SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
Quarterly report pursuant to Section 13 or 15(d) of the Securities
[X] Exchange Act of 1934 for the quarterly period ended June 30, 2002; 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 1-10315
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HEALTHSOUTH CORPORATION
------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
Delaware 63-0860407
-------- ----------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
ONE HEALTHSOUTH PARKWAY, BIRMINGHAM, ALABAMA 35243
--------------------------------------------------
(Address of Principal Executive Offices)
(Zip Code)
(205) 967-7116
--------------
(Registrant's Telephone Number, Including Area Code)
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 and 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 the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at August 12, 2002
----------------------- ------------------------------
COMMON STOCK, PAR VALUE 396,377,017 SHARES
$.01 PER SHARE
Page 1
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
INDEX
PART I -- FINANCIAL INFORMATION
Page
----
Item 1. Financial Statements
Consolidated Balance Sheets -- June 30, 2002 (Unaudited) and
December 31, 2001 3
Consolidated Statements of Income (Unaudited) -- Three Months and
Six Months Ended June 30, 2002 and 2001 5
Consolidated Statements of Cash Flows (Unaudited) -- Six Months
Ended June 30, 2002 and 2001 6
Notes to Consolidated Financial Statements (Unaudited) -- Three Months
and Six Months Ended June 30, 2002 and 2001 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures about Market Risk 21
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings 23
Item 2. Changes in Securities and Use of Proceeds 24
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 6. Exhibits and Reports on Form 8-K 25
Page 2
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
JUNE 30, DECEMBER 31,
2002 2001
----------- -----------
(Unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 544,991 $ 276,583
Other marketable securities 1,873 1,873
Accounts receivable--net 1,010,083 940,414
Inventories, prepaid expenses and
other current assets 433,409 438,295
Income tax refund receivable 31,449 79,290
---------- ----------
TOTAL CURRENT ASSETS 2,021,805 1,736,455
OTHER ASSETS 385,777 342,943
PROPERTY, PLANT AND EQUIPMENT--NET 3,064,617 2,774,736
INTANGIBLE ASSETS--NET 2,659,399 2,725,103
---------- ----------
TOTAL ASSETS $8,131,598 $7,579,237
========== ==========
Page 3
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(IN THOUSANDS)
JUNE 30, DECEMBER 31,
2002 2001
---------------- ----------------
(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 29,682 $ 37,085
Salaries and wages payable 62,042 65,364
Deferred income taxes 72,463 99,873
Accrued interest payable and other liabilities 135,656 134,762
Current portion of long-term debt 589,662 21,912
----------- -----------
TOTAL CURRENT LIABILITIES 889,505 358,996
LONG-TERM DEBT 2,889,863 3,005,035
DEFERRED INCOME TAXES 253,034 259,535
DEFERRED REVENUE AND OTHER LONG-TERM LIABILITIES 4,024 4,206
MINORITY INTERESTS--LIMITED PARTNERSHIPS 161,966 154,541
STOCKHOLDERS' EQUITY:
Preferred Stock, $.10 par value--1,500,000
shares authorized; issued and outstanding--
none -- --
Common Stock, $.01 par value--600,000,000 shares authorized; 436,837,000
and 430,422,000 shares issued at June 30, 2002 and
December 31, 2001, respectively 4,368 4,304
Additional paid-in capital 2,707,728 2,657,804
Accumulated other comprehensive income 21,470 16,607
Retained earnings 1,512,936 1,430,846
Treasury stock, at cost (38,896,000 shares at June 30, 2002
and 38,742,000 shares at December 31, 2001) (282,528) (280,524)
Receivable from Employee Stock Ownership Plan (1,405) (2,699)
Notes receivable from stockholders, officers
and management employees (29,363) (29,414)
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 3,933,206 3,796,924
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 8,131,598 $ 7,579,237
=========== ===========
See accompanying notes.
Page 4
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED - IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- --------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Revenues $ 1,163,683 $ 1,098,989 $ 2,293,458 $ 2,189,451
Operating unit expenses 747,412 722,705 1,483,813 1,458,750
Corporate general and administrative expenses 43,291 51,214 83,257 83,868
Provision for doubtful accounts 25,642 34,858 50,636 59,241
Depreciation and amortization 79,807 93,223 157,389 184,442
Loss on extinguishment of debt 5,534 6,475 5,534 6,475
Loss on sale of assets 76,690 139,883 76,690 139,883
Interest expense 52,892 55,247 100,935 114,667
Interest income (1,204) (1,591) (2,267) (4,312)
----------- ----------- ----------- -----------
1,030,064 1,102,014 1,955,987 2,043,014
----------- ----------- ----------- -----------
Income (loss) before income taxes, minority interests
and cumulative effect of accounting change 133,619 (3,025) 337,471 146,437
Provision (benefit) for income taxes 45,782 (7,636) 113,950 41,534
----------- ----------- ----------- -----------
Income before minority interests and
cumulative effect of accounting change 87,837 4,611 223,521 104,903
Minority interests (30,331) (24,558) (58,266) (49,539)
----------- ----------- ----------- -----------
Income (loss) before cumulative effect of
accounting change 57,506 (19,947) 165,255 55,364
Cumulative effect of accounting change, net of tax (Note 7) -- -- (83,165) --
----------- ----------- ----------- -----------
Net income (loss) $ 57,506 $ (19,947) $ 82,090 $ 55,364
=========== =========== =========== ===========
Weighted average common shares outstanding 395,302 388,665 393,559 388,463
=========== =========== =========== ===========
Income (loss) per common share before
cumulative effect of accounting change $ 0.15 $ (0.05) $ 0.42 $ 0.14
Cumulative effect of accounting change -- -- (0.21) --
----------- ----------- ----------- -----------
Net income (loss) per common share $ 0.15 $ (0.05) $ 0.21 $ 0.14
=========== =========== =========== ===========
Weighted average common shares
outstanding -- assuming dilution 402,472 388,665 400,896 397,993
=========== =========== =========== ===========
Income (loss) per common share before
cumulative effect of accounting change --
assuming dilution $ 0.14 $ (0.05) $ 0.41 $ 0.14
Cumulative effect of accounting change -- -- (0.21) --
----------- ----------- ----------- -----------
Net income (loss) per common share --
assuming dilution $ 0.14 $ (0.05) $ 0.20 $ 0.14
=========== =========== =========== ===========
See accompanying notes.
