Annual Report (Form 10-K), fiscal year 1994

Item 1. Business.
General
HEALTHSOUTH Corporation ("HEALTHSOUTH" or the "Company") is the nation's largest provider of rehabilitative healthcare services. At December 31, 1994, the Company had 402 locations in 33 states, the District of Columbia and Ontario, Canada. In its outpatient and inpatient rehabilitation facilities, the Company has established interdisciplinary programs for the rehabilitation of patients experiencing disability due to a wide variety of physical conditions, such as stroke, head injury, orthopaedic problems, neuromuscular disease and sports-related injuries. The Company's rehabilitation services include physical therapy, sports medicine, work hardening, neurorehabilitation, occupational therapy, respiratory therapy, speech-language pathology and rehabilitation nursing. In addition to rehabilitation services, HEALTHSOUTH's medical center facilities also provide general and specialty medical and surgical healthcare services.
The Company was organized as a Delaware corporation in February 1984. The Company's principal executive offices are located at Two Perimeter Park South, Birmingham, Alabama 35243, and its telephone number is (205) 967-7116.
Recent Acquisitions
Acquisition of ReLife, Inc.
Effective December 29, 1994, HEALTHSOUTH and its wholly-owned subsidiary, RRS Acquisitions Company, Inc., a Delaware corporation ("RRS"), completed the acquisition of ReLife, Inc., a Delaware corporation ("ReLife"), through the merger of RRS into ReLife. ReLife is the surviving corporation in the merger, and is wholly-owned by HEALTHSOUTH. ReLife stockholders received .7053 shares of Common Stock, par value $.01 per share, of HEALTHSOUTH ("HEALTHSOUTH Common Stock") for each share of Common Stock of ReLife held by them. A total of 5,512,645 shares of HEALTHSOUTH Common Stock were issued in the transaction. The exchange ratio represents a value of $24.00 per share to ReLife's former stockholders, resulting in an approximate value of the transaction of $180,000,000.
ReLife provides a comprehensive system of rehabilitation services for disabled and injured individuals. As of December 31, 1994, ReLife operated 31 inpatient facilities with an aggregate of 1,102 licensed beds, including nine free-standing rehabilitation hospitals, nine acute rehabilitation units, five sub-acute rehabilitation units, seven transitional living units and one residential facility and provided outpatient rehabilitation services at twelve outpatient centers. ReLife also provides other services and programs, including contract staffing of rehabilitation therapists and specialized programs for spinal cord injury, brain injury and industrial rehabilitation.
NovaCare Rehabilitation Hospitals Acquisition
On February 3, 1995, HEALTHSOUTH entered into a definitive agreement to purchase the operations of the rehabilitation hospital division of NovaCare, Inc., consisting of 11 rehabilitation hospitals in seven states, 12 other facilities and two Certificates of Need (the "NovaCare Rehabilitation Hospitals"). This transaction will be a cash purchase and involves the payment of $215,000,000 in cash and the assumption of approximately $20,000,000 in liabilities, for a total consideration of $235,000,000. The acquisition is to be funded by an increase in HEALTHSOUTH's existing bank credit facilities. The transaction is subject to certain regulatory and governmental reviews, including clearance under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSR Act"), and is expected to be completed early in the second quarter of 1995.
Acquisition of Surgical Health Corporation
As of January 22, 1995, HEALTHSOUTH entered into an Amended and Restated Plan and Agreement of Merger, pursuant to which HEALTHSOUTH will acquire Surgical Health Corporation ("SHC") through the merger of a wholly-owned subsidiary of the Company into SHC, with SHC being the surviving corporation. SHC stockholders will receive, for each of their shares of capital stock of SHC ("SHC Shares"), the right to receive a fraction of a share of HEALTHSOUTH Common Stock of the Company to be determined by multiplying the number of outstanding SHC Shares owned by each SHC stockholder at the effective time of the merger by a fraction, the numerator of which is $4.60 and the denominator of which is the Base Period Trading Price (as defined); provided, however, that for purposes of such calculations, the Base Period Trading Price shall be deemed to equal (i) $37.00 in the event the Base Period Trading Price is greater than $37.00 or (ii) $33.00 in the event that the Base Period Trading Price is less than $33.00. The exchange ratio will result in an approximate value of the transaction of $155,000,000.
SHC is the second largest independent operator of free-standing outpatient surgery centers in the United States. SHC operates a network of 36 free-standing surgery centers and surgery hospitals in eleven states, with an aggregate of 155 operating and procedures rooms, and is currently developing an additional three surgery centers in two states. SHC surgery centers provide the facilities and medical support staff necessary for physicians to perform non-emergency surgical procedures that do not generally require overnight hospitalization.
The SHC acquisition represents the entry by the Company into a new line of the healthcare business, and the Company's Board of Directors believes that the transaction is desirable for the following reasons, among others: (i) SHC has facilities in desirable locations, primarily in markets where HEALTHSOUTH has an existing presence; (ii) SHC has a strong senior management team which is knowledgeable and experienced in the industry; (iii) SHC's existing relationships with physicians and payors will be enhanced by affiliation with the Company's national network; (iv) the merger will further broaden the continuum of care that HEALTHSOUTH is able to provide and (v) the merger is expected to be accretive to 1995 earnings per share. The transaction is subject to certain regulatory and governmental approvals, including clearance under the HSR Act. It is expected that the transaction will close during April 1995.
Post-Acquisition Status
The Company believes that the acquisition of ReLife, the NovaCare Rehabilitation Hospitals acquisition and the SHC acquisition will complement its existing facilities and enhance its market position as well as provide some diversification. The Company believes that the geographic dispersion of the more than 450 locations now operated and to be operated by the Company makes it more attractive to managed care networks, major insurance companies, regional and national employers and regional provider alliances. In addition, since the facilities acquired and to be acquired have very limited contractual relationships with insurance companies, managed care providers, employers or others, the Company plans to expand its existing payor relationships to include these facilities. The Company has completed the integration of the former National Medical Enterprises, Inc. ("NME") facilities which it acquired effective December 31, 1993 (the "NME Selected Hospitals") with this existing network and is in the process of doing likewise with the former ReLife facilities. In these efforts, it is implementing centralized management and financial controls, utilization of HEALTHSOUTH's clinical programs and protocols and HEALTHSOUTH's national accounts and marketing programs. HEALTHSOUTH believes that, as was the case with the NME Selected Hospitals, it will be able to increase the utilization of the former ReLife facilities by managed care and commercial payors and thus improve the operating margins of those facilities. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations".
Industry Background
In 1991 (the most recent year for which data are available), about 4,000,000 people in the United States received rehabilitative healthcare services. "Rehabilitative healthcare services" refers to the range of skilled services provided to individuals in order to minimize physical and cognitive impairments, maximize functional ability and restore lost functional capacity. The focus of rehabilitative healthcare is to ameliorate physical and cognitive impairments resulting from illness or injury, and to restore or improve functional ability so that individuals can return to work and lead independent and fulfilling lives. Typically, rehabilitative healthcare services are provided by a variety of healthcare professionals including physiatrists, rehabilitation nurses, physical therapists, occupational therapists, speech-language pathologists, respiratory therapists, recreation therapists, social workers, psychologists, rehabilitation counselors and others. Over 80% of those receiving rehabilitative healthcare services return to their homes, work, schools or active retirement.
Demand for rehabilitative healthcare services continues to be driven by advances in medical technologies, an aging population and the recognition on the part of the payor community (insurers, self-insured companies, managed care organizations and federal, state and local governments) that appropriately administered rehabilitative services can improve quality of life as well as lower overall healthcare costs. Studies conducted by insurance companies demonstrate the ability of rehabilitation to significantly reduce the cost of future care. Estimates of the savings range from $11 to $30 per dollar spent on rehabilitation. Further, reimbursement changes have encouraged the rapid discharge of patients from acute-care hospitals while they remain in need of rehabilitative healthcare services.
Patient Care Services Locations
At December 31, 1994, the Company operated inpatient and outpatient rehabilitation facilities and medical centers in the following locations:
At December 31, 1994, the Company provided other patient care services (including physician services, diagnostic services, home health services and impairment evaluation services) at 54 additional locations.
Patient Care Services
General
When a patient is referred to one of the Company's rehabilitation facilities, he undergoes an initial evaluation and assessment process that results in the development of a rehabilitation care plan designed specifically for that patient. Depending upon the patient's disability, this evaluation process may involve the services of a single discipline, such as physical therapy for a knee injury, or of multiple disciplines, as in the case of a complicated stroke patient. The Company has developed numerous rehabilitation programs, which include stroke, head injury, spinal cord injury, neuromuscular and work injury, that combine certain services to address the needs of patients with similar disabilities. In this way, all of the facilities' patients, regardless of the severity and complexity of their disabilities, can receive the level and intensity of those services necessary for them to be restored to as productive, active and independent a lifestyle as possible.
The professional staff at each facility consists of licensed or credentialed healthcare practitioners. The staff, together with the patient, his family and the referring physician, form the "team" that assists the patient in attaining his rehabilitation goals. This interdisciplinary team approach permits the delivery of coordinated, integrated patient care services.
Outpatient Rehabilitation Services
HEALTHSOUTH operates the largest group of affiliated proprietary outpatient rehabilitation facilities in the United States. The Company's outpatient rehabilitation centers offer a comprehensive range of rehabilitative healthcare services, including physical therapy and occupational therapy, that are tailored to the individual patient's needs, focusing predominantly on orthopaedic injuries, sports injuries, work injuries, hand and upper extremity injuries, back injuries, and various neurological/neuromuscular conditions. As of December 31, 1994, the Company provided outpatient rehabilitative healthcare services through 111 outpatient centers and their 127 associated satellite clinics as well as through the 39 satellite outpatient clinics associated with its inpatient facilities.
The continuing emphasis on containing the increases in healthcare costs, as evidenced by Medicare's prospective payment system, the growth in managed care and the various alternative healthcare reform proposals, results in the early discharge of patients from acute-care facilities. As a result, many hospital patients do not receive the intensity of services that may be necessary for them to achieve a full recovery from their diseases, disorders or traumatic conditions. The Company's outpatient rehabilitation services play a significant role in the continuum of care because they provide hospital-level services, in terms of intensity, quality and frequency, in a more cost-efficient setting.
