SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended March 31, 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 ------- 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 May 6, 2002 ----------------------- -------------------------- COMMON STOCK, PAR VALUE 393,504,322 shares $.01 PER SHARE Page 1
HEALTHSOUTH CORPORATION AND SUBSIDIARIES INDEX <TABLE> <CAPTION> PART I -- FINANCIAL INFORMATION Page ---- <S> <C> <C> Item 1. Financial Statements Consolidated Balance Sheets -- March 31, 2002 (Unaudited) 3 and December 31, 2001 Consolidated Statements of Income (Unaudited) -- Three Months Ended March 31, 2002 and 2001 5 Consolidated Statements of Cash Flows (Unaudited) -- Three Months Ended March 31, 2002 and 2001 6 Notes to Consolidated Financial Statements (Unaudited) -- Three Months Ended March 31, 2002 and 2001 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 PART II -- OTHER INFORMATION Item 1. Legal Proceedings 19 Item 2. Changes in Securities 20 Item 6. Exhibits and Reports on Form 8-K 20 </TABLE> Page 2
PART I -- FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS HEALTHSOUTH CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) <TABLE> <CAPTION> MARCH 31, DECEMBER 31, 2002 2001 ----------------- ------------------ (Unaudited) <S> <C> <C> ASSETS CURRENT ASSETS Cash and cash equivalents $ 236,178 $ 276,583 Other marketable securities 1,873 1,873 Accounts receivable 1,023,160 940,414 Inventories, prepaid expenses and other current assets 443,284 438,295 Income tax refund receivable 49,063 79,290 ----------------- ------------------ TOTAL CURRENT ASSETS 1,753,558 1,736,455 OTHER ASSETS 367,354 342,943 PROPERTY, PLANT AND EQUIPMENT--NET 2,888,573 2,774,736 INTANGIBLE ASSETS--NET 2,720,886 2,725,103 ----------------- ------------------ TOTAL ASSETS $ 7,730,371 $ 7,579,237 ================ ================== </TABLE> Page 3
HEALTHSOUTH CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (CONTINUED) (IN THOUSANDS) <TABLE> <CAPTION> MARCH 31, DECEMBER 31, 2002 2001 ----------------- ------------------ (Unaudited) <S> <C> <C> CURRENT LIABILITIES Accounts payable $ 35,687 $ 37,085 Salaries and wages payable 64,476 65,364 Deferred income taxes 127,617 99,873 Accrued interest payable and other liabilities 143,758 134,762 Current portion of long-term debt 21,912 21,912 ----------------- ------------------ TOTAL CURRENT LIABILITIES 393,450 358,996 LONG-TERM DEBT 2,997,129 3,005,035 DEFERRED INCOME TAXES 271,506 259,535 DEFERRED REVENUE AND OTHER LONG-TERM LIABILITIES 6,492 4,206 MINORITY INTERESTS--LIMITED PARTNERSHIPS 151,433 154,541 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; 430,623,000 and 430,422,000 shares issued at March 31, 2002 and December 31, 2001, respectively 4,306 4,304 Additional paid-in capital 2,660,480 2,657,804 Accumulated other comprehensive income 20,251 16,607 Retained earnings 1,538,595 1,430,846 Treasury stock (282,478) (280,524) Receivable from Employee Stock Ownership Plan (1,405) (2,699) Notes receivable from stockholders, officers and management employees (29,388) (29,414) ----------------- ------------------ TOTAL STOCKHOLDERS' EQUITY 3,910,361 3,796,924 ----------------- ------------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 7,730,371 $ 7,579,237 ================= ================== </TABLE> See accompanying notes. Page 4
HEALTHSOUTH CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED - IN THOUSANDS, EXCEPT FOR PER SHARE DATA) <TABLE> <CAPTION> THREE MONTHS ENDED MARCH 31, --------------------------------------------- 2002 2001 ------------------- ------------------- <S> <C> <C> Revenues $ 1,129,775 $ 1,090,462 Operating unit expenses 736,401 736,045 Corporate general and administrative expenses 39,966 32,654 Provision for doubtful accounts 24,995 24,383 Depreciation and amortization 77,582 91,219 Interest expense 48,043 59,420 Interest income (1,063) (2,721) ----------------- ------------------ 925,924 941,000 ----------------- ------------------ Income before income taxes and minority interests 203,851 149,462 Provision for income taxes 68,167 49,170 ----------------- ------------------ Income before minority interests 135,684 100,292 Minority interests (27,935) (24,981) ----------------- ------------------ Net income $ 107,749 $ 75,311 ================= ================== Weighted average common shares outstanding 391,863 388,143 ================= ================== Net income per common share $ 0.27 $ 0.19 ================= ================== Weighted average common shares outstanding -- assuming dilution 414,872 398,456 ================= ================== Net income per common share -- assuming dilution $ 0.27 $ 0.19 ================= ================== </TABLE> See accompanying notes. Page 5