Page 5
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED - IN THOUSANDS)
SIX MONTHS ENDED
JUNE 30,
----------------------
2002 2001
--------- ---------
OPERATING ACTIVITIES
Net income $ 82,090 $ 55,364
Adjustments to reconcile net income to net
cash provided by operating activities:
Cumulative effect of accounting change 115,042 --
Depreciation and amortization 157,389 184,442
Provision for doubtful accounts 50,636 59,241
Equity-based compensation (724) 2,320
Income applicable to minority interests of
limited partnerships 58,266 49,539
Loss on sale of assets 76,690 139,883
Loss on extinguishment of debt 5,534 6,475
(Benefit) provision for deferred income taxes (12,949) 31,638
Changes in operating assets and liabilities, net of effects of
acquisitions:
Accounts receivable (135,509) (54,286)
Inventories, prepaid expenses and other current
assets 51,025 (48,056)
Accounts payable and accrued expenses (11,681) (187,823)
--------- ---------
NET CASH PROVIDED BY
OPERATING ACTIVITIES 435,809 238,737
INVESTING ACTIVITIES
Purchases of property, plant and equipment (485,903) (172,462)
Proceeds from sale of non-strategic assets 12,272 102,819
Additions to intangible assets, net of effects of
acquisitions (72,307) (22,672)
Assets obtained through acquisitions, net of liabilities
assumed (14,138) (5,031)
Purchase of limited partnership units (15,232) 10,092
Changes in other assets (34,079) (20,477)
Investments in other marketable securities -- (1,287)
--------- ---------
NET CASH USED IN
INVESTING ACTIVITIES (609,387) (109,018)
Page 6
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(UNAUDITED - IN THOUSANDS)
SIX MONTHS ENDED
JUNE 30,
------------------------
2002 2001
--------- ---------
FINANCING ACTIVITIES
Proceeds from borrowings $ 1,382,578 $ 794,000
Principal payments on long-term debt (930,000) (898,982)
Proceeds from exercise of options 26,286 17,282
Purchase of treasury stock (2,004) --
Reduction in receivable from Employee Stock
Ownership Plan 1,294 2,716
Decrease in loans to stockholders 51 536
Payment of cash distributions to limited partners (35,607) (36,480)
Foreign currency translation adjustment (612) 1,204
----------- -----------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES 441,986 (119,724)
----------- -----------
INCREASE IN CASH AND
CASH EQUIVALENTS 268,408 9,995
Cash and cash equivalents at beginning of period 276,583 180,317
----------- -----------
CASH AND CASH EQUIVALENTS
AT END OF PERIOD $ 544,991 $ 190,312
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest $ 96,998 $ 113,140
Income taxes 47,712 27,434
See accompanying notes.
Page 7
HEALTHSOUTH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2002 AND 2001
NOTE 1 -- The accompanying consolidated financial statements include the
accounts of HEALTHSOUTH Corporation (the "Company") and its
subsidiaries. This information should be read in conjunction
with the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 2001. It is management's opinion that
the accompanying consolidated financial statements reflect all
adjustments (which are normal recurring adjustments, except as
otherwise indicated) necessary for a fair presentation of the
results for the interim period and the comparable period
presented.
NOTE 2 -- The Company had a $1,750,000,000 revolving credit facility with
Bank of America, N.A. and other participating banks (the "1998
Credit Agreement"). Interest on the 1998 Credit Agreement was
paid based on LIBOR plus a predetermined margin, a base rate, or
competitively bid rates from the participating banks. The
Company was required to pay a fee based on the unused portion of
the revolving credit facility ranging from 0.09% to 0.25%,
depending on certain defined ratios. The principal amount was
payable in full on June 22, 2003.
On June 14, 2002, the Company entered into a five-year,
$1,250,000,000 revolving credit facility (the "2002 Credit
Agreement"), which replaced the 1998 Credit Agreement. Interest
on the 2002 Credit Agreement is paid based on LIBOR plus a
predetermined margin or a base rate. The Company is required to
pay a fee based on the unused portion of the revolving credit
facility ranging from .275% to .500% depending on the Company's
debt ratings. The principal amount is payable in full on June
14, 2007. The Company has provided a negative pledge on all
assets under the 2002 Credit Agreement. At June 30, 2002, there
were no amounts outstanding under the 2002 Credit Agreement. The
Company recorded a loss of $5,534,000 in the second quarter of
2002 related to the write-off of the unamortized balance of loan
fees on the 1998 Credit Agreement.
On March 20, 1998, the Company issued $500,000,000 in 3.25%
Convertible Subordinated Debentures due 2003 (the "3.25%
Convertible Debentures") in a private placement. An additional
$67,750,000 principal amount of the 3.25% Convertible Debentures
was issued on March 31, 1998 to cover underwriters'
overallotments. Interest is payable on April 1 and October 1.
The 3.25% Convertible Debentures are convertible into common
stock of the Company at the option of the holder at a conversion
price of $36.625 per share. The conversion price is subject to
adjustment upon the occurrence of (a) a subdivision, combination
or reclassification of outstanding shares of common stock, (b)
the payment of a stock dividend or stock distribution on any
shares of the Company's capital stock, (c) the issuance of
rights or warrants to all holders of common stock entitling them
to purchase shares of common stock at less than the current
market price, or (d) the payment of certain other distributions
with respect to the Company's common stock. In addition, the
Company may, from time to time, lower the conversion price for
periods of not less than 20 days, in its discretion. The net
proceeds from the issuance of the 3.25% Convertible Debentures
were used by the Company to pay down indebtedness outstanding
under its then-existing credit facilities. The 3.25% Convertible
Debentures mature on April 1, 2003.
On June 22, 1998, the Company issued $250,000,000 in 6.875%
Senior Notes due 2005 and $250,000,000 in 7.0% Senior Notes due
2008 (collectively, the "Senior Notes"). Interest is payable on
June 15 and December 15. The Senior Notes are unsecured,
Page 8
unsubordinated obligations of the Company. The net proceeds from
the issuance of the Senior Notes were used by the Company to pay
down indebtedness outstanding under its then-existing credit
facilities. The Senior Notes mature on June 15, 2005 and June
15, 2008.
On September 25, 2000, the Company issued $350,000,000 in
10-3/4% Senior Subordinated Notes due 2008 (the "10-3/4%
Notes"). Interest is payable on April 1 and October 1. The
10-3/4% Notes are senior subordinated obligations of the Company
and, as such, are subordinated to all existing and future senior
indebtedness of the Company, and also are effectively
subordinated to all existing and future liabilities of the
Company's subsidiaries and partnerships. The net proceeds from
the issuance of the 10-3/4% Notes were used by the Company to
redeem its then-outstanding 9.5% Senior Notes due 2001 and to
pay down indebtedness outstanding under its then-existing credit
facilities. The 10-3/4% Notes mature on October 1, 2008.
On February 1, 2001, the Company issued $375,000,000 in 8-1/2%
Senior Notes due 2008 (the "8-1/2% Notes"). Interest is payable
on February 1 and August 1. The 8-1/2% Notes are unsecured,
unsubordinated obligations of the Company. The net proceeds from
the issuance of the 8-1/2% Notes were used to pay down
indebtedness outstanding under the Company's credit facilities.
The 8-1/2% Notes mature on February 1, 2008.
On September 28, 2001, the Company issued $400,000,000 in 8-3/8%
Senior Notes due 2011 (the "8-3/8% Notes"). Interest is payable
on April 1 and October 1. The 8-3/8% Notes are unsecured,
unsubordinated obligations of the Company. The net proceeds from
the issuance of the 8-3/8% Notes were used to pay down
indebtedness outstanding under the Company's credit facilities.
The 8-3/8% Notes mature on October 1, 2011.
On September 28, 2001, the Company issued $200,000,000 in 7-3/8%
Senior Notes due 2006 (the "7-3/8% Notes"). Interest is payable
on April 1 and October 1. The 7-3/8% Notes are unsecured,
unsubordinated obligations of the Company. The net proceeds from
the issuance of the 7-3/8% Notes were used to pay down
indebtedness outstanding under the Company's credit facilities.