Patients treated at the Company's outpatient centers will undergo varying courses of therapy depending upon their needs. Some patients may only require a few hours of therapy per week for a few weeks, while others may spend up to five hours per day in therapy for six months or more, depending on the nature, severity and complexity of their injuries.
In general, the Company initially establishes an outpatient center in a given market, either by acquiring an existing private therapy practice or through de novo development, and institutes its clinical protocols and programs in response to the community's general need for services. The Company will then establish satellite clinics that are dependent upon the main facility for management and administrative services. These satellite clinics generally provide a specific evaluative or specialty service/program, such as hand therapy or foot and ankle therapy, in response to specific market demands. The Company's outpatient rehabilitation facilities range in size from 1,200 square feet for specialty clinics to 20,000 square feet for large, full-service facilities. Currently, the typical outpatient facility configuration ranges in size from 2,000 to 5,000 square feet and costs less than $500,000 to build and equip.
Outpatient rehabilitation services provided by Medicare-certified Comprehensive Outpatient Rehabilitation Facilities ("CORFs") or rehabilitation agencies are exempt from Medicare's prospective payment system. At December 31, 1994, six of the Company's outpatient centers were Medicare-certified CORFs and 79 were Medicare-certified rehabilitation agencies. Applications for Medicare certification as rehabilitation agencies were pending with respect to 15 additional facilities. In determining whether to seek Medicare certification, and in determining the type of certification to seek, for a new or existing outpatient center, the Company assesses the relevant market, the services to be offered and the projected Medicare patient utilization. Based on this assessment, the Company may choose to seek certification as either a CORF or a rehabilitation agency, or may elect not to seek certification. Regardless of certification status, all of the Company's outpatient centers generally provide similar rehabilitation services and must satisfy an internal quality standards program to assure that they are meeting comparable standards of care. Thus, the Company maintains flexibility for change in certification status. See this Item, "Business Regulation".
Patient utilization of the Company's outpatient rehabilitation facilities cannot be measured in the conventional manner applied to acute-care hospitals, nursing homes and other healthcare providers which have a fixed number of licensed beds and serve patients on a 24-hour basis. Utilization patterns in outpatient rehabilitation facilities will be affected by the market to be served, the types of injuries treated, the patient mix and the number of available therapists, among other factors. Moreover, because of variations in size, location, hours of operation, referring physician base and services provided and other differences among each of the Company's outpatient facilities, it is not possible to accurately assess patient utilization against a norm.
Inpatient Services
Inpatient Rehabilitation Facilities. At December 31, 1994, HEALTHSOUTH operated 66 inpatient rehabilitation facilities with 4,058 beds, representing the largest group of affiliated proprietary inpatient rehabilitation facilities in the United States. The Company's inpatient rehabilitation facilities provide high-quality comprehensive services to patients who require intensive institutional rehabilitation care.
Inpatient rehabilitation patients are typically those who are experiencing significant physical disabilities due to various conditions, such as head injury, spinal cord injury, stroke, certain orthopaedic problems and neuromuscular disease. The Company's inpatient rehabilitation facilities provide the medical, nursing, therapy and ancillary services required to comply with local, state and federal regulations as well as accreditation standards of the Joint Commission on Accreditation of Healthcare Organizations (the "JCAHO") and the Commission on Accreditation of Rehabilitation Facilities.
All of the Company's inpatient rehabilitation facilities utilize an interdisciplinary team approach to the rehabilitation process and involve the patient and family, as well as the payor, in the determination of the goals for the patient. Internal case managers monitor each patient's progress and provide documentation of patient status, achievement of goals, functional outcomes and efficiency.
The Company acquires or develops inpatient rehabilitation facilities in those communities where it believes there is a demonstrated need for comprehensive inpatient rehabilitation services. Depending upon the specific market opportunity, these facilities may be licensed as rehabilitation hospitals or skilled nursing facilities. The Company believes that it can provide high-quality rehabilitation services in either type of facility, but prefers to utilize the rehabilitation hospital form.
In certain markets where the Company does not provide free-standing outpatient facilities, the Company's rehabilitation hospitals may provide outpatient rehabilitation services as a complement to their inpatient services. Typically, this opportunity arises when patients complete their inpatient course of treatment but remain in need of additional therapy that can be accomplished on an outpatient basis. Depending upon the demand for outpatient services and physical space constraints, the rehabilitation hospital may establish the services either within its building or in a satellite location. In either case, the clinical protocols and programs developed for use in the free-standing outpatient centers will be utilized by these facilities.
The Company's recently developed start-up rehabilitation hospital projects, the Nashville, Tennessee (Vanderbilt University), Memphis, Tennessee (Methodist Hospitals), Dothan, Alabama (Southeast Alabama Medical Center) and Charleston, South Carolina (North Trident Regional Medical Center) facilities, have been developed in conjunction with local tertiary-care facilities. This strategy of developing effective referral and service networks prior to opening results in improved operating efficiencies for the new facilities. The Company has established limited partnerships to own and operate its Nashville and Memphis, Tennessee rehabilitation hospitals. The Company has a 50% ownership interest in the Vanderbilt partnership and a 70% ownership interest in the Memphis partnership. The Company may utilize this same concept in certain of its other rehabilitation hospitals in the future.
Medical Centers. The Company operates five medical centers with 912 licensed beds in four distinct markets. These facilities provide general and specialty medical and surgical healthcare services, emphasizing orthopaedics, sports medicine and rehabilitation.
The Company acquired its five medical centers as outgrowths of its rehabilitative healthcare services. Often, patients require medical and surgical interventions prior to the initiation of their rehabilitative care. In each of the markets in which the Company has acquired a medical center, the Company had well-established relationships with the medical communities servicing each facility. As a result of these relationships, the Company was able to respond to opportunities to enhance its capabilities to better serve the patients and physicians in those markets. In addition, each of the facilities enjoyed well-established reputations in orthopaedics and/or sports medicine prior to their acquisition by the Company.
Following the acquisition of each of the Company's medical centers, the Company has provided the resources to improve upon the physical plant and expand services through the introduction of new technology. The Company has also developed additional relationships between these facilities and certain university facilities, including the University of Miami, Auburn University and the University of Alabama at Birmingham. Through these relationships, the influx of celebrity athletes and personalities and the acquisition of new technology, all five institutions have improved their operating efficiencies and enhanced census. Each of the five medical center facilities is licensed as an acute-care hospital, is accredited by the JCAHO and participates in the Medicare prospective payment system. See this Item, "Business -- Regulation".
Inpatient Facility Utilization. In measuring patient utilization of the Company's inpatient facilities, various factors must be considered. Due to market demand, demographics, start-up status, renovation, patient mix and other factors, the Company may not treat all licensed beds in a particular facility as available beds, which sometimes results in a material variance between licensed beds and beds actually available for utilization at any specific time. The Company is in a position to increase the number of available beds at such facilities as market conditions dictate. During the year ended December 31, 1994, the Company's inpatient facilities achieved an overall utilization, based on patient days and available beds, of 61.0%.
Other Patient Care Services
In certain of its markets, the Company provides other patient care services, including home healthcare, diagnostic services, physician services and contract management of hospital-based rehabilitative healthcare services. The Company evaluates market opportunities on a case-by-case basis in determining whether to provide additional services of these types, which may be complementary to facility-based services provided by the Company or stand-alone businesses.
Marketing of Facilities and Services
The Company markets its facilities, and their services and programs, on local, regional and national levels. Local and regional marketing activities are typically coordinated by facility-based marketing personnel, whereas large-scale regional and national efforts are coordinated by corporate-based personnel.
In general, the Company develops a marketing plan for each facility based on a variety of factors, including population characteristics, physician characteristics and incidence of disability statistics, in order to identify specific service opportunities. Facility-oriented marketing programs are focused on increasing the volume of patient referrals to the specific facility and involve the development of ongoing relationships with area schools, businesses and industries as well as physicians, health maintenance organizations and preferred provider organizations.
The Company's larger-scale marketing activities are focused more broadly on efforts to generate patient referrals to multiple facilities and the creation of new business opportunities. Such activities include the development and maintenance of contractual relationships or national pricing agreements with large third-party payors, such as CIGNA, Metrahealth (MetLife/Travelers) or other national insurance companies, with national HMO/PPO companies, such as Healthcare-COMPARE/AFFORDABLE Hospital Network of America and Multiplan, with national case management companies, such as INTRACORP and Crawford & Co., and with national employers, such as Georgia-Pacific Corporation, Dillard Department Stores, Goodyear Tire & Rubber and Winn-Dixie.
The Company carries out broader programs designed to further enhance its public image. Among these is the HEALTHSOUTH Sports Medicine Council, headed by Bo Jackson, which is dedicated to developing educational programs focused on athletics for use in high schools. The Company has ongoing relationships with the Ladies Professional Golf Association, the Southeastern Conference and more than 400 universities, colleges and high schools to provide sports medicine coverage of events and rehabilitative healthcare services for injured athletes. In addition, the Company has established relationships with or provided treatment services for athletes from some 35 to 40 major professional sports teams, as well as providing sports medicine services for Olympic and amateur athletes.
HEALTHSOUTH is a national sponsor of the United Cerebral Palsy Association and the National Arthritis Foundation and supports many other charitable organizations on national and local levels. Through these endeavors, the Company provides its employees with opportunities to support their communities.
Sources of Revenues
Private pay revenue sources represent the majority of the Company's revenues. The following table sets forth the percentages of the Company's revenues from various sources for the periods indicated:
The above table does not reflect the NME Selected Hospitals or the ReLife facilities for 1993. The NME Selected Hospitals are included in the 1994 figures. Comparable information for the ReLife facilities is not available and is not reflected in either year in the table. The Company has expanded its existing payor relationships to include the former NME and ReLife facilities; however, the percentage of revenues derived from Medicare increased in 1994.
See this Item, "Business-Regulation-Medicare Participation and Reimbursement" for a description of the reimbursement regulations applicable to the Company's facilities.