HEALTHSOUTH CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED - IN THOUSANDS) <TABLE> <CAPTION> THREE MONTHS ENDED MARCH 31, ----------------------------------- 2002 2001 ---------------- ---------------- <S> <C> <C> OPERATING ACTIVITIES Net income $ 107,749 $ 75,311 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 77,582 91,219 Provision for doubtful accounts 24,995 24,383 Equity-based compensation 1,130 (4,015) Income applicable to minority interests of limited partnerships 27,935 24,981 Provision for deferred income taxes 37,264 33,200 Changes in operating assets and liabilities, net of effects of acquisitions: Accounts receivable (107,741) (45,263) Inventories, prepaid expenses and other current assets 25,238 (20,473) Accounts payable and accrued expenses 6,710 (99,147) --------- --------- NET CASH PROVIDED BY OPERATING ACTIVITIES 200,862 80,196 INVESTING ACTIVITIES Purchases of property, plant and equipment (183,950) (95,528) Proceeds from sale of property, plant and equipment -- 992 Additions to intangible assets, net of effects of acquisitions (615) (11,097) Assets obtained through acquisitions, net of liabilities assumed (2,637) (2,539) Purchase of limited partnership units (14,015) (7,060) Changes in other assets (15,800) (10,788) Investments in other marketable securities -- (1,272) --------- --------- NET CASH USED IN INVESTING ACTIVITIES (217,017) (127,292) </TABLE> Page 6
HEALTHSOUTH CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (UNAUDITED - IN THOUSANDS) <TABLE> <CAPTION> THREE MONTHS ENDED MARCH 31, ----------------------------------- 2002 2001 ---------------- ---------------- <S> <C> <C> FINANCING ACTIVITIES Proceeds from borrowings $ 201,000 $ 580,000 Principal payments on long-term debt (208,906) (535,398) Proceeds from exercise of options 1,548 12,171 Purchases of treasury stock (1,954) - Reduction in receivable from Employee Stock Ownership Plan 1,294 2,716 Decrease in loans to stockholders, officers and management employees 26 511 Proceeds from investment by minority interests - 3,576 Payment of cash distributions to limited partners (17,028) (16,803) Foreign currency translation adjustment (230) 1,683 ---------------- ---------------- NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (24,250) 48,456 ---------------- ---------------- (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (40,405) 1,360 Cash and cash equivalents at beginning of period 276,583 180,317 ---------------- ---------------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 236,178 $ 181,677 ================ ================ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the year for: Interest $ 19,891 $ 34,213 Income taxes 4,098 4,480 </TABLE> See accompanying notes. Page 7
HEALTHSOUTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) THREE MONTHS ENDED MARCH 31, 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 has 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 is paid based on LIBOR plus a predetermined margin, a base rate, or competitively bid rates from the participating banks. The Company is required to pay a fee 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 is payable in full on June 22, 2003. The Company has provided a negative pledge on all assets under the 1998 Credit Agreement. At March 31, 2002, the effective interest rate associated with the 1998 Credit Agreement was approximately 2.34%. 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, 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 Page 8
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. At March 31, 2002, and December 31, 2001, long-term debt consisted of the following: <TABLE> <CAPTION> March 31, December 31, 2002 2001 ----------------- ----------------- (In thousands) <S> <C> <C> Advances under a $1,750,000,000 credit agreement with banks $ 540,000 $ 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 Other long-term debt 86,291 94,197 ----------------- ----------------- 3,019,041 3,026,947 Less amounts due within one year 21,912 21,912 ----------------- ----------------- $2,997,129 $3,005,035 ================= ================= </TABLE> Page 9
NOTE 3 -- During the first three months of 2002, the Company acquired two outpatient rehabilitation facilities. The total purchase price of these acquired facilities was approximately $2,638,000. The Company also entered into non-compete agreements totaling approximately $350,000 in connection with these transactions. The cost in excess of the acquired facilities' net asset value was approximately $2,503,000. 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. Details of the impairment and restructuring charge activity through the first quarter of 2002 are as follows: <TABLE> <CAPTION> Activity -------- Balance at Cash Non-Cash Balance at Description 12/31/01 Payments Impairments 03/31/02 -------------------------------------------------------------------------------------------- (In thousands) <S> <C> <C> <C> <C> Fourth Quarter 1998 Charge: Lease abandonment costs $ 9,465 $ 1,101 $ - $ 8,364 --------------------------------------------------------- Total Fourth Quarter 1998 Charge $ 9,465 $ 1,101 $ - $ 8,364 ========================================================= </TABLE> The remaining balance at March 31, 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 10