The 7-3/8% Notes mature on October 1, 2006.
On May 17, 2002, the Company issued $1,000,000,000 in 7-5/8%
Senior Notes due 2012 (the "7-5/8% Notes"). Interest is payable
on June 1 and December 1. The 7-5/8% Notes are unsecured,
unsubordinated obligations of the Company. The net proceeds from
the issuance of the 7-5/8% Notes were used to pay down
indebtedness outstanding under the Company's credit facilities
and for other corporate purposes. The 7-5/8% Notes mature on
June 1, 2012.
Page 9
At June 30, 2002, and December 31, 2001, long-term debt consisted of
the following:
June 30, December 31,
2002 2001
-------------- --------------
(In thousands)
Advances under a $1,750,000,000 credit
agreement with banks $ -- $ 540,000
3.25% Convertible Subordinated Debentures
due 2003 567,750 567,750
6.875% Senior Notes due 2005 250,000 250,000
7-3/8% Senior Notes due 2006 200,000 200,000
7.0% Senior Notes due 2008 250,000 250,000
10-3/4% Senior Subordinated Notes due 2008 350,000 350,000
8-1/2% Senior Notes due 2008 375,000 375,000
8-3/8% Senior Notes due 2011 400,000 400,000
7-5/8% Senior Notes due 2012 1,000,000 --
Other long-term debt 86,775 94,197
---------- ----------
3,479,525 3,026,947
Less amounts due within one year 589,662 21,912
---------- ----------
$2,889,863 $3,005,035
========== ==========
During 1995 and 1998, the Company entered into two tax retention
operating lease agreements structured through financial
institutions for its corporate headquarters building and for
nine of its rehabilitation hospitals. In December 2001, the
Company entered into a seven-and-one-half year operating lease
agreement to provide for the financing of a replacement medical
center in Birmingham, Alabama. On May 29, 2002, the Company
exercised its option to purchase the properties financed under
these leases. The total purchase price of these properties was
approximately $207,109,000.
NOTE 3 -- During the first six months of 2002, the Company acquired two
outpatient rehabilitation facilities and one outpatient
diagnostic center. The total purchase price of these acquired
facilities was approximately $14,138,000. The Company also
entered into non-compete agreements totaling approximately
$2,650,000 in connection with these transactions.
The cost in excess of the acquired facilities' net asset value
was approximately $13,253,000. The results of operations (not
material individually or in the aggregate) of these acquisitions
are included in the consolidated financial statements from their
respective acquisition dates.
NOTE 4 -- During 1998, the Company recorded impairment and restructuring
charges related to the Company's decision to close certain
facilities that did not fit with the Company's strategic vision,
underperforming facilities and facilities not located in target
markets (the "Fourth Quarter 1998 Charge"). Approximately 97.8%
of the locations identified in the Fourth Quarter 1998 Charge
have been closed.
Page 10
Details of the impairment and restructuring charge activity
through the first six months of 2002 are as follows:
Activity
--------
Balance at Cash Non-Cash Balance at
Description 12/31/01 Payments Impairments 06/30/02
--------------------------------------------------------------------------------------------
(In thousands)
Fourth Quarter 1998 Charge:
Lease abandonment costs $ 9,465 $ 4,164 $ -- $ 5,301
---------------------------------------------------------
Total Fourth Quarter 1998 Charge $ 9,465 $ 4,164 $ -- $ 5,301
=========================================================
The remaining balance at June 30, 2002 is included in accrued
interest payable and other liabilities in the accompanying
balance sheet.
NOTE 5 -- The Company has adopted the provisions of FASB Statement No.
131, "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS No. 131"). SFAS No. 131 requires the
utilization of a "management approach" to define and report the
financial results of operating segments. The management approach
defines operating segments along the lines used by management to
assess performance and make operating and resource allocation
decisions. The Company has based its management and reporting
structure on three segments: (1) Inpatient and Other Clinical
Services, (2) Outpatient Services and (3) Non-Patient Care
Services. The inpatient and other clinical services segment
includes the operations of inpatient rehabilitation facilities
and medical centers, as well as the operations of certain
physician practices and other clinical services which are
managerially aligned with inpatient services. The outpatient
services segment includes the operations of outpatient
rehabilitation facilities, outpatient surgery centers and
outpatient diagnostic centers. The non-patient care services
segment includes the operations of the corporate office, general
and administrative costs, non-clinical subsidiaries and other
operations that are independent of the inpatient and outpatient
services segments.
Page 11
Operating results and other financial data are presented for the
principal operating segments as follows:
Three Months Ended
June 30,
2002 2001
----------- -----------
(In thousands)
Revenues:
Inpatient and other clinical services $ 533,920 $ 509,116
Outpatient services 623,329 583,865
----------- -----------
1,157,249 1,092,981
Non-patient care services 6,434 6,008
----------- -----------
Revenues $ 1,163,683 $ 1,098,989
=========== ===========
Income before unusual and non-recurring
items, income taxes and minority interests:
Inpatient and other clinical services $ 158,849 $ 103,532
Outpatient services 167,885 138,900
----------- -----------
326,734 242,432
Non-patient care services (116,425) (105,574)
----------- -----------
Income before unusual and non-recurring
items, income taxes and minority interests 210,309 136,858
Loss on sale of assets (76,690) (139,883)
----------- -----------
Income (loss) before income taxes and
minority interests $ 133,619 $ (3,025)
=========== ===========
Page 12
Six Months Ended
June 30,
2002 2001
----------- -----------
(In thousands)
Revenues:
Inpatient and other clinical services $ 1,051,579 $ 989,402
Outpatient services 1,225,158 1,184,633
----------- -----------
2,276,737 2,174,035
Non-patient care services 16,721 15,416
----------- -----------
Revenues $2,293,458 $ 2,189,451
=========== ===========
Income before unusual and non-recurring items,
income taxes, minority interests and
cumulative effect of accounting change:
Inpatient and other clinical services $ 301,264 $ 208,347
Outpatient services 321,850 278,759
----------- -----------
623,114 487,106
Non-patient care services (208,953) (200,786)
----------- -----------
Income before unusual and non-recurring
items, income taxes, minority interests and
cumulative effect of accounting change 414,161 286,320
Loss on sale of assets (76,690) (139,883)
Cumulative effect of accounting change (115,042) --
----------- -----------
Income before income taxes and minority
interests $ 222,429 $ 146,437
=========== ===========
NOTE 6 -- During the first six months of 2002, the Company granted
nonqualified stock options to certain Directors, employees and
others to purchase 4,293,000 shares of Common Stock at exercise
prices ranging from $10.90 to $14.90 per share.
NOTE 7 -- In June 2001, the Financial Accounting Standards Board issued
FASB Statement No. 141, "Business Combinations" ("SFAS No.