Competition
The Company competes in the geographic markets in which its facilities are located. In addition, the Company competes on a regional and national basis with other providers of specialized services such as sports medicine and work hardening, and specific concentrations such as head injury rehabilitation and orthopaedic surgery. The competition faced in each of these markets is similar, with variations arising from the number of healthcare providers in the given metropolitan area. The primary competitive factors in the rehabilitation services business are quality of services, projected patient outcomes, charges for services, responsiveness to the needs of the patients, community and physicians, and ability to tailor programs and services to meet specific needs of the patients. Competitors and potential competitors include hospitals, private practice therapists, rehabilitation agencies and others. Some of these competitors may have greater patient referral support and financial and personnel resources in particular markets than the Company. Management believes that the Company competes successfully within the marketplace based upon its reputation for quality, competitive prices, positive rehabilitation outcomes, innovative programs, clean and bright facilities and responsiveness to needs.
HEALTHSOUTH's medical centers are located in four urban areas of the country, all with well-established healthcare services provided by a number of proprietary, not-for-profit, and municipal hospital facilities. The Company's facilities compete directly with these local hospitals as well as various nationally recognized centers of excellence in orthopaedics, sports medicine and other specialties. Because HEALTHSOUTH's facilities enjoy a national and international reputation for orthopaedic surgery and sports medicine, the Company believes that its medical centers' level of service and continuum of care enable them to compete successfully, both locally and nationally.
Upon completion of the acquisition of SHC, the Company will operate 36 outpatient surgery centers in eleven states. Such surgery centers will compete primarily with hospitals and other operators of freestanding surgery centers in attracting physicians and patients, and developing new centers and in acquiring existing centers. The primary competitive factors in the outpatient surgery business are convenience, cost, quality of service, physician loyalty and reputation. Hospitals have many competitive advantages in attracting physicians and patients, including established standing in a community, historical physician loyalty and convenience for physicians making rounds or performing inpatient surgery in the hospital. However, the Company believes that its national market system and its historical presence in many of the markets where the SHC facilities are located will enhance the Company's ability to operate these facilities successfully.
The Company potentially faces competition any time it initiates a Certificate of Need ("CON") project or seeks to acquire an existing facility or CON. See this Item, "Business Regulation". This competition may arise either from competing companies, national or regional, or from local hospitals which file competing applications or oppose the proposed CON project. The necessity for these approvals serves as a barrier to entry and has the potential to limit competition by creating a franchise to provide services to a given area. To date the Company has been successful in obtaining each of the CONs or similar approvals which it has sought, although there can be no assurance that it will achieve similar success in the future.
Regulation
The healthcare industry is subject to regulation by federal, state and local governments. The various levels of regulatory activity affect the Company's business activities by controlling its growth, requiring licensure or certification of its facilities, regulating the use of its properties and controlling the reimbursement to the Company for services provided.
Licensure, Certification and Certificate of Need Regulations
Capital expenditures for the construction of new facilities, the addition of beds or the acquisition of existing facilities may be reviewable by state regulators under a statutory scheme which is sometimes referred to as a Certificate of Need program. States with CON programs place limits on the construction and acquisition of healthcare facilities and the expansion of existing facilities and services. For example, in such states approvals are required for capital expenditures exceeding certain amounts which involve inpatient rehabilitation facilities or services. At December 31, 1994, 54 of the Company's inpatient facilities (including four of the Company's medical centers) were located in CON states. Outpatient rehabilitation facilities and services do not require such approvals in a majority of states.
State CON statutes generally provide that, prior to the addition of new beds, the construction of new facilities or the introduction of new services, a state health planning designated agency (a "SHPDA") must determine that a need exists for those beds, facilities or services. The CON process is intended to promote comprehensive healthcare planning, assist in providing high quality healthcare at the lowest possible cost and avoid unnecessary duplication by ensuring that only those healthcare facilities that are needed will be built.
Typically, the provider of services submits an application to the appropriate SHPDA with information concerning the area and population to be served, the anticipated demand for the facility or service to be provided, the amount of capital expenditure, the estimated annual operating costs, the relationship of the proposed facility or service to the overall state health plan and the cost per patient day for the type of care contemplated. Whether the CON is granted is based upon a finding of need by the SHPDA in accordance with criteria set forth in CON statutes and state and regional health facilities plans. If the proposed facility or service is found to be necessary and the applicant to be the appropriate provider, the SHPDA will issue a CON containing a maximum amount of expenditure and a specific time period for the holder of the CON to implement the approved project.
Licensure and certification are separate, but related, regulatory activities. The former is usually a state or local requirement and the latter is a federal requirement. In almost all instances, licensure and certification will follow specific standards and requirements that are set forth in readily available public documents. Compliance with the requirements is monitored by annual on-site inspections by representatives of various government agencies. All of the Company's inpatient facilities are currently required to be licensed, but only the outpatient rehabilitation facilities located in Alabama, Arizona, Maryland and New Hampshire currently must satisfy such a licensing requirement.
Medicare Participation and Reimbursement
In order to participate in the Medicare program and receive Medicare reimbursement, each facility must comply with the applicable regulations of the United States Department of Health and Human Services relating to, among other things, the type of facility, its equipment, its personnel and its standards of medical care, as well as compliance with all state and local laws and regulations. All of the Company's inpatient facilities, except for the St. Louis head injury center, participate in the Medicare program. One hundred of the Company's outpatient facilities currently participate in, or are awaiting the assignment of a provider number to participate in, the Medicare program. The Company's Medicare-certified facilities, inpatient and outpatient, undergo annual on-site Medicare certification surveys in order to maintain their certification status. All such facilities have been deemed to be in satisfactory compliance on all applicable surveys. The Company has developed its operational systems to assure compliance with the various standards and requirements and has established ongoing quality assurance activities to monitor compliance. The Company believes that all of such facilities currently meet all applicable Medicare requirements.
As a result of the Social Security Act Amendments of 1983, Congress adopted a prospective payment system ("PPS") to cover the routine and ancillary operating costs of most Medicare inpatient hospital services. Under this system, the Secretary of Health and Human Services has established fixed payment amounts per discharge based on diagnosis-related groups ("DRGs"). With limited exceptions, a hospital's payment for Medicare inpatients is limited to the DRG rate, regardless of the number of services provided to the patient or the length of the patient's hospital stay. Under PPS, a hospital may retain the difference, if any, between its DRG rate and its operating costs incurred in furnishing inpatient services, and is at risk for any operating costs that exceed its DRG rate. HEALTHSOUTH's medical center facilities are generally subject to PPS with respect to Medicare inpatient services.
The PPS program has been beneficial for the rehabilitation segment of the healthcare industry because of the economic pressure on acute-care hospitals to discharge patients as soon as possible. The result has been increased demand for rehabilitation services for those patients discharged early from acute-care hospitals. Outpatient rehabilitation services and free-standing inpatient rehabilitation facilities are currently exempt from PPS, and inpatient rehabilitation units within acute-care hospitals are eligible to obtain an exemption from PPS upon satisfaction of certain federal criteria.
Currently, six of the Company's outpatient centers are Medicare-certified CORFs and 79 are Medicare-certified rehabilitation agencies. CORFs have been designated cost-reimbursed Medicare providers since 1982. Under the regulations, CORFs are reimbursed reasonable costs (subject to certain limits) for services provided to Medicare beneficiaries. Outpatient rehabilitation facilities certified by Medicare as rehabilitation agencies are reimbursed on the basis of the lower of reasonable costs for services provided to Medicare beneficiaries or charges for such services. Outpatient rehabilitation facilities which are physician-directed clinics are reimbursed by Medicare on a fee screen basis; that is, they receive a fixed fee, which is determined by the geographical area in which the facility is located, for each procedure performed. The Company's outpatient facilities submit monthly bills to their fiscal intermediaries for services provided to Medicare beneficiaries, and the Company files annual cost reports with the intermediaries for each such facility. Adjustments are then made if costs have exceeded payments from the fiscal intermediary or vice versa.
Inpatient rehabilitation facilities, including the Company's inpatient facilities (other than the medical center facilities), either are not currently covered by PPS or are exempt from PPS, and are also cost-reimbursed, receiving the lower of reasonable costs or charges. Typically, the fiscal intermediary pays a set rate based on the prior year's costs for each facility. As with outpatient facilities subject to cost-based reimbursement, annual cost reports are filed with the Company's fiscal intermediary and payment adjustments are made, if necessary.
Congress has directed the United States Department of Health and Human Services to develop regulations, which could subject inpatient rehabilitation hospitals to PPS in place of the current "reasonable cost within limits" system of reimbursement. In addition, informal proposals have been made for a prospective payment system for Medicare outpatient care. Other proposals for a prospective payment system for rehabilitation hospitals are also being considered by the federal government. Therefore, the Company cannot predict at this time the effect that any such changes may have on its operations. Regulations relating to prospective payment or other aspects of reimbursement may be developed in the future which could adversely affect reimbursement for services provided by the Company.
Over the past several years an increasing number of healthcare providers have been accused of violating the federal False Claims Act. That Act prohibits the knowing presentation of a false claim to the United States government. Because the Company performs thousands of similar procedures a year for which it is reimbursed by Medicare and there is a relatively long statute of limitations, a billing error could result in significant civil penalties. The Company does not believe that it is or has been in violation of the False Claims Act.
Relationships with Physicians and Other Providers
Various state and federal laws regulate relationships among providers of healthcare services, including employment or service contracts and investment relationships. These restrictions include a federal criminal law prohibiting the offer, payment, solicitation or receipt of remuneration by individuals or entities, to induce referrals of patients for services reimbursed under the Medicare or Medicaid programs (the "Fraud and Abuse Law"). In addition to federal criminal sanctions, violators of the Fraud and Abuse Law may be subject to significant civil sanctions, including fines and/or exclusion from the Medicare and/or Medicaid programs.