Operating results and other financial data are presented for the principal operating segments as follows: <TABLE> <CAPTION> Three Months Ended March 31, 2002 2001 ----------------- ----------------- (In thousands) <S> <C> <C> Revenues: Inpatient and other clinical services $ 517,659 $ 480,286 Outpatient services 601,825 600,768 ----------------- ----------------- 1,119,484 1,081,054 Non-patient care services 10,291 9,408 ----------------- ----------------- Consolidated revenues $1,129,775 $1,090,462 ================= ================= Income before income taxes and minority interests: Inpatient and other clinical services $ 142,415 $ 104,816 Outpatient services 153,965 139,859 ----------------- ----------------- 296,380 244,675 Non-patient care services (92,529) (95,213) ----------------- ----------------- Consolidated income before income taxes and minority interests $ 203,851 $ 149,462 ================ ================= </TABLE> NOTE 6 -- During the first three months of 2002, the Company granted nonqualified stock options to certain Directors, employees and others to purchase 4,313,500 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 first quarter of 2001, reported net income for that period would have increased by $11,700,000, or $.03 per share (assuming dilution). In June 2001, the Financial Accounting Standards Board issued FASB Statement No. 143, "Accounting for Asset Retirement Obligations" ("SFAS No. 143"). SFAS No. 143 requires that the fair value of a liability for an asset retirement be recognized in the period in which it is incurred if a reasonable estimate of fair value can be determined. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. Management has not determined the effect of the adoption of this statement. In August 2001, the Financial Accounting Standards Board issued FASB Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"). SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets. The Company adopted this statement on January 1, 2002. Management is currently evaluating the financial impact of adopting the new policy. Page 11
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 March 31, 2002, we had approximately 1,900 locations in 50 states, Puerto Rico, the United Kingdom, Australia and Canada, including 1,419 outpatient rehabilitation locations, 117 inpatient rehabilitation facilities, four medical centers, 208 surgery centers and 134 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 12
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 13
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 are generally grouped at the individual operational facility level, which is the lowest level for which there are identifiable cash flows. If we acquired the group of assets 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 first quarter of 2001, reported net income for that period would have increased by $11,700,000, or $.03 per share (assuming dilution). We are currently evaluating goodwill at December 31, 2001 for impairment under SFAS No. 142. Because we have recorded (and expect in the future to record) significant goodwill in connection with acquisitions, the impact of this new policy on our future reported results could be material. RESULTS OF OPERATIONS -- THREE MONTHS ENDED MARCH 31, 2002 Our operations generated revenues of $1,129,775,000 for the quarter ended March 31, 2002, an increase of $39,313,000, or 3.6%, as compared to the same period in 2001. The increase in revenues is primarily attributable to increases in patient volumes. Same store revenues for the quarter ended March 31, 2002 were $1,107,120,000, an increase of $89,456,000, or 8.8%, 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 $22,655,000. Revenues generated from patients under the Medicare and Medicaid programs respectively accounted for 34.0% and 2.5% of revenue for the first quarter of 2002, compared to 30.5% and 2.5% for the same period in 2001. Our Medicare utilization has increased due to expanded clinical programs directed towards Medicare beneficiaries. Revenues from any other single third-party payor were not significant in relation to our revenues. During the first quarter of 2002, same store outpatient visits, inpatient discharges, surgical cases and diagnostic cases increased by 