141"), and FASB Statement No. 142, "Goodwill and Other
Intangibles" ("SFAS No. 142"). SFAS No. 141 eliminates the use
of the pooling method for business combinations and requires
that all acquisitions be accounted for under the purchase
method. This statement is effective for acquisitions completed
after June 30, 2001. SFAS No. 142 requires the periodic testing
of goodwill for impairment rather than a monthly amortization of
the balance. This testing takes place in two steps: (1) the
determination of the fair value of a reporting unit, and (2) the
determination of the implied fair value of the goodwill. The
Company adopted this statement on January 1, 2002. If the policy
had been in effect in the second quarter of 2001, reported net
income for that period would have increased by $11,994,400, or
$.03 per share (assuming dilution). Subsequent to quarter-end,
the Company completed the evaluation of goodwill at December 31,
2001 for impairment under SFAS No. 142 and recognized a goodwill
impairment of $83,165,000 net of tax of $31,877,000. The Company
utilized independent appraisers in conducting this evaluation.
The effects of this impairment are reflected as the cumulative
effect of a change in accounting principle in the results of
operations for the six months ended June 30, 2002.
Page 13
The following table represents net income and earnings per share results during
1999, 2000 and 2001 as if FAS 142 had been in effect:
TWELVE MONTHS ENDED
DECEMBER 31,
--------- --------- ---------
2001 2000 1999
--------- --------- ---------
Reported net income $ 202,387 $ 278,465 $ 76,517
Add back: Goodwill amortization (net of tax) 46,670 45,304 45,491
--------- --------- ---------
Adjusted net income $ 249,057 $ 323,769 $ 122,008
========= ========= =========
BASIC EARNINGS PER SHARE:
Reported net income $ 0.52 $ 0.72 $ 0.19
Add back: Goodwill amortization (net of tax) 0.12 0.12 0.11
--------- --------- ---------
Adjusted net income $ 0.64 $ 0.84 $ 0.30
========= ========= =========
DILUTED EARNINGS PER SHARE:
Reported net income $ 0.51 $ 0.71 $ 0.18
Add back: Goodwill amortization (net of tax) 0.11 0.12 0.11
--------- --------- ---------
Adjusted net income $ 0.62 $ 0.83 $ 0.29
========= ========= =========
Page 14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
GENERAL
We provide outpatient and rehabilitative healthcare services through
our inpatient and outpatient rehabilitation facilities, surgery centers,
diagnostic centers and medical centers. We have expanded our operations through
the acquisition or opening of new facilities and satellite locations and by
enhancing our existing operations. As of June 30, 2002, we had approximately
1,900 locations in 50 states, Puerto Rico, the United Kingdom, Australia and
Canada, including 1,427 outpatient rehabilitation locations, 118 inpatient
rehabilitation facilities, four medical centers, 209 surgery centers and 136
diagnostic centers.
FASB Statement ("SFAS") No. 131, "Disclosures about Segments of an
Enterprise and Related Information", requires an enterprise to report operating
segments based upon the way its operations are managed. This approach defines
operating segments along the lines used by management to assess performance and
make operating and resource allocation decisions. Based on our management and
reporting structure, segment information has been presented for (1) inpatient
and other clinical services, (2) outpatient services and (3) non-patient care
services. The inpatient and other clinical services segment includes the
operations of our inpatient rehabilitation facilities and medical centers, as
well as the operations of certain physician practices and other clinical
services which are managerially aligned with our inpatient services. The
outpatient services segment includes the operations of our outpatient
rehabilitation facilities, outpatient surgery centers and outpatient diagnostic
centers. The non-patient care services segment includes the operations of our
corporate office, general and administrative costs, non-clinical subsidiaries
and other operations that are independent of our inpatient and outpatient
services segments. See Note 5 of "Notes to Consolidated Financial Statements"
for financial data for each of our operating segments.
There are increasing pressures from many payor sources to control
healthcare costs and to reduce or limit increases in reimbursement rates for
medical services. There can be no assurance that payments under governmental and
third-party payor programs will remain at levels comparable to present levels.
In addition, there have been, and we expect that there will continue to be, a
number of proposals to limit Medicare reimbursement for certain services. We
cannot now predict whether any of these proposals will be adopted or, if adopted
and implemented, what effect such proposals would have on us. Changes in
reimbursement policies or rates by private or governmental payors could have an
adverse effect on our future results of operations.
Medicare reimbursement for inpatient rehabilitation services is
changing from a cost-based reimbursement system to a prospective payment system
("PPS"), with the phase-in of the PPS having begun January 1, 2002. We believe
we are well-positioned and well-prepared for the transition and that our
emphasis on cost-effective services means that the inpatient rehabilitation PPS
will have a positive effect on our results of operations. Our early experience
with payments under PPS has been consistent with our internal estimates.
However, because implementation of PPS has only recently begun, we cannot be
certain that the ultimate impact of the PPS transition will be consistent with
our current expectations. In addition, the climate for both governmental and
non-governmental reimbursement frequently changes, and future changes in
reimbursement rates could have a material effect on our financial condition or
results of operations.
In many cases, we operate more than one site within a market. In such
markets, there is customarily an outpatient center or inpatient facility with
associated satellite outpatient locations. For purposes of the following
discussion and analysis, same store outpatient rehabilitation operations are
measured on locations within markets in which similar operations existed at the
end of the period and include the operations of additional outpatient
rehabilitation locations opened within the same market. New store outpatient
rehabilitation operations are measured on locations within new markets. Same
store
Page 15
operations in our other business lines are measured based on specific locations.
We may, from time to time, close or consolidate similar locations in
multi-site markets to obtain efficiencies and respond to changes in demand.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. In preparing these financial statements, we are required to make
estimates and judgments that affect the reported amounts of our assets,
liabilities, revenues and expenses. Those reported amounts could differ, in some
cases materially, if we made different estimates and judgments with respect to
particular items in our financial statements. We make such estimates and
judgments based on our historical experience and on assumptions that we believe
are reasonable under the circumstances in an effort to ensure that our financial
statements fairly reflect our financial condition and results of operations. We
describe some of the most important policies that we follow in making such
estimates and judgments below.
Revenues and Contractual Reserves
Our revenues include net patient service revenues and other operating
revenues. Net patient service revenues are reported at estimated net realizable
amounts from patients, insurance companies, third-party payors (primarily
Medicare and Medicaid) and others for services rendered. Revenues from
third-party payors also include estimated retroactive adjustments under
reimbursement agreements that are subject to final review and settlement by
appropriate authorities. We estimate contractual adjustments from
non-governmental third-party payors based on historical experience and the terms
of payor contracts. Our reimbursement from governmental third-party payors is
based upon cost reports, Medicare and Medicaid payment regulations and other
reimbursement mechanisms which require the application and interpretation of
complex regulations and policies, and such reimbursement is subject to various
levels of review and adjustment by fiscal intermediaries and others, which may
affect the final determination of reimbursement. We estimate net realizable
amounts from governmental payors based on historical experience and
interpretations of such regulations and policies. In the event that final
reimbursement differs from our estimates, our actual revenues and net income,
and our accounts receivable, could vary from the amounts reported.
Allowance for Doubtful Accounts
As with any healthcare provider, some of our accounts receivable will
ultimately prove uncollectible for various reasons, including the inability of
patients or third-party payors to satisfy their financial obligations to us. We
estimate allowances for doubtful accounts based on the specific agings and payor
classifications at each facility. Net accounts receivable includes only those
amounts we estimate to be collectible based on this evaluation. Unforeseen
factors, such as the insolvency of third-party payors, could cause our estimate
to be inaccurate and could cause our actual results and the amount of our
accounts receivable to vary from amounts reported in our financial statements.