In 1991, the Office of the Inspector General ("OIG") of the United States Department of Health and Human Services promulgated regulations describing compensation arrangements which are not viewed as illegal remuneration under the Fraud and Abuse Law (the "Safe Harbor Rules"). The Safe Harbor Rules create certain standards ("Safe Harbors") for identified types of compensation arrangements, which, if fully complied with, assure participants in the particular arrangement that the OIG will not treat such participation as a criminal offense under the Fraud and Abuse Law or as the basis for an exclusion from the Medicare and Medicaid programs or an imposition of civil sanctions.
The Company operates five of its rehabilitation hospitals and almost all of its outpatient facilities as limited partnerships. Three of the rehabilitation hospital partnerships involve physician investors, and two of the rehabilitation hospital partnerships involve other institutional healthcare providers. Eight of the outpatient partnerships currently have a total of 26 physician limited partners, some of whom refer patients to the partnerships. Those partnerships which are providers of services under the Medicare program, and their limited partners, are subject to the Fraud and Abuse Law. A number of the relationships established by the Company with physicians and other healthcare providers do not fit within any of the Safe Harbors. The Safe Harbor Rules do not expand the scope of activities that the Fraud and Abuse Law prohibits, nor do they provide that failure to fall within a Safe Harbor constitutes a violation of the Fraud and Abuse Law; however, the OIG has informally indicated that failure to fall within a Safe Harbor may subject an arrangement to increased scrutiny. While several federal court decisions have aggressively applied the restrictions of the Fraud and Abuse Law, they provide little guidance as to the application of the Fraud and Abuse Law to the Company's limited partnerships. The Company believes that it is in compliance with the current requirements of applicable federal and state law, but no assurances can be given that a federal or state agency charged with enforcement of the Fraud and Abuse Law and similar laws might not assert a contrary position or that new federal or state laws, or new interpretations of existing laws, might not adversely affect relationships established by the Company with physicians or other healthcare providers or result in the imposition of penalties on the Company or certain of its facilities. Even the assertion of a violation could have a material adverse effect upon the Company.
The Omnibus Budget Reconciliation Act of 1993 amends the federal Medicare statute to prohibit the making by a physician of referrals for "designated health services" (including physical therapy and occupational therapy) to an entity in which the physician has an investment interest or other financial relationship, subject to certain exceptions. Such prohibition took effect on January 1, 1995 and applies to all of the Company's outpatient partnerships with physician limited partners. Additional regulation at the federal level is possible. In addition, a number of states have passed or are considering statutes which prohibit or limit physicians from referring patients to facilities in which they have an investment interest. In response to these regulatory activities, the Company has restructured most of its partnerships which involve physician investors, in order to eliminate physician ownership interests not permitted by applicable law. The Company intends to take such actions as may be required to cause the remaining partnerships to be in compliance with applicable laws and regulations, including, if necessary, the prohibition of physician partners from referring patients. The Company believes that this restructuring has not adversely affected and will not adversely affect the operations of its facilities. The Company cannot predict whether other regulatory or statutory provisions will be enacted by federal or state authorities which would prohibit or otherwise regulate relationships which the Company has established or may establish with other healthcare providers or the possibility of materially adverse effects on its business or revenues arising from such future actions. Management of the Company believes, however, that the Company will be able to adjust its operations so as to be in compliance with any regulatory or statutory provision as may be applicable. See this Item, "Business Sources of Revenues" and "Business Patient Care Services".
Insurance
Beginning December 1, 1993, the Company became self-insured for professional liability and comprehensive general liability. The Company purchased coverage for all claims incurred prior to December 1, 1993. In addition, the Company purchased underlying insurance which would cover all claims once established limits have been exceeded. It is the opinion of management that at December 31, 1994, the Company has adequate reserves to cover losses on asserted and unasserted claims. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations".
Employees
As of December 31, 1994, giving effect to the acquisition of ReLife, the Company employed 18,423 persons, of whom 12,966 were full-time employees and 5,457 were part-time employees. Of the above employees, 306 are employed at the Company's headquarters in Birmingham, Alabama. Except for approximately 100 employees at one rehabilitation hospital (about 20% of that facility's workforce), none of the Company's employees is represented by a labor union, and the Company is not aware of any current activities to organize its employees at other facilities. Management of the Company considers the relationship between the Company and its employees to be good.
Item 2.



Item 2. Properties.
The Company's executive offices currently occupy approximately 62,000 square feet in Birmingham, Alabama, under a lease which expires in 1996. In early 1995, the Company entered into an agreement with its landlord for a new lease, which will increase the size of its executive offices to approximately 120,000 square feet. The expanded executive offices are expected to be fully available by early 1996. Certain of the Company's other physical properties are listed in the table of facilities and businesses set forth under Item 1, "Business-Patient Care Services", which table is hereby incorporated herein by reference. All of the Company's outpatient services operations are carried out in leased facilities, except for its outpatient facilities located in Birmingham and Montgomery, Alabama, Orlando, Florida and one of its facilities in Baltimore, Maryland. The Company owns 31 of its inpatient rehabilitation facilities and leases or operates under management contracts 35 of its inpatient rehabilitation facilities. The Company constructed its rehabilitation hospitals in Florence and Columbia, South Carolina, Kingsport and Nashville, Tennessee, Concord, New Hampshire, and Dothan, Alabama on property leased under long-term ground leases. The property on which the Company's Memphis, Tennessee rehabilitation hospital is located is owned in partnership by the Company and Methodist Hospitals of Memphis. The Company owns its four medical center facilities in Birmingham, Alabama, Richmond, Virginia and Miami, Florida and leases its medical center facility in Dallas, Texas. The Company currently owns, and from time to time may acquire, certain other improved and unimproved real properties in connection with its business. See Notes 5 and 7 of "Notes to Consolidated Financial Statements" for information with respect to the properties owned by the Company and certain indebtedness related thereto.
In Management's opinion, the Company's physical properties are adequate for the Company's needs for the foreseeable future, and are consistent with the Company's expansion plans described elsewhere in this Annual Report on Form 10-K. See Item 1, "Business" and Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations".
Item 3.

Item 3. Legal Proceedings.
In the ordinary course of its business, the Company may be subject, from time to time, to claims and legal actions by patients and others. No material actions are currently pending against the Company. See this Item, "Business Insurance" and Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" for a description of the Company's insurance coverage arrangements.
From time to time, the Company appeals decisions of various rate-making authorities with respect to Medicare rates established for the Company's facilities. These appeals are initiated in the ordinary course of business. Management believes that adequate reserves have been established for possible adverse decisions on any pending appeals and that the outcomes of currently pending appeals, either individually or in the aggregate, will have no material adverse effect on the Company's operations.
Item 4.

Item 4. Submission of Matters to a Vote of Security Holders.
On December 6, 1994, a Special Meeting of Stockholders of the Company was held, at which the following actions were taken:
1. The shares of Common Stock represented at the Special Meeting were voted for the change of the name of the Company to "HEALTHSOUTH Corporation" as follows:
2. The shares of Common Stock represented at the Special Meeting were voted for the approval of an Amendment to the Restated Certificate of Incorporation of the Company to increase the authorized shares of Common Stock to 100,000,000 shares as follows:
3. The shares of Common Stock represented at the Special Meeting were voted against the approval of the 1994 Stock Option Plan of the Company as follows:
PART II
Item 5.

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
HEALTHSOUTH's Common Stock is listed for trading on the New York Stock Exchange (Symbol: HRC). The following table sets forth for the fiscal periods indicated the high and low reported sale prices for the Company's Common Stock.
The closing price for the Common Stock on the New York Stock Exchange on March 3, 1995, was $39.13.
There were approximately 1,281 holders of record of the Common Stock as of March 3, 1995, excluding those shares held by depository companies for certain beneficial owners.
The Company has never paid cash dividends on its Common Stock and does not anticipate the payment of cash dividends in the foreseeable future. The Company currently anticipates that any future earnings will be retained to finance the Company's operations.
Item 6.

Item 6. Selected Financial Data.
Set forth below is a summary of selected consolidated financial data for the Company for the years indicated. All amounts have been restated to reflect the effects of the 1994 ReLife acquisition, which was accounted for as a pooling of interests.
See accompanying notes.
HEALTHSOUTH Corporation and Subsidiaries
Consolidated Statements of Income
See accompanying notes.
See accompanying notes.
Non-cash financing activities:
The Company received a tax benefit from the disqualifying disposition of incentive stock options of $5,635,000, $585,000 and $6,470,000 for the years ended December 31, 1992, 1993 and 1994, respectively.
See accompanying notes.
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 1994
1. Significant Accounting Policies
The significant accounting policies followed by HEALTHSOUTH Corporation (formerly HEALTHSOUTH Rehabilitation Corporation) and its subsidiaries (the Company) are presented as an integral part of the consolidated financial statements.
Principles of Consolidation
The consolidated financial statements include the accounts of HEALTHSOUTH Corporation (HEALTHSOUTH) and its wholly-owned subsidiaries, as well as its limited partnerships (see Note 9). All significant intercompany accounts and transactions have been eliminated in consolidation.
HEALTHSOUTH Corporation is engaged in the business of providing comprehensive rehabilitative and clinical healthcare services on an inpatient and outpatient basis.
Marketable Securities
Marketable equity securities and debt securities are classified as available-for-sale. Available-for-sale securities are carried at fair value, with the unrealized gains and losses, if material, reported as a separate component of stockholders' equity, net of tax. The adjusted cost of the specific security sold method is used to compute gain or loss on the sale of securities. Interest and dividends on securities classified as available-for-sale are included in investment income. Marketable equity securities and debt securities of the Company have maturities of less than one year.
Accounts Receivable and Third-Party Reimbursement Activities
Receivables from patients, insurance companies and third-party contractual insured accounts (Medicare and Medicaid) are based on payment agreements which generally result in the Company collecting an amount different from the established rates. Final determination of the settlement is subject to review by appropriate authorities. Adequate allowances are provided for doubtful accounts and contractual adjustments. Uncollectible accounts are written off against the allowance for doubtful accounts after adequate collection efforts are made. Net accounts receivable include only those amounts estimated by management to be collectible.