7.9%, 4.4%, 6.5% and 4.1%, respectively. Revenue per outpatient visit, inpatient discharge, surgical case and diagnostic case for same store operations increased (decreased) by 4.0%, 7.1%, 0.0% and (1.1)%, respectively. Operating expenses (expenses excluding corporate general and administrative expenses, provision for doubtful accounts, depreciation and amortization, and interest expense) were $736,401,000, or 65.2% of revenues, for the quarter ended March 31, 2002, compared to 67.5% of revenues for the first quarter of 2001. Same store operating expenses were $718,697,000, or 64.9% of comparable revenue. New store operating expenses were $17,704,000, or 78.2% of comparable revenue. The increase in new store operating expenses is primarily attributable to start-up costs at new inpatient rehabilitation hospitals. Corporate general and administrative expenses increased from $32,654,000 during the 2001 quarter to $39,966,000 during the 2002 quarter. The variance in corporate general and administrative expense is primarily attributable to adjustments required under FASB Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation, an interpretation of APB Opinion No. 25". The provision for doubtful accounts was $24,995,000, or 2.2% of revenues, for the first quarter of 2002, compared to $24,383,000, or 2.2% of revenues, for the same period in 2001. Management believes that the allowance for doubtful accounts generated by this provision is adequate to cover any uncollectible receivables. Page 14
Depreciation and amortization expense was $77,582,000 for the quarter ended March 31, 2002, compared to $91,219,000 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 $48,043,000 for the quarter ended March 31, 2002, compared to $59,420,000 for the quarter ended March 31, 2001. The decrease is primarily attributable to decreases in effective interest rates. For the first quarter of 2002, interest income was $1,063,000, compared to $2,721,000 for the first quarter of 2001. Income before income taxes and minority interests for the first quarter of 2002 was $203,851,000, compared to income of $149,462,000 for the same period in 2001. Minority interests decreased income before income taxes by $27,935,000 for the quarter ended March 31, 2002, compared to decreasing income before income taxes by $24,981,000 for the first quarter of 2001. The provision for income taxes for the first quarter of 2002 was $68,167,000, compared to $49,170,000 for the same period in 2001. The effective tax rate was 38.75% for the quarter ended March 31, 2002 compared to 39.5% for the quarter ended March 31, 2001. Net income for the first quarter of 2002 was $107,749,000, compared to net income of $75,311,000 for the first quarter of 2001. LIQUIDITY AND CAPITAL RESOURCES As of March 31, 2002, we had working capital of $1,360,108,000, including cash and marketable securities of $238,051,000. Working capital at December 31, 2001, was $1,377,459,000, including cash and marketable securities of $278,456,000. For the first three months of 2002, cash provided by operating activities was $200,862,000, compared to $80,196,000 for the same period in 2001. The increase is primarily attributable to a significant reduction in accounts payable in the first quarter of 2001. Additions to property, plant and equipment and acquisitions accounted for $183,950,000 and $2,637,000, respectively, during the first three months of 2002. Those same investing activities accounted for $95,528,000 and $2,539,000, 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 quarter of 2002 in connection with expansion activities at some of our facilities and accelerated development activities. Financing activities used $24,250,000 and provided $48,456,000 during the first three months of 2002 and 2001, respectively. Net principal payments on long-term debt for the first three months of 2002 were $7,906,000, versus net borrowing proceeds of $44,602,000 for the first three months of 2001. Net accounts receivable were $1,023,160,000 at March 31, 2002, compared to $940,414,000 at December 31, 2001. The number of days of average quarterly revenues in ending receivables at March 31, 2002, was 81.5, 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 March 31, 2002, is consistent with the related concentration of revenues for the period then ended. We have 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 is paid based on LIBOR plus a predetermined margin, a base rate, or competitively bid rates from the participating banks. We are 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 is payable in full on June 22, 2003. We have provided a negative pledge on all assets under the 1998 Credit Agreement. The effective interest rate on the average outstanding balance under the 1998 Credit Agreement was 2.38% for the three months ended March 31, 2002, compared to the average prime rate of 4.75% during the same period. At March 31, 2002, we had drawn $540,000,000 under the 1998 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. These agreements have a total value of $187,000,000 and terminate on June 22, 2003. At Page 15