Impairment of Goodwill
Many of our facilities came to us through acquisitions. We determine
the amortization period of the cost in excess of net asset value of purchased
facilities based on an evaluation of the facts and circumstances of each
individual purchase transaction. The evaluation includes an analysis of historic
and projected financial performance, an evaluation of the estimated useful life
of the buildings and fixed assets acquired, the indefinite useful life of
certificates of need and licenses acquired, the competition within local
markets, lease terms where applicable, and the legal terms of partnerships where
applicable. We utilize independent appraisers and rely on our own management
expertise in evaluating each of the factors noted above. With respect to the
carrying value of the excess of cost over net asset value of individual
purchased facilities and other intangible assets, we determine on a quarterly
basis whether an impairment event has
Page 16
occurred by considering factors such as the market value of the asset, a
significant adverse change in legal factors or in the business climate, adverse
action by regulators, a history of operating losses or cash flow losses, or a
projection of continuing losses associated with an operating entity. The
carrying value of excess cost over net asset value of purchased facilities and
other intangible assets will be evaluated if the facts and circumstances suggest
that it has been impaired. If this evaluation indicates that the value of the
asset will not be recoverable, as determined based on the undiscounted cash
flows of the entity acquired over the remaining amortization period, our
carrying value of the asset will be reduced to the estimated fair market value.
Fair value is determined based on the individual facts and circumstances of the
impairment event, and the available information related to it. Such information
might include quoted market prices, prices for comparable assets, estimated
future cash flows discounted at a rate commensurate with the risks involved, and
independent appraisals. For purposes of analyzing impairment, assets of
facilities are generally grouped at a market level, which is the lowest level
for which there are identifiable cash flows. If we acquired the assets of the
facilities being tested as part of a purchase business combination, any goodwill
that arose as part of the transaction is included as part of the asset grouping.
In July 2001, the Financial Accounting Standards Board issued FASB
Statement ("SFAS") No. 142, "Goodwill and Other Intangibles". SFAS No. 142
requires the periodic testing of goodwill for impairment rather than a monthly
amortization of the balance. This testing takes place in two steps: (1) the
determination of the fair value of a reporting unit, and (2) the determination
of the implied fair value of the goodwill. We adopted SFAS No. 142 on January 1,
2002. We determined that if the policy had been in effect in the second quarter
of 2001, reported net income for that period would have increased by
$11,994,400, or $.03 per share (assuming dilution). Subsequent to quarter-end,
we completed the evaluation of goodwill at December 31, 2001 for impairment
under SFAS No. 142 and we recognized a goodwill impairment of $83,165,000, net
of tax of $31,877,000. We utilized independent appraisers in conducting this
evaluation. The effects of this impairment are reflected as the cumulative
effect of a change in accounting principle in our results of operations for the
six months ended June 30, 2002.
RESULTS OF OPERATIONS -- THREE MONTHS ENDED JUNE 30, 2002
Our operations generated revenues of $1,163,683,000 for the quarter
ended June 30, 2002, an increase of $64,694,000, or 5.9%, as compared to the
same period in 2001. The increase in revenues is primarily attributable to
increases in pricing and volume. Same store revenues for the quarter ended June
30, 2002 were $1,139,945,000, an increase of $84,171,000, or 8.0%, as compared
to the same period in 2001, excluding facilities in operation in 2001 but no
longer in operation in 2002. New store revenues were $23,738,000. Revenues
generated from patients under the Medicare and Medicaid programs respectively
accounted for 34.5% and 2.7% of revenue for the second quarter of 2002, compared
to 35.2% and 3.0% for the same period in 2001. Revenues from any other single
third-party payor were not significant in relation to our revenues. During the
second quarter of 2002, same store outpatient visits, inpatient discharges,
surgical cases and diagnostic cases increased by 6.5%, 5.2%, 4.8% and 5.6%,
respectively. Revenue per outpatient visit, inpatient discharge, surgical case
and diagnostic case for same store operations increased (decreased) by 5.5%,
5.3%, 4.2% and (1.1)%, respectively.
Operating expenses (expenses excluding corporate general and
administrative expenses, provision for doubtful accounts, depreciation and
amortization, interest expense and impairment charges) were $747,412,000, or
64.2% of revenues, for the quarter ended June 30, 2002, compared to 65.8% of
revenues for the second quarter of 2001. Same store operating expenses were
$731,103,000, or 64.1% of comparable revenue. New store operating expenses were
$16,309,000, or 68.7% of comparable revenue. The increase in new store operating
expenses as a percentage of revenue is primarily attributable to start-up costs
at new inpatient rehabilitation hospitals. Corporate general and administrative
expenses decreased from $51,214,000 during the 2001 quarter to $43,291,000
during the 2002 quarter. Included in corporate general and administrative
expenses for the quarter ended June 30, 2001 was a non-recurring expense item of
approximately $8,248,000 related to the settlement of litigation with the United
States Department of Justice. The provision for doubtful accounts was
$25,642,000, or 2.2% of revenues, for the second quarter of 2002, compared to
$34,858,000, or 3.2% of revenues, for the same period in 2001. Included in the
second quarter 2001 provision for doubtful accounts was approximately
$10,300,000 due to the charge-off
Page 17
of accounts receivable related to the sale of our Richmond, Virginia medical
center. Management believes that the allowance for doubtful accounts generated
by this provision is adequate to cover any uncollectible receivables.
Depreciation and amortization expense was $79,807,000 for the quarter
ended June 30, 2002, compared to $93,223,000 for the same period in 2001. The
decrease was primarily attributable to decreased amortization expense due to our
adoption of SFAS No. 142. Interest expense was $52,892,000 for the quarter ended
June 30, 2002, compared to $55,247,000 for the quarter ended June 30, 2001. The
decrease is primarily attributable to decreases in effective interest rates. For
the second quarter of 2002, interest income was $1,204,000, compared to
$1,591,000 for the second quarter of 2001.
In the second quarter of 2001, we terminated our secondary credit
facility and recorded an impairment charge of $6,475,000 related to the
write-off of the unamortized balances of loan fees on that facility. In the
second quarter of 2002, we terminated our 1998 Credit Agreement, as described
below and recorded a loss on extinguishment of debt of $5,534,000 related to the
write-off of the unamortized balance of loan fees on that facility.
In the second quarter of 2001, we also recorded a non-recurring expense
item of approximately $84,629,000, net of taxes of $55,254,000, reflecting the
net loss on the sale of substantially all of our occupational medicine
operations and our Richmond, Virginia medical center. In the second quarter of
2002, we recorded a non-recurring expense item of approximately $52,786,000, net
of taxes of $23,904,000, reflecting the loss of the disposition of five nursing
homes in Massachusetts originally acquired in connection with the 1997
acquisition of Horizon/CMS Healthcare Corporation. We sold the five properties
in a single transaction to a privately held long-term care operator. We have no
remaining ownership interest in any other former Horizon/CMS long-term care
facilities, substantially all of which were sold at the end of 1997.