HEALTHSOUTH Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. Significant Accounting Policies (continued)
The concentration of net accounts receivable from third-party contractual payors and others, as a percentage of total net accounts receivable, was as follows:
December 31 ------------------------------- 1993 1994 ------------------------------- Medicare 33% 36% Medicaid 4% 6% Other 63% 58% ------------------------------- 100% 100% -------------------------------
Inventories
Inventories are stated at the lower of cost or market using the specific identification method.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost. Upon sale or retirement of property, plant or equipment, the cost and related accumulated depreciation are eliminated from the respective account and the resulting gain or loss is included in the results of operations.
Interest cost incurred during the construction of a facility is capitalized. The Company incurred interest of $13,274,000, $16,645,000 and $59,014,000 of which $1,979,000, $2,384,000 and $1,759,000 was capitalized during 1992, 1993 and 1994, respectively.
Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the assets or the term of the lease, as appropriate. The estimated useful life of buildings is 30-40 years and the general range of useful lives for leasehold improvements, furniture, fixtures and equipment is 10-15 years.
Intangible Assets
Cost in excess of net asset value of purchased facilities is amortized over 20 to 40 years using the straight-line method. Organization and start-up costs incurred prior to opening a new facility and partnership formation costs are deferred and amortized on a straight-line basis over a period of 36 months. Organization, partnership formation and start-up costs for a project that is subsequently abandoned are charged to operations in that period. Debt issue costs are amortized over the term of the debt. Noncompete agreements are amortized using the straight-line method over the term of the agreements.
Minority Interests
The equity of minority investors in limited partnerships of the Company is reported on the balance sheet as minority interests. Minority interests reported in the income statement reflect the respective shares of income or loss of the limited partnerships attributable to the minority investors, the effect of which is removed from the results of operations of the Company.
Revenues
Revenues include net patient service revenues and other operating revenues. Net patient service revenues are reported at the estimated net realizable amounts from patients, third-party payors and others for services rendered, including estimated retroactive adjustments under reimbursement agreements with third-party payors.
Income Per Common and Common Equivalent Share
Income per common and common equivalent share is computed based on the weighted average number of common shares and common equivalent shares outstanding during the periods. Common equivalent shares include dilutive employees' stock options, less the number of treasury shares assumed to be purchased from the proceeds using the average market price of the Company's common stock. Fully diluted earnings per share (based on 40,299,000 shares in 1994) assumes conversion of the 5% Convertible Subordinated Debentures due 2001 (see Note 7).
1. Significant Accounting Policies (continued)
Impairment of Assets
Long-lived assets, such as property, plant and equipment and identifiable intangible assets are reviewed for impairment losses when certain impairment indicators exist. If an impairment exists, the related asset is adjusted to the lower of book value or estimated future cash flows from the use and eventual disposal of the asset.
2. Merger
Effective December 29, 1994, the Company merged with ReLife, Inc. ("ReLife") and in connection therewith issued 5,512,645 shares of its Common Stock for all of ReLife's outstanding common stock. ReLife provides a system of rehabilitation services and operates 31 inpatient facilities with an aggregate of approximately 1,100 licensed beds, including nine free-standing rehabilitation hospitals, nine acute rehabilitation units, five sub-acute rehabilitation units, seven transitional living units and one residential facility and provides outpatient rehabilitation services at twelve outpatient centers.
The merger was accounted for as a pooling of interests and, accordingly, the Company's financial statements have been restated to include the results of ReLife for all periods presented. Prior to the merger, ReLife reported on a fiscal year ending on September 30. The accompanying financial statements are based on a combination of the Company's results for its December 31 fiscal year and ReLife's results for its September 30 fiscal year for all periods presented. Costs and expenses of $2.9 million incurred by HEALTHSOUTH in connection with the merger have been recorded in operations in 1994 and reported as ReLife merger expenses in the accompanying consolidated statements of income.
Combined and separate results of the Company and ReLife are as follows (in thousands):
There were no transactions between the Company and ReLife prior to the merger. The effects of conforming the accounting policies of the two companies are not material.
3. Cash, Cash Equivalents and Other Marketable Securities (Including Funds Subject to Withdrawal Restrictions)
Cash, cash equivalents and other marketable securities consisted of the following:
For purposes of the consolidated balance sheets and statements of cash flows, marketable securities purchased with an original maturity of ninety days or less are considered cash equivalents.
4. Other Assets
Other assets consisted of the following:
The Company has a 24% ownership interest in Caretenders Health Corp. (Caretenders). Accordingly, the Company's investment is being accounted for using the equity method of accounting. The investment was initially valued at $7,250,000. The Company's equity in earnings of Caretenders for the years ended December 31, 1992, 1993 and 1994 was not material to the Company's results of operations.
It was not practicable to estimate the fair value of the Company's various investments in other unconsolidated subsidiaries (involved in operations similar to those of the Company) because of the lack of a quoted market price and the inability to estimate fair value without incurring excessive costs. The carrying amount at December 31, 1994 represents the original cost of the investments, which management believes is not impaired.
5. Property, Plant and Equipment
Property, plant and equipment consisted of the following:
6. Intangible Assets
Intangible assets consisted of the following:
7. Long-Term Debt
Long-term debt consisted of the following:
The fair value of total long-term debt approximates book value at December 31, 1994 and 1993.
During 1994, the Company entered into a Credit Agreement with NationsBank of North Carolina, N.A. and other participating banks (the 1994 Credit Agreement) which consists of a $550,000,000 revolving facility and term loan. The 1994 Credit Agreement replaced a previous $390,000,000 Credit Agreement with NationsBank. Interest is paid quarterly based on LIBOR rates plus a predetermined margin, a base rate, or competitively bid rates from the participating banks. The Company is required to pay a fee on the unused portion of the 1994 revolving credit facility ranging from 0.25% to 0.5%, depending on certain defined ratios. The principal amount is payable in 15 equal quarterly installments beginning on June 30, 1997. The Company has provided a negative pledge of all its assets and has granted a first priority security interest in and lien on all shares of stock of its subsidiaries and rights and interests in its partnerships.
The amount shown as Due to National Medical Enterprises, Inc. at December 31, 1993 was subsequently repaid from proceeds of other notes and bonds.
On March 24, 1994, the Company issued $250,000,000 principal amount of 9.5% Senior Subordinated Notes due 2001 (the "Notes"). Interest is payable on April 1 and October 1. The Notes are senior subordinated obligations of the Company and as such will be subordinated to all existing and future senior indebtedness of the Company, and also will be effectively subordinated to all existing and future liabilities of the Company's subsidiaries and partnerships. The Notes rank senior to all subordinated indebtedness of the Company, including the 5% Convertible Subordinated Debentures due 2001 described below. The Notes mature on April 1, 2001.
Also on March 24, 1994, the Company issued $100,000,000 principal amount of 5% Convertible Subordinated Debentures due 2001 (the "Convertible Debentures"). An additional $15,000,000 principal amount of Convertible Debentures was issued in April 1994 to cover underwriters' over allotments. Interest is payable on April 1 and October 1. The Convertible Debentures are convertible into Common Stock of the Company at the option of the holder at a conversion price of $37.625 per share, subject to adjustment in the occurrence of certain events.
The net proceeds from the issuance of the Notes and Convertible Debentures were used by the Company to pay down indebtedness outstanding under its other existing credit facilities.
7. Long-Term Debt (continued)
Principal maturities of long-term debt are as follows:
Year ending December 31 (In thousands) - ------------------------ ---------------- 1995 $ 14,713 1996 12,246 1997 112,233 1998 143,334 1999 140,605 After 1999 521,643 ---------------- $ 944,774 ----------------
8. Stock Options
The Company has various stockholder-approved stock option plans which provide for the grant of options to Directors, officers and other key employees to purchase common stock at 100% of the fair market value as of the date of grant. The Board of Directors administers the stock option plans. Options may be granted as incentive stock options or as non-qualified stock options. Incentive stock options vest 25% annually, commencing upon completion of one year of employment subsequent to the date of grant. Non-qualified stock options generally are not subject to any vesting provisions. The options expire at dates ranging from five to ten years from the date of grant.
The following table summarizes activity in the stock option plans:
1992 1993 1994 ------------------------------------
Options outstanding January 1: 3,368,571 5,339,742 6,875,786 Granted 2,762,000 1,770,000 330,000 Exercised 765,328 180,455 981,286 Cancelled 25,501 53,501 202,563 ------------------------------------ Options outstanding at December 31 5,339,742 6,875,786 6,021,937 ------------------------------------
8. Stock Options (continued)
9. Limited Partnerships
HEALTHSOUTH operates a number of rehabilitation centers as limited partnerships. HEALTHSOUTH serves as the general partner and operates the partnerships as comprehensive outpatient rehabilitation facilities or inpatient rehabilitation facilities. These limited partnerships are included in the consolidated financial statements (as more fully described in Note 1 under "Minority Interests"). The limited partners share in the profit or loss of the partnerships based on their respective ownership percentage (ranging from 1% to 50% at December 31, 1994) during their ownership period.
Beginning in 1992, due to federal and state regulatory requirements, the Company began the process of buying back the partnership interests of its physician limited partners. The buyback prices for the interests were in general based on a predetermined multiple of projected cash flows of the partnerships. The excess of the buyback price over the book value of the limited partners' capital amounts was charged to the Company's retained earnings.
10. Acquisitions
At various dates during 1994, the Company acquired 53 separate outpatient operations located throughout the United States. The combined purchase price of these acquired outpatient operations was approximately $53,947,000. The Company also acquired a specialty medical center in Dallas, Texas, a contract therapist provider and a diagnostic imaging company. The combined purchase price of these three operations was approximately $25,861,000. In connection with these transactions, the Company entered into non-compete agreements totaling $10,814,000.
The fair value of the total net assets relating to the 1994 acquisitions described above was approximately $11,087,000. The total cost for 1994 acquisitions exceeded the fair value of the net assets acquired by approximately $68,721,000. This excess is being amortized over a forty-year period on a straight-line basis.
All of the acquisitions described above were accounted for as purchases and, accordingly, the results of operations of the acquired businesses (not material individually or in the aggregate) are included in the accompanying consolidated financial statements from their respective dates of acquisition.