termination, unless we renegotiate and extend the leases, we must purchase the facilities or obtain a purchaser for them. We provide a residual value guaranty of approximately $163,690,000 related to these lease agreements. 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. During the construction period, we provide a residual value guaranty for up to 89% of the value of the improvements. At March 31, 2002, the value of the improvements totaled approximately $15,752,000. At maturity, our residual value guaranty will total 85% of the value of the improvements. The table below sets forth certain information concerning amounts due with respect to our long-term debt and various other commitments as of March 31, 2002: <TABLE> <CAPTION> Due Due Due Due 2007 Total 2002 2003-2004 2005-2006 and beyond ------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> Long-Term Debt $ 2,978,375,000 $ 6,662,000 $ 1,118,460,000 $ 458,586,000 $ 1,394,667,000 Capital Lease Obligations 22,686,000 17,000 8,025,000 5,036,000 9,608,000 Noncompete Obligations 17,980,000 6,847,000 8,829,000 2,304,000 - Operating Leases 1,310,754,000 164,951,000 355,219,000 237,633,000 552,951,000 ------------- ----------- ----------- ------------------------------ Total Obligations $ 4,329,795,000 $ 178,477,000 $ 1,490,533,000 $ 703,559,000 $ 1,957,226,000 </TABLE> While the rates of interest payable under our principal credit facility and payments under some of our operating leases vary depending in part on investment ratings of our debt, 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 investment rating. We intend to pursue the acquisition or development of additional healthcare operations, including outpatient rehabilitation facilities, inpatient rehabilitation facilities, ambulatory surgery centers, outpatient diagnostic centers and companies engaged in the provision of other complementary services, and to expand certain of our existing facilities. 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 and on continued development of the Integrated Service Model. Although we are continually considering and evaluating acquisitions and opportunities for future growth, we have not entered into any agreements with respect to material future acquisitions. Our 1998 Credit Agreement matures in June 2003, and we are in the process of obtaining commitments for a replacement primary credit facility, which we currently expect to have in place before the end of the second quarter of 2002. 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, together with the proposed replacement credit facility and proceeds from potential capital markets transactions as market conditions allow, 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. EXPOSURES TO 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 Page 16
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 March 31, 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. With respect to our interest-bearing liabilities, approximately $540,000,000 in long-term debt at March 31, 2002 is subject to variable rates of interest, while the remaining balance in long-term debt of $2,479,041,000 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 March 31, 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 and 7-3/8% Senior Notes due 2006. The fair value of the 3.25% Convertible Debentures was approximately $547,524,000 and $541,974,000 at March 31, 2002 and December 31, 2001, respectively. The fair value of the 6.875% Senior Notes was approximately $247,500,000 and $250,191,000 at March 31, 2002 and December 31, 2001, respectively. The fair value of the 7% Senior Notes was approximately $245,000,000 and $243,713,000 at March 31, 2002 and December 31, 2001, respectively. The fair value of the 10-3/4% Senior Notes was approximately $385,438,000 and $386,365,000 at March 31, 2002 and December 31, 2001, respectively. The fair value of the 8-1/2% Senior Notes was approximately $387,188,000 and $392,231,000 at March 31, 2002 and December 31, 2001, respectively. The fair value of the 8-3/8% Senior Notes was approximately $413,000,000 and $414,940,000 at March 31, 2002 and December 31, 2001, respectively. The fair value of the 7-3/8% Senior Notes was approximately $200,250,000 and $201,350,000 at March 31, 2002 and December 31, 2001, respectively. Based on a hypothetical 1% increase in interest rates, the potential losses in future annual pre-tax earnings would be approximately $5,400,000. The impact of such a change on the carrying value of long-term debt would not be significant. These amounts are determined considering the impact of the hypothetical interest rates on 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. 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 Page 17