Income before income taxes and minority interests for the second
quarter of 2002 was $133,619,000, compared to a loss of ($3,025,000) for the
same period in 2001. Minority interests decreased income before income taxes by
$30,331,000 for the quarter ended June 30, 2002, compared to decreasing income
before income taxes by $24,558,000 for the second quarter of 2001. The provision
for income taxes for the second quarter of 2002 was $45,782,000, compared to a
benefit of $7,636,000 for the same period in 2001. The effective tax rate was
44.3% for the quarter ended June 30, 2002 compared to 39.5% for the quarter
ended June 30, 2001. Net income for the second quarter of 2002 was $57,506,000,
compared to a net loss of $19,947,000 for the second quarter of 2001.
RESULTS OF OPERATIONS -- SIX MONTHS ENDED JUNE 30, 2002
Our operations generated revenues of $2,293,458,000 for the six months
ended June 30, 2002, an increase of $104,007,000, or 4.8%, as compared to the
six months ended June 30, 2001. Same store revenues were $2,247,065,000, an
increase of $173,627,000, or 8.4%, as compared to the same period in 2001,
excluding facilities in operation in 2001 but no longer in operation in 2002.
New store revenues were $46,393,000. Revenues generated from patients under the
Medicare and Medicaid programs respectively accounted for 34.3% and 2.6% of
revenue for the first six months of 2002, compared to 32.7% and 2.7% for the
same period in 2001. Revenues from any other single third-party payor were not
significant in relation to our revenues. During the first six months of 2002,
same store outpatient visits, inpatient discharges, surgical cases and
diagnostic cases increased by 7.2%, 4.8%, 5.7% and 4.9%, respectively. Revenue
per outpatient visit, inpatient discharge, surgical case and diagnostic case for
same store operations increased (decreased) by 4.7%, 6.2%, 2.1% and (1.1)%,
respectively.
Operating expenses (expenses excluding corporate general and
administrative expenses, provision for doubtful accounts, depreciation and
amortization, interest expense and impairment charges) were $1,483,813,000, or
64.7% of revenues, for the six months ended June 30, 2002, compared to 66.6% of
revenues for the first six months of 2001. Same store operating expenses were
$1,449,800,000, or 64.5% of comparable revenue. New store operating expenses
were $34,013,000, or 73.3% of comparable revenue.
Page 18
Net income for the six months ended June 30, 2002, was $82,090,000, compared to
$55,364,000 for the same period in 2001.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2002, we had working capital of $1,132,300,000,
including cash and marketable securities of $546,864,000. Working capital at
December 31, 2001, was $1,377,459,000, including cash and marketable securities
of $278,456,000. For the first six months of 2002, cash provided by operating
activities was $435,809,000, compared to $238,737,000 for the same period in
2001. The increase is primarily attributable to improvements in operating
results. Additions to property, plant and equipment and acquisitions accounted
for $485,903,000 and $14,138,000, respectively, during the first six months of
2002. Those same investing activities accounted for $172,462,000 and $5,031,000,
respectively, in the same period in 2001. Because of the favorable results we
have seen in the early transition to inpatient rehabilitation PPS, we have
incurred additional capital expenditures in the first six months of 2002 in
connection with expansion activities at some of our facilities and accelerated
development activities. Additionally, we incurred capital expenditures totaling
$207,109,000 in the second quarter of 2002 in connection with the purchase of
various facilities and properties previously held under tax retention operating
leases, as described below. Financing activities provided $441,986,000 and used
$119,724,000 during the first six months of 2002 and 2001, respectively. Net
borrowings on long-term debt for the first six months of 2002 were $452,578,000,
versus net principal payments of $104,982,000 for the first six months of 2001.
Net accounts receivable were $1,010,083,000 at June 30, 2002, compared
to $940,414,000 at December 31, 2001. The number of days of average quarterly
revenues in ending receivables at June 30, 2002, was 79.0, compared to 77.6 days
of average quarterly revenues in ending receivables at December 31, 2001. This
increase was primarily attributable to delays by some of our Medicare fiscal
intermediaries in implementing systems for processing inpatient rehabilitation
PPS payments. The concentration of net accounts receivable from patients,
third-party payors, insurance companies and others at June 30, 2002, is
consistent with the related concentration of revenues for the period then ended.
We had a $1,750,000,000 revolving credit facility with Bank of America,
N.A. and other participating banks (the "1998 Credit Agreement"), which was to
expire in June 2003. The effective interest rate on the average outstanding
balance under the 1998 Credit Agreement was 2.42% for the six months ended June
30, 2002, compared to the average prime rate of 4.75% during the same period. On
June 14, 2002, the Company entered into a five-year, $1,250,000,000 revolving
credit facility (the "2002 Credit Agreement"), which replaced the 1998 Credit
Agreement. Interest on the 2002 Credit agreement is paid based on LIBOR plus a
predetermined margin or a base rate. The Company is required to pay a fee based
on the unused portion of the revolving credit facility ranging from .275% to
..500% depending on our debt ratings. The principal amount is payable in full on
June 14, 2007. The company has provided a negative pledge on all assets under
the 2002 Credit Agreement. At June 30, 2002, there were no outstanding amounts
under the 2002 Credit Agreement.
During 1995 and 1998, we entered into two tax retention operating lease
agreements structured through financial institutions for our corporate
headquarters building and for nine of our rehabilitation hospitals. In December
2001, we entered into a seven-and-one-half year operating lease agreement to
provide for the financing of our replacement medical center in Birmingham,
Alabama. On May 29, 2002, we exercised our option to purchase the properties
financed under these leases. The total purchase price of these properties was
approximately $207,109,000.
Page 19
The table below sets forth certain information concerning amounts due
with respect to our long-term debt and various other commitments as of June 30,
2002:
Due Due Due Due 2007
Total 2002 2003-2004 2005-2006 and beyond
-------------------------------------------------------------------------------
(In thousands)
Long-Term Debt $ 3,438,539 $ 5,051 $ 579,818 $ 460,517 $ 2,393,153
Capital Lease Obligations 22,427 2,550 8,598 5,027 6,252
Noncompete Obligations 18,559 4,760 10,627 3,172 --
Operating Leases 1,130,810 106,163 324,063 201,633 498,951
----------- --------- --------- --------- -----------
Total Obligations $ 4,610,335 $ 118,524 $ 923,106 $ 670,349 $ 2,898,356
Since the end of the quarter, we have used approximately $217,335,000
in available cash to repurchase approximately $221,340,000 in principal amount
of our outstanding debt securities, and we have also spent approximately
$26,300,000 to repurchase shares of our common stock pursuant to our stock
repurchase program.
While the rates of interest payable under our principal credit facility
vary depending in part on our debt ratings, we have no credit or lease
agreements which provide for the acceleration of maturities or the termination
of such agreements based upon any change in our debt ratings.
As part of our corporate strategy, we are continually evaluating
opportunities for strategic acquisitions and divestitures. We intend to pursue
the acquisition or development of additional healthcare operations and other
businesses providing complementary services. While it is not possible to
estimate precisely the amounts which will actually be expended in the foregoing
areas, we anticipate that over the next twelve months, we will spend
approximately $150,000,000 to $200,000,000 on maintenance and expansion of our
existing facilities and approximately $300,000,000 to $350,000,000 on
development activities. These amounts exclude $207,109,000 that we spent in the
second quarter of 2002 to acquire properties previously held under tax retention
operating leases, as described above. We believe that existing cash, cash flow
from operations, and borrowings under existing credit facilities will be
sufficient to satisfy our estimated cash requirements for the next twelve months
and for the reasonably foreseeable future.