Effective December 31, 1993, the Company completed an acquisition from National Medical Enterprises, Inc. (NME) of 28 inpatient rehabilitation facilities and 45 outpatient rehabilitation centers, which constituted substantially all of NME's rehabilitation services division (the NME Selected Hospitals Acquisition). The purchase price was approximately $296,661,000 cash, plus net working capital of $64,503,000, subject to certain adjustments, the assumption of approximately $16,313,000 of current liabilities and the assumption of approximately $17,111,000 in long-term debt.
The pro forma effect of this acquisition on 1993 operations and net income per common and common equivalent share is reflected in the pro forma summary in Note 17.
As a result of the NME Selected Hospitals Acquisition, HEALTHSOUTH recognized an expense of approximately $49,742,000 during the year ended December 31, 1993. This expense represents management's estimate of the cost to consolidate operations of thirteen existing HEALTHSOUTH facilities (three inpatient facilities and ten outpatient facilities) into the operations of certain facilities acquired from NME. This plan was formulated by HEALTHSOUTH management in order to more efficiently provide services in markets where multiple locations now exist as a result of the acquisition. The plan of consolidation calls for the affected operations to be merged into the operations of the acquired facilities over a period of twelve to twenty-four months from the date of the NME Selected Hospitals Acquisition. Due to the single-use nature of these properties, the consolidation plan does not provide for the sale of these facilities.
The total expense of $49,742,000 consists of several components. First, approximately $39,000,000 relates to the writedown of the assets of the affected HEALTHSOUTH facilities to their estimated net realizable value. Of this $39,000,000, approximately $31,500,000 relates to the assets of the three inpatient facilities and approximately $7,500,000 relates to the assets of the ten outpatient facilities. The $39,000,000 is broken down into the following asset categories (net of any related accumulated depreciation or amortization):
During the year ended December 31, 1994, management discontinued operations in two of the inpatient facilities and three of the outpatient facilities affected by the plan and merged them into the operations of the acquired facilities. Accordingly, assets with a net book value of approximately $17,911,000 were written off in 1994 against the reserves established at December 31, 1993. The two inpatient facilities and three outpatient facilities affected by the plan in 1994 had revenues of approximately $11,441,000, $8,640,000 and $9,125,000 for the years ended December 31, 1992, 1993 and 1994, respectively. These same facilities had net operating income (loss) before income taxes of $(489,000), $(844,000) and $67,000 for the years ended December 31, 1992, 1993 and 1994, respectively. Operations at the remaining inpatient facility and the remaining seven outpatient facilities identified in the plan will be discontinued during 1995.
Second, $7,700,000 relates to the write-off of certain capitalized development projects. These projects relate to planned facilities that, if completed, would be in direct competition with certain of the acquired NME facilities. These development projects were written off in 1994 against the reserves established at December 31, 1993.
Finally, approximately $3,000,000 was accrued for costs of employee separations, relocations and other direct costs related to the planned consolidation of the affected operations. During the second quarter of 1994, management revised its estimate of the cost of the employee separations and relocations. The revised estimate calls for approximately 150 employees to be affected by separations and approximately 400 to be affected by relocations. Separation benefits under the revised plan range from one month's to one year's compensation and total approximately $2,188,000. Relocation benefits are estimated to be $2,000 per employee and total $800,000. An additional $350,000 has been provided for additional direct administrative costs associated with the implementation of the plan, including outplacement services, travel and legal fees. Accordingly, the total revised estimated cost of employee separations and relocations is $3,338,000. The difference between the initial estimate and the revised estimate was treated as a change in accounting estimate and charged to operations in the second quarter of 1994.
During the year ended 1994, a total of 208 employees were affected by terminations and relocations at a cost of approximately $758,000. This cost is the only cash expense included in the acquisition-related expense.
It is management's opinion that remaining accrual at December 31, 1994 of $23,669,000 is adequate to complete the plan of consolidation of the affected operations.
11. Income Taxes
HEALTHSOUTH and its subsidiaries file a consolidated federal income tax return. The limited partnerships file separate income tax returns. HEALTHSOUTH's allocable portion of each partnership's income or loss is included in the taxable income of the Company. The remaining income or loss of each partnership is allocated to the limited partners.
Effective January 1, 1993, the Company changed its method of accounting for income taxes to the liability method required by Financial Accounting Standards Board (FASB) Statement No. 109, "Accounting for Income Taxes". The cumulative effect of adopting Statement No. 109 was not material. Previously, the Company had used the liability method as prescribed by FASB Statement No. 96.
Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax liabilities and assets as of December 31, 1993 are as follows:
Significant components of the Company's deferred tax liabilities and assets as of December 31, 1994 are as follows:
The current portion of the Company's deferred tax asset is included with prepaid expenses and other current assets on the accompanying balance sheet.
The provision for income taxes was as follows:
11. Income Taxes (continued)
The components of the provision for deferred income taxes for the year ended DecemberE31, 1992 are as follows:
(In thousands) ---------------- Depreciation and amortization $ 5,599 Bad debts (1,119) Other 21 -------- $ 4,501 --------
The difference between the provision for income taxes and the amount computed by applying the statutory federal income tax rate to income before taxes was as follows:
Year ended December 31 ---------------------------------------- 1992 1993 1994 ---------------------------------------- (In thousands)
Federal taxes at statutory rates $ 18,013 $ 7,910 $ 30,471 Add (deduct): State income taxes, net of federal tax benefit 1,054 1,121 $2,671 Tax-exempt interest income (1,076) (454) (276) Other 392 432 969 ---------------------------------------- $ 18,383 $ 9,009 $ 33,835 ----------------------------------------
12. Commitments and Contingencies
At December 31, 1994, anticipated capital expenditures for the next twelve months approximate $120,000,000. This amount includes expenditures for the construction and equipping of additions to existing facilities, the construction of two inpatient rehabilitation facilities for which regulatory approval is being obtained and the acquisition or development of comprehensive outpatient rehabilitation facilities.
12. Commitments and Contingencies (continued)
Beginning December 1, 1993, the Company became self-insured for professional liability and comprehensive general liability. The Company purchased coverage for all claims incurred prior to December 1, 1993. In addition, the Company purchased underlying insurance which would cover all claims once established limits have been exceeded. It is the opinion of management that at December 31, 1994 the Company has adequate reserves to cover losses on asserted and unasserted claims.
Operating leases
Operating leases generally consist of short-term lease agreements for buildings where facilities are located. These leases generally have 5-year terms, with one or more renewal options, with terms to be negotiated at the time of renewal. Total rental expense for all operating leases was $15,902,000, $23,417,000 and $58,529,000 for the years ended December 31, 1992, 1993 and 1994, respectively.
The following is a schedule of future minimum lease payments under all operating leases having initial or remaining non-cancelable lease terms in excess of one year:
Year ending December 31 (In thousands) - ------------------------- ---------------
1995 $ 50,173 1996 46,383 1997 42,493 1998 38,554 1999 33,618 After 1999 96,667 -------------- Total minimum payments required $ 307,888 --------------
13. Employee Benefit Plans
The Company has a 401(k) savings plan which matches 15% of the first 4% of earnings that an employee contributes. All contributions are in the form of cash. All employees who have completed one year of service with a minimum of 1,000 hours worked are eligible to participate in the plan. Company contributions are gradually vested over a seven-year service period. Contributions to the plan by the Company were approximately $521,000, $490,000 and $1,094,000 in 1992, 1993 and 1994, respectively.
In 1991, the Company established an Employee Stock Ownership Plan (ESOP) for the purpose of providing substantially all employees of the Company the opportunity to save for their retirement and acquire a proprietary interest in the Company. The ESOP currently owns approximately 830,000 shares of the Company's Common Stock, which were purchased with funds borrowed from the Company, $10,000,000 in 1991 (the 1991 ESOP Loan) and $10,000,000 in 1992 (the 1992 ESOP Loan). At December 31, 1994, the combined ESOP Loans had a balance of $17,477,000. The 1991 ESOP Loan, which bears an interest rate of 10%, is payable in annual installments covering interest and principal over a ten-year period beginning in 1992. The 1992 ESOP Loan, which bears an interest rate of 8.5%, is payable in annual installments covering interest and principal over a ten-year period beginning in 1993. Company contributions to the ESOP began in 1992 and shall at least equal the amount required to make all ESOP Loan amortization payments for each plan year. The Company recognizes compensation expense based on the shares allocated method. The total compensation expense related to the ESOP recognized by the Company was $1,701,000, $3,198,000 and $3,673,000 in 1992, 1993 and 1994, respectively. Interest incurred on the ESOP Loans was approximately $964,000, $1,743,000 and $1,608,000 in 1992, 1993 and 1994, respectively. Approximately 213,000 shares owned by the ESOP have been allocated to participants at December 31, 1994.
During 1993 the American Institute of Certified Public Accountants issued Statement of Position ("SOP") 93-6, "Employers Accounting for Employee Stock Ownership Plans." Among other provisions, SOP 93-6 requires that compensation expense relating to employee stock ownership plans be measured based on the fair market value of the shares when allocated to the employees. The provisions of SOP 93-6 apply only to leveraged ESOPs formed after December 31, 1992, or shares newly acquired by an existing leveraged ESOP after December 31, 1992. Because all shares owned by the Company's ESOP were acquired prior to December 31, 1992, the Company's accounting policies for the shares currently owned by the ESOP are not affected by SOP 93-6.
14. Terminated Merger
On January 2, 1992, the Company and Continental Medical System, Inc. (CMS) jointly announced an agreement to combine their business operations as provided in an Agreement and Plan of Reorganization (the Plan). On May 6, 1992, the Company and CMS jointly announced the termination of the Plan. Accordingly, all costs and expenses incurred in connection with the Plan were charged to operations in 1992 and reported as terminated merger expense in the accompanying statements of income.
