
November 21, 1997