Inflation in recent years has not had a significant effect on our
business, and is not expected to adversely affect us in the future unless it
increases significantly.
FORWARD-LOOKING STATEMENTS
Statements contained in this Quarterly Report on Form 10-Q which are
not historical facts are forward-looking statements. Without limiting the
generality of the preceding statement, all statements in this Quarterly Report
on Form 10-Q concerning or relating to estimated and projected earnings,
margins, costs, expenditures, cash flows, growth rates and financial results are
forward-looking statements. In addition, HEALTHSOUTH, through its senior
management, from time to time makes forward-looking public statements concerning
our expected future operations and performance and other developments. Such
forward-looking statements are necessarily estimates that we believe are
reasonable based upon current information, involve a number of risks and
uncertainties and are made pursuant to the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995. There can be no assurance that
our actual results will not differ materially from the results anticipated in
such forward-looking statements. While is impossible to identify all such
factors, factors which could cause actual results to differ materially from
those estimated by us include, but are not limited to, changes in the regulation
of the healthcare industry at either or both of the federal and state levels,
changes or delays in reimbursement for our services by governmental or private
payors, competitive pressures in the healthcare industry and our response
thereto, our ability to obtain and retain favorable arrangements with
third-party payors, unanticipated delays in the implementation of our strategic
initiatives,
Page 20
general conditions in the economy and capital markets, and other factors which
may be identified from time to time in our Securities and Exchange Commission
filings and other public announcements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk related to changes in interest rates. The
impact on earnings and value of market risk-sensitive financial instruments
(principally marketable security investments and long-term debt) is subject to
change as a result of movements in market rate and prices. We use sensitivity
analysis models to evaluate these impacts. We do not hold or issue derivative
instruments for trading purposes and are not a party to any instruments with
leverage features.
Our investment in marketable securities was $1,873,000 at June 30,
2002, which represents less than 1% of total assets at that date. These
securities are generally short-term, highly liquid instruments and, accordingly,
their fair value approximates cost. Earnings on investments in marketable
securities are not significant to our results of operations, and therefore any
changes in interest rates would have a minimal impact on future pre-tax
earnings.
Upon application of the proceeds from the sale of our 7-5/8% Notes, all
of our long-term indebtedness was subject to fixed rates of interest. In May
2002, we entered into two interest rate swap arrangements in order to improve
our mix of fixed and variable rate exposure. Each swap has a notional amount of
$250,000,000 and matures 120 months from the date of the original transaction.
The notional amounts are used to measure interest to be paid or received and do
not represent an amount of exposure to credit loss. In these arrangements, we
pay the counterparties a variable rate of interest tied to six-month LIBOR
rates, and the counterparties pay us a fixed rate of interest on the notional
amount. The variable rates paid by us under these swaps are reset every six
months. Thus, these interest rate swaps have the effect of converting
$500,000,000 of our fixed-rate debt into variable-rate debt through their
maturity dates of June 2012. We would be exposed to credit losses if the
counterparties did not perform their obligations under the swap arrangements;
however, the counterparties are major commercial banks whom we believe to be
creditworthy, and we expect them to fully satisfy their obligations. At June 30,
2002, the weighted average interest rate we were obligated to pay under these
interest rate swaps was 3.82%, and the weighted average interest rate we
received was 7.625%.
With respect to our interest-bearing liabilities, approximately
$500,000,000 in long-term debt at June 30, 2002 is subject to variable rates of
interest after giving effect to the interest rate swaps described previously,
while the remaining balance in long-term debt of $2,979,525,000 is subject to
fixed rates of interest (see Note 2 of "Notes to Consolidated Financial
Statements" for further description). This compares to $540,000,000 in long-term
debt subject to variable rates of interest and $2,486,947,000 in long-term debt
subject to fixed rates of interest at December 31, 2001. The fair value of our
total long-term debt, based on discounted cash flow analyses, approximates its
carrying value at June 30, 2002 and December 31, 2001 except for our 3.25%
Convertible Subordinated Debentures due 2003, 6.875% Senior Notes due 2005, 7.0%
Senior Notes due 2008, 10-3/4% Senior Notes due 2008, 8-1/2% Senior Notes due
2008, 8-3/8% Senior Notes due 2011, 7-3/8% Senior Notes due 2006 and 7-5/8%
Senior Notes due 2012. The fair value of the 3.25% Convertible Debentures was
approximately $557,814,000 and $541,974,000 at June 30, 2002 and December 31,
2001, respectively. The fair value of the 6.875% Senior Notes was approximately
$248,395,000 and $250,191,000 at June 30, 2002 and December 31, 2001,
respectively. The fair value of the 7% Senior Notes was approximately
$246,250,000 and $243,713,000 at June 30, 2002 and December 31, 2001,
respectively. The fair value of the 10-3/4% Senior Notes was approximately
$385,000,000 and $386,365,000 at June 30, 2002 and December 31, 2001,
respectively. The fair value of the 8-1/2% Senior Notes was approximately
$392,813,000 and $392,231,000 at June 30, 2002 and December 31, 2001,
respectively. The fair value of the 8-3/8% Senior Notes was approximately
$418,000,000 and $414,940,000 at June 30, 2002 and December 31, 2001,
respectively. The fair value of the 7-3/8% Senior Notes was approximately
$200,000,000 and $201,350,000 at June 30, 2002 and December 31, 2001,
respectively. The fair value of the 7-5/8% Senior Notes was approximately
$991,760,000 at June 30, 2002. Based on a hypothetical 1% increase in interest
rates, the potential losses in future annual pre-tax earnings would be
approximately $5,000,000. The impact of such a change on the
Page 21
carrying value of long-term debt would not be significant. These amounts are
determined considering the impact of the hypothetical interest rates on our
borrowing cost and long-term debt balances. These analyses do not consider the
effects, if any, of the potential changes in the overall level of economic
activity that could exist in such an environment. Further, in the event of a
change of significant magnitude, management would expect to take actions
intended to further mitigate its exposure to such change.
Foreign operations, and the related market risks associated with
foreign currency, are currently insignificant to our results of operations and
financial position.
Page 22
PART II -- OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS.
We were served with various lawsuits filed beginning September 30, 1998
purporting to be class actions under the federal and Alabama securities laws.
These lawsuits were filed following a decline in our stock price at the end of
the third quarter of 1998. Seven such suits were filed in the United States
District Court for the Northern District of Alabama. In January 1999, those
suits were ordered to be consolidated under the case style In re HEALTHSOUTH
Corporation Securities Litigation, Master File No. CV98-O-2634-S. On April 12,
1999, the plaintiffs filed a consolidated amended complaint against HEALTHSOUTH
and certain of our current and former officers and directors alleging that,
during the period April 24, 1997 through September 30, 1998, the defendants
misrepresented or failed to disclose certain material facts concerning our
business and financial condition and the impact of the Balanced Budget Act of
1997 on our operations in order to artificially inflate the price of our common
stock and issued or sold shares of such stock during the purported class period,
all allegedly in violation of Section 10(b) of the Securities Exchange Act of
1934 and Rule 10b-5 thereunder. Certain of the named plaintiffs in the
consolidated amended complaint also purport to represent separate subclasses
consisting of former stockholders of Horizon/CMS Healthcare Corporation and
National Surgery Centers, Inc. who received shares of HEALTHSOUTH common stock
in connection with our acquisition of those entities and assert additional
claims under Section 11 of the Securities Act of 1933 with respect to the
registration of securities issued in those acquisitions.