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 Integrated Service Model and other strategic initiatives, 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. Page 18
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. We do not expect any ruling on class certification earlier than the third quarter of 2002. 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 19
In late December 2001, the United States Department of Justice filed a Notice of Election to Intervene in Part and to Decline to Intervene in Part in a case styled United States ex rel. DeWayne Manning v. HEALTHSOUTH Corporation, No. CV-99-BE-2150-S, filed in the United States District Court for the Northern District of Alabama. The Department's Notice indicated that it was partially intervening in a complaint under the federal False Claims Act filed by a former employee of HEALTHSOUTH which alleged that certain physical therapy practices, primarily involving the use of physical therapy aids and other assistive personnel, violated Medicare regulations related to the provision of physical therapy to Medicare beneficiaries in freestanding outpatient centers. The Notice also indicated that the Department was declining to intervene in any other claims asserted by the relator, but that the Department intended to assert other claims relating to alleged violations of certain regulations relating to technical documentation requirements for Medicare physical therapy claims, that the Department may seek to consolidate other cases containing similar allegations, and that the Department intended to file a complaint with respect to such allegations within 120 days. On January 15, 2002, the Court entered an Order unsealing the original relator's complaint, granting the Department 120 days from that date to file and serve its complaint, and prohibiting the relator from serving his complaint until the Department served its new complaint. We are aware of four similar complaints that were filed under seal in three other federal district courts, in at least two of which the Department has filed a substantially identical notice of partial intervention and in at least one of which the Department has declined to intervene. We understand that the relator in the case in which the Department has declined to intervene is seeking to dismiss his complaint with prejudice. On May 8, 2002, one day before its court-ordered deadline to file its complaint in the Manning case, the Department filed a notice withdrawing its intervention based on the existence of earlier-filed cases alleging the same claims, a fact apparently known to the Department when it originally intervened. The relator in that case has moved to dismiss his original complaint. To date, we have not been served with any of the underlying complaints in the other cases in which the Department has elected to intervene. Based upon the information available to us, we believe that the Department's theory with respect to the issues regarding the use of physical therapy aides and other assistive personnel is without support in applicable law or regulation and is inconsistent with traditionally accepted practices in the physical therapy industry. Accordingly, we expect to vigorously defend against the claims asserted at such time as we are served with any of the complaints. 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. (c) Recent Sales of Unregistered Securities We had no unregistered sales of equity securities during the three months ended March 31, 2002. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits 11. Computation of Income Per Share (unaudited) (b) Reports on Form 8-K During the three months ended March 31, 2002, we filed Current Reports on form 8-K dated January 8, 2002, January 29, 2002 and February 4, 2002, in each case furnishing under Item 9 the text of slides currently being used in investor and analyst presentations by our management. No other items of Part II are applicable to the Registrant for the period covered by this Quarterly Report on Form 10-Q. Page 20
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. <TABLE> <CAPTION> <S> <C> HEALTHSOUTH CORPORATION ----------------------- (Registrant) Date: May 10, 2002 /s/ RICHARD M. SCRUSHY ------------------------- Richard M. Scrushy Chairman of the Board and Chief Executive Officer Date: May 10, 2002 /s/ WESTON L. SMITH ------------------------- Weston L. Smith Executive Vice President and Chief Financial Officer </TABLE> Page 21