15. Sale of Assets
During the second quarter of 1994, the Company consummated the sale of selected properties to Capstone Capital Corporation ("Capstone"), a real estate investment trust. These properties include six ancillary hospital facilities, three outpatient rehabilitation facilities, and one research facility. The net proceeds to the Company as a result of this transaction was approximately $49,025,000. The net book value of the properties was approximately $41,335,000. Because the Company is leasing back substantially all of the properties from Capstone and guarantees the associated operating leases, payments under which aggregate approximately $5.7 million annually, the resulting gain on sale of approximately $7,690,000 has been recorded on the accompanying consolidated balance sheet as deferred revenue and will be amortized into income over the initial lease terms of the properties. The Company and certain Company officers own approximately 3.9% of the outstanding common stock of Capstone.
16. Impairment of Long-Term Assets
During 1994, certain events have occurred impairing the value of specific long-term assets of ReLife (see Note 2). A hospital in Missouri with a distinct part unit which ReLife was managing was purchased in 1994 by an acute care provider which terminated the contract with ReLife. Remaining goodwill of $1,700,000 and costs allocated to the management contract of $1,300,000 were written off as there is no value remaining for the terminated contract.
A ReLife facility in central Florida incurred tornado damage and has not been operating since September 1993. During 1994, management of ReLife has determined that it is probable that this facility will not reopen. Start-up costs of $1,600,000 were written off. This facility is leased under an operating lease as described in Note 12. The lease payments related to this facility were determined to be $5,900,000 based on the net projected cash flows of all the facilities under the lease. This value was written off resulting in a current accrued liability of $600,000 and other long-term liabilities of $5,300,000.
During 1994, ReLife entered into an agreement to upgrade its computer system. Lease payments and other costs have been capitalized during the conversion phase of implementing the new computer system which were to be amortized over the remaining lease term after implementation was completed. After the agreement to merge with HEALTHSOUTH was entered into (see Note 2), the computer project was abandoned resulting in a write-off of capitalized cost of $4,500,000.
The above amounts are shown as operating expenses in the consolidated statement of income.
17. Subsequent Events
On January 24, 1995, the Company signed an agreement to merge with Surgical Health Corporation ("SHC"). SHC operates 36 outpatient surgery centers in eleven states. Under the terms of the agreement, all shares of common and preferred stock of SHC will be exchanged for shares of the Company's Common Stock pursuant to an exchange ratio that will yield an aggregate value of approximately $155,000,000 to SHC shareholders. The transaction will be accounted for as a pooling of interests and is subject to certain regulatory and governmental reviews, and to approval by the shareholders of both companies. The transaction is expected to be completed early in the second quarter of 1995. The effects of conforming the accounting policies of the two companies is not expected to be material.
The following table summarizes the unaudited consolidated pro forma results of operations, assuming the SHC acquisition described above had occurred at the beginning of each of the following periods. This pro forma summary does not necessarily reflect the results of operations as they would have been had the Company and the acquired entities constituted a single entity during such periods. HEALTHSOUTH 1993 amounts reflect the pro forma effect of the NME Selected Hospital Acquisition (see Note 10).
Year ended December 31 1992 1993 1994 ------------------------------------------------ (In thousands, except for per share amounts)
Revenues $ 501,046 $1,111,198 $1,236,190 Net income 34,929 25,076 49,961 Net income per common and common equivalent share 0.95 0.65 1.19
On February 3, 1995, the Company entered into a definitive agreement to purchase the operations of the rehabilitation hospital division of NovaCare, Inc., consisting of 11 rehabilitation hospitals in seven states, 12 other facilities and certificates of need to build two additional facilities. The purchase price will be approximately $215,000,000 in cash and the assumption of $20,000,000 in liabilities for a total consideration of $235,000,000. The transaction is expected to be completed in the second quarter of 1995.
Subsequent to December 31, 1994, the Company received a fully underwritten commitment to amend and restate the 1994 Credit Agreement (see Note 7) which will increase the size of the facility to $1 billion.
Item 9.




Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
The Company has not changed independent accountants within the twenty-four months prior to December 31, 1994.
PART III
Item 10.



Item 10. Directors and Executive Officers of the Registrant.
Directors
The following table sets forth certain information with respect to the Company's Directors.
Richard M. Scrushy, one of the Company's management founders, has served as Chairman of the Board, President and Chief Executive Officer of the Company since 1984. From 1979 to 1984, Mr. Scrushy was with Lifemark Corporation, a publicly-owned healthcare corporation, serving in various operational and management positions. Mr. Scrushy is also a director of Integrated Health Services, Inc. and MedPartners, Inc., both publicly-traded healthcare corporations, and serves on the boards of directors of several privately-held healthcare corporations.
Phillip C. Watkins, M.D., FACC, is and has been in private practice for more than five years with Cardiovascular Associates, P.C. in Birmingham, Alabama. A graduate of The Medical College of Alabama, Dr. Watkins is a Diplomate of the American Board of Internal Medicine. He is also a Fellow of the American College of Cardiology and the Subspecialty Board of Cardiovascular Disease.
George H. Strong retired as senior vice president and chief financial officer of Universal Health Services, Inc. in December 1984, a position he held for more than six years. Mr. Strong is a private investor and a director of Universal Health Services, Inc., a publicly-owned hospital management corporation. Mr. Strong is also a director of The Viking Group of Funds, a public mutual fund group.
C. Sage Givens is a general partner of First Century Partners, a private venture capital fund capitalized at $100,000,000. Ms. Givens joined First Century Partners in 1983, where she manages the fund's healthcare investments. Ms. Givens serves on the boards of directors of PhyCor, Inc., a publicly-owned healthcare corporation, and several privately-held healthcare companies.
Charles W. Newhall III is a general partner and founder of New Enterprise Associates Limited Partnerships, Baltimore, Maryland, where he has been engaged in the venture capital business since 1978. Mr. Newhall is also a director of Integrated Health Services, Inc., Genetic Therapy, Inc., Opta Food Ingredients, Inc. and Sepracor, Inc., all of which are publicly-traded corporations.
Aaron Beam, Jr., C.P.A., a management founder, serves as Executive Vice President and Chief Financial Officer of the Company and was elected a Director in February 1993. From 1980 to 1984, Mr. Beam was employed by Lifemark Corporation in several financial and operational management positions for the Shared Services Division, including division controller. Mr. Beam is a director of Ramsey Healthcare, Inc., a publicly-traded healthcare corporation.
James P. Bennett joined the Company in May 1991 as Director of Inpatient Operations, was promoted to Group Vice President Inpatient Rehabilitation Operations in September 1991, again to President and Chief Operating Officer -- HEALTHSOUTH Rehabilitation Hospitals in June 1992 and to President -- HEALTHSOUTH Inpatient Operations in February 1993. Mr. Bennett also was elected a Director in February 1993. From August 1987 to May 1991, Mr. Bennett was employed by Russ Pharmaceuticals, Inc., Birmingham, Alabama, as Vice President Operations, Chief Financial Officer, Secretary and director. Mr. Bennett served as certified public accountant on the audit staff of the Birmingham, Alabama office of Ernst & Whinney (now Ernst & Young LLP) from October 1980 to August 1987.
Larry R. House is Chairman of the Board, President and Chief Executive Officer of MedPartners, Inc. a publicly-held physician practice management firm, a position he assumed as his principal occupation in August 1993. Mr. House was elected a Director of the Company in February 1993. At the same time he became President -- HEALTHSOUTH International, Inc. and New Business Ventures, a position which he held until August 31, 1994, when he terminated his employment with the Company to concentrate on his duties at MedPartners. Mr. House joined the Company in September 1985 as Director of Marketing, subsequently served as Senior Vice President and Chief Operating Officer of the Company, and in June 1992 became President and Chief Operating Officer -- HEALTHSOUTH Medical Centers. Prior to joining the Company, Mr. House was president and chief executive officer of a provider of clinical contract management services for more than ten years.
Anthony J. Tanner, Sc.D., a management founder, serves as Executive Vice President -- Administration and Secretary of the Company and was elected a Director in February 1993. From 1980 to 1984, Mr. Tanner was with Lifemark Corporation in the Shared Services Division as director, clinical and professional programs (1982-1984) and director, quality assurance and education (1980-1982), where he was responsible for the development of clinical programs and marketing programs.
John S. Chamberlin retired in 1988 as president and chief operating officer of Avon Products, Inc., a position he had held since 1985. From 1976 until 1985, he served as chairman and chief executive officer of Lenox, Incorporated, after 22 years in various assignments for General Electric. From 1990 to 1991, he served as chairman and chief executive officer of New Jersey Publishing Co. Mr. Chamberlin is chairman of the board of Life Fitness Company and WNS, Inc., and is a director of The Scotts Company. He is a member of the Board of Trustees of the Medical Center at Princeton and the Board of Overseers of Parsons School of Design and is a trustee of the Woodrow Wilson National Fellowship Foundation.
Richard F. Celeste originally joined the Board of Directors in 1991, took a leave of absence from the Board of Directors in August 1993 to head the Democratic National Committee's healthcare reform campaign, and rejoined the Board in May 1995. He is a principal of Celeste and Sabaty, Ltd., a business advisory firm located in Columbus, Ohio, which assists United States companies to build strategic business alliances in Europe, Africa, South Asia and the Pacific Rim. He served as Governor of Ohio from 1983 to 1991, during which time he chaired the National Governors' Association Committee on Science and Technology, and directed the United States Peace Corps from 1979 to 1981. He is a member of the Advisory Council of the Carnegie Commission on Science, Technology and Government, and chairs Carnegie's Task Force on Science, Technology and the States. He is a director of Navistar International, Inc. and Republic Engineered Steels, Inc., both of which are publicly-traded companies.
Executive Officers
The following table sets forth certain information with respect to the Company's executive officers.
Stock Option Grants in 1994
No stock option grants to the Named Executive Officers were made in 1994.
Stock Option Exercises in 1994 and Option Values at December 31, 1994
Stock Option Plans
Set forth below is information concerning the various stock option plans of the Company at December 31, 1994.