Another suit, Peter J. Petrunya v. HEALTHSOUTH Corporation, et al.,
Civil Action No. 98-05931, was filed in the Circuit Court for Jefferson County,
Alabama, alleging that during the period July 16, 1996 through September 30,
1998 the defendants misrepresented or failed to disclose certain material facts
concerning the Company's business and financial condition, allegedly in
violation of Sections 8-6-17 and 8-6-19 of the Alabama Securities Act. The
Petrunya complaint was voluntarily dismissed by the plaintiff without prejudice
in January 1999. Additionally, a suit styled Dennis Family Trust v. Richard M.
Scrushy, et al., Civil Action No. 98-06592, has been filed in the Circuit Court
for Jefferson County, Alabama, purportedly as a derivative action on behalf of
HEALTHSOUTH. That suit largely replicates the allegations originally set forth
in the individual complaints filed in the federal actions described in the
preceding paragraph and alleges that our then-current directors, certain of our
former directors and certain of our officers breached their fiduciary duties to
HEALTHSOUTH and engaged in other allegedly tortious conduct. The plaintiff in
that case has forborne pursuing its claim thus far pending further developments
in the federal action, and the defendants have not yet been required to file a
responsive pleading in the case.
We filed a motion to dismiss the consolidated amended complaint in the
federal action in late June 1999. On September 13, 2000, the magistrate judge
issued his report and recommendation, recommending that the court dismiss the
amended complaint in its entirety, with leave to amend. The plaintiffs objected
to that report, and we responded to that objection. On December 20, 2000,
without oral argument, the court issued an order rejecting the magistrate
judge's report and recommendation and denying our motion to dismiss. We believed
that the December 20, 2000 order failed to follow the standards required under
the Private Securities Litigation Reform Act of 1995 and Rule 9(b) of the
Federal Rules of Civil Procedure, and we filed a motion asking the court to
reconsider that order or to certify it for an interlocutory appeal to the United
States Eleventh Circuit Court of Appeals. Oral argument on that motion was held
on March 2, 2001, and the court denied that motion on March 12, 2001.
Accordingly, we filed our answer to the consolidated amended complaint on March
26, 2001. The court held a hearing on the plaintiffs' motion for class
certification on April 23, 2002, and requested further briefing on various
issues. Those issues have now been briefed, and we are awaiting the court's
ruling on class certification, although we do not know when the court will issue
its ruling. We believe that all claims asserted in the above suits are without
merit, and expect to vigorously defend against such claims. Because such suits
remain at an early stage, we cannot currently predict the outcome of any such
suits or the magnitude of any potential loss if our defense is unsuccessful.
Page 23
As previously disclosed, beginning in late December 2001, the United
States Department of Justice filed notices of partial intervention in complaints
filed against us by private parties under the federal False Claims Act in United
States District Courts in Alabama, Florida, New York and Texas. In each case,
the Department did not file a complaint in intervention at the time it filed its
notice of intervention, and sought and received additional time to file such a
complaint. After various motions and procedural actions in the underlying cases,
on May 23, 2002, the Department served us with a complaint in intervention in
the Texas case, which is styled United States ex rel. James J. Devage v.
HEALTHSOUTH Corporation, Civil Action No. SA-98-CA-0372-FB, United States
District Court for the Western District of Texas. The complaint alleges that we
submitted false claims for reimbursement under Medicare and other federal
healthcare programs and federal employee benefit plans in connection with
certain physical therapy services provided at our outpatient rehabilitation
centers. The complaint does not specify the damages claimed by the Department.
The relator has indicated that he is not pursuing any claims other than those in
which the Department has intervened. The Alabama, Florida and New York cases
have, to the extent not dismissed, been transferred to the Texas court, where
various motions relating to the consolidation or dismissal of those cases and
the status of the various relators remain pending. The Department and we have
entered into a stipulation delaying the time by which we must file responsive
pleadings to allow the Texas court an opportunity to consider those matters. As
we have previously noted, we believe that our practices during the period
purportedly covered by the complaint were consistent with accepted clinical
standards and practices in physical therapy and with existing Medicare
regulations. Accordingly, we expect to vigorously defend against the claims
asserted in the Department's complaint. However, because of the preliminary
status of this litigation, it is not possible to predict at this time the
outcome or effect of this litigation or the length of time it will take to
resolve this litigation.
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
(c) Recent Sales of Unregistered Securities
We had no unregistered sales of equity securities during the
three months ended June 30, 2002.
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Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On May 16, 2002, we held our 2002 Annual Meeting of Stockholders of the
Company, at which shares of common stock represented at the Annual Meeting were
voted in favor of the election of Directors as follows:
FOR WITHHOLD
--------------------- ---------------------
1. Richard M. Scrushy 342,858,416 9,555,242
2. Phillip C. Watkins, M.D. 345,633,551 6,780,107
3. George H. Strong 344,722,841 7,690,817
4. C. Sage Givens 344,791,588 7,622,070
5. Charles W. Newhall III 346,304,084 6,109,574
6. John S. Chamberlin 345,145,042 7,268,616
7. Larry D. Striplin, Jr. 343,773,995 8,639,663
8. Joel C. Gordon 346,534,835 5,878,823
9. William T. Owens 345,613,000 6,800,658
No other matters were submitted to the Annual Meeting.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
10. Credit Agreement, dated as of June 14, 2002, among
HEALTHSOUTH Corporation, the Lenders Party Thereto, JPMorgan
Chase Bank, as Administrative Agent, Wachovia Bank, National
Association, as Syndication Agent, UBS Warburg LLC,
ScotiaBanc, Inc. and Deutsche Bank AG, New York Branch, as
Co-Documentation Agents, and Bank of America, N.A., as Senior
Managing Agent
11. Computation of Income Per Share (unaudited)
(b) Reports on Form 8-K
During the three months ended June 30, 2002, we filed (i)
Current Reports on form 8-K dated May 7, 2002 and June 11,
2002, in each case furnishing under Item 9 the text of slides
currently being used in investor and analyst presentations by
our management, and (ii) a Current Report on Form 8-K dated
May 28, 2002, reporting under Item 5 the filing by the United
States Department of Justice of its complaint in intervention
in the case of United States ex rel. James J. Devage v.
HEALTHSOUTH Corporation.
No other items of Part II are applicable to the Registrant for the
period covered by this Quarterly Report on Form 10-Q.
Page 25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this Quarterly Report on Form 10-Q to be signed
on its behalf by the undersigned thereunto duly authorized.
HEALTHSOUTH CORPORATION
(Registrant)
Date: August 14, 2002 RICHARD M. SCRUSHY
----------------------------
Richard M. Scrushy
Chairman of the Board and
Chief Executive Officer
Date: August 14, 2002 WESTON L. SMITH
----------------------------
Weston L. Smith
Executive Vice President and
Chief Financial Officer
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