1984 Incentive Stock Option Plan
The Company had a 1984 Incentive Stock Option Plan (the "ISO Plan"), intended to qualify under Section 422(b) of the Internal Revenue Code of 1986, as amended (the "Code"), covering an aggregate of 1,200,000 shares of Common Stock. The ISO Plan expired on February 28, 1994, in accordance with its terms. As of December 31, 1994, there were outstanding under the ISO Plan options to purchase 14,733 shares of the Company's Common Stock at prices ranging from $10.08 to $15.13 per share. All such options remain in full force and effect in accordance with their terms and the ISO Plan. Under the ISO Plan, which was administered by the Board of Directors, key employees could be granted options to purchase shares of Common Stock at 100% of fair market value on the date of grant (or 110% of fair market value in the case of a 10% stockholder/grantee). The outstanding options granted under the ISO Plan must be exercised within ten years from the date of grant, are cumulatively exercisable with respect to 25% of the shares covered thereby after the expiration of each of the first through the fourth years following the date of grant, are nontransferable except by will or pursuant to the laws of descent and distribution, are protected against dilution and expire within three months after termination of employment, unless such termination is by reason of death.
1988 Non-Qualified Stock Option Plan
The Company also has a 1988 Non-Qualified Stock Option Plan (the "NQSO Plan") covering a maximum of 1,200,000 shares of Common Stock. As of December 31, 1994, there were outstanding under the NQSO Plan options to purchase 86,340 shares of the Company's Common Stock at prices ranging from $6.25 to $13.17 per share. The NQSO Plan, which is administered by the Board of Directors (except with respect to options granted to Directors, as to which it is administered by an Independent Stock Option Committee), provides that Directors, executive officers and other key employees may be granted options to purchase shares of Common Stock at 100% of fair market value on the date of grant. The NQSO Plan terminates on the earliest of (a) February 28, 1998, (b) such time as all shares of Common Stock reserved for issuance under the NQSO Plan have been acquired through the exercise of options granted thereunder or (c) such earlier time as the Board of Directors of the Company may determine. Except for options covering 33,500 shares, which contain vesting provisions similar to those contained in options granted under the ISO Plan, options granted pursuant to the NQSO Plan have a five-year term (except for options covering 172,500 shares which have a ten-year term), are exercisable at any time during such period, are nontransferable except by will or pursuant to the laws of descent and distribution, are protected against dilution and expire within three months of termination of association with the Company as a Director or termination of employment, unless such termination is by reason of death.
1989, 1990, 1992, 1992 and 1993 Stock Option Plans
The Company also has a 1989 Stock Option Plan (the "1989 Plan"), a 1990 Stock Option Plan (the "1990 Plan"), a 1991 Stock Option Plan (the "1991 Plan"), a 1992 Stock Option Plan (the "1992 Plan"), and a 1993 Stock Option Plan (the "1993 Plan"), under each of which incentive stock options ("ISOs") and non-qualified stock options ("NQSOs") may be granted. The 1989, 1990, 1991, 1992 and 1992 Plans cover a maximum of 600,000 shares, 900,000 shares, 2,800,000 shares, 1,400,000 shares and 1,400,000 shares, respectively, of the Company's Common Stock. As of December 31, 1994, there were outstanding options to purchase 218,692 shares of Common Stock at prices ranging from $10.08 to $15.13 per share under the 1989 Plan, 678,763 shares of Common Stock at prices ranging from $11.55 to $15.13 per share under the 1990 Plan, 2,356,079 shares of Common Stock at an exercise price of $15.13 per share under the 1991 Plan, 1,224,625 shares of Common Stock at exercise prices ranging from $15.13 to $15.25 per share under the 1992 Plan, and 1,070,205 shares of Common Stock at prices ranging from $13.50 to $36.50 per share under the 1993 Plan. Each of the 1989, 1990, 1991, 1992 and 1993 Plans is administered in the same manner as the NQSO Plan and provides that Directors, executive officers and other key employees may be granted options to purchase shares of Common Stock at 100% of fair market value on the date of grant. Each of the 1989, 1990, 1991, 1992 and 1993 Plans terminate on the earliest of (a) October 25, 1999, October 15, 2000, June 19, 2001, June 16, 2002, and April 19, 2003, respectively, (b) such time as all shares of Common Stock reserved for issuance under the respective Plan have been acquired through the exercise of options granted thereunder, or (c) such earlier times as the Board of Directors of the Company may determine. Options granted under these Plans which are designated as ISOs contain vesting provisions similar to those contained in options granted under the ISO Plan and have a ten-year term. NQSOs granted under these Plans, if any, will have a ten-year term. Options granted under these Plans are nontransferable except by will or pursuant to the laws of descent and distribution, are protected against dilution and will expire within three months of termination of association with the Company as a Director or termination of employment, unless such termination is by reason of death.
1993 Consultants' Stock Option Plan
The Company also has a 1993 Consultants' Stock Option Plan (the "1993 Consultants' Plan"), under which NQSOs may be granted, covering a maximum of 750,000 shares of Common Stock. As of December 31, 1994, there were outstanding under the 1993 Consultants' Plan options to purchase 372,500 shares of Common Stock at prices ranging from $13.50 to $36.50 per share. The 1993 Consultants' Plan, which is administered in the same manner as the NQSO Plan, provides that certain non-employee consultants who provide significant services to the Company may be granted options to purchase shares of Common Stock at such prices as are determined by the Board of Directors or the appropriate committee. The 1993 Consultants' Plan terminates on the earliest of (a) February 25, 2003, (b) such time as all shares of Common Stock reserved for issuance under the 1993 Consultants' Plan have been acquired through the exercise of options granted thereunder, or (c) such earlier time as the Board of Directors of the Company may determine. Options granted under the 1993 Consultants' Plan have a ten-year term. Options granted under the 1993 Consultants' Plan are nontransferable except by will or pursuant to the laws of descent and distribution, are protected against dilution and expire within three months of termination of association with the Company as a consultant, unless such termination is by reason of death.
Executive Loans
In order to enhance equity ownership by senior management, in 1989 the Company adopted a program of making loans to officers holding the position of Group Vice President and above to facilitate the exercise of stock options held by such persons. Each loan bears interest at the prime rate announced from time to time by AmSouth Bank N.A., Birmingham, Alabama and is secured by a first lien on the shares of Common Stock acquired with the proceeds of the loan. Each loan has a ten-year term, and the Company's lien on the shares of Common Stock is released as the indebtedness is repaid at the rate of one share per the weighted average option exercise price repaid. The only loan currently outstanding under such program is a loan made on May 7, 1992, to P. Daryl Brown, President -- HEALTHSOUTH Outpatient Centers, which had an original principal balance of $213,613 and of which $190,000 remained outstanding at December 31, 1994.
Retirement Investment Plan
Effective January 1, 1990, the Company adopted the HEALTHSOUTH Retirement Investment Plan (the "401(k) Plan"), a retirement plan intended to qualify under Section 401(k) of the Internal Revenue Code of 1986, as amended. The 401(k) Plan is open to all full-time and part-time employees of the Company who are over the age of 21, have one full year of service with the Company and have at least 1,000 hours of service in the year in which they enter the 401(k) Plan. Eligible employees may elect to participate in the Plan on January 1 and July 1 in each year.
Under the 401(k) Plan, participants may elect to defer up to 20% of their annual compensation (subject to nondiscrimination rules under the Internal Revenue Code). The deferred amounts may be invested among four options, at the participant's direction: a money market fund, a bond fund, a guaranteed insurance contract or an equity fund. The Company will match a minimum of 10% of the amount deferred by each participant, up to 4% of such participant's total compensation, with the matched amount also directed by the participant. See Note 12 of "Notes to Consolidated Financial Statements".
Aaron Beam, Jr., Executive Vice President and Chief Financial Officer of the Company, and Anthony J. Tanner, Executive Vice President -- Administration and Secretary of the Company, serve as Trustees of the 401(k) Plan, which is administered by the Company.
Employee Stock Benefit Plan
Effective January 1, 1991, the Company adopted the HEALTHSOUTH Rehabilitation Corporation and Subsidiaries Employee Stock Benefit Plan (the "ESOP"), a retirement plan intended to qualify under sections 401(a) and 4975(e)(7) of the Internal Revenue Code of 1986, as amended. The ESOP is open to all full-time and part-time employees of the Company who are over the age of 21, have one full year of service with the Company and have at least 1,000 hours of service in the year in which they begin participation in the ESOP on the next January 1 or July 1 after the date on which such employee satisfies the aforementioned conditions.
The ESOP was established with a $10,000,000 loan from the Company, the proceeds of which were used to purchase 413,793 shares of the Company's Common Stock. In 1992, an additional $10,000,000 loan was made to the ESOP, which was used to purchase an additional 416,666 shares of Common Stock. Under the ESOP, a Company Common Stock account (a "company stock account") is established and maintained for each eligible employee who participates in the ESOP. In each plan year, such account is credited with such employee's allocable share of the Common Stock held by the ESOP and allocated with respect to such plan year. Each employee's allocable share for any given plan year is determined according to the ratio which such employee's compensation for such plan year bears to the compensation of all eligible participating employees for the same plan year.
Under the ESOP, eligible employees who participate in the ESOP and who have attained age 55 and have completed 10 years of participation in the ESOP may elect to diversify the assets in their company stock account by directing the plan administrator to transfer to the 401(k) Plan a portion of their company stock account to be invested, as the eligible employee directs, in one or more of the investment options available under the 401(k) Plan. See Note 12 of "Notes to Consolidated Financial Statements".
Richard M. Scrushy, Chairman of the Board, President and Chief Executive Officer of the Company, Aaron Beam, Jr., Executive Vice President and Chief Financial Officer of the Company, and Anthony J. Tanner, Executive Vice President -- Administration and Secretary of the Company, serve as Trustees of the ESOP, which is administered by the Company.
Stock Purchase Plan
In order to further encourage employees to obtain equity ownership in the Company, the Company's Board of Directors adopted an Employee Stock Purchase Plan (the "Stock Purchase Plan") effective January 1, 1994. Under the Stock Purchase Plan, participating employees may contribute $10 to $200 per pay period toward the purchase of the Company's Common Stock in open-market transactions. The Stock Purchase Plan is open to regular full-time or part-time employees who have been employed for six months and are at least 21 years old. After six months of participation in the Stock Purchase Plan, the Company will provide a 10% matching contribution to be applied to purchases under the Stock Purchase Plan. The Company also pays all fees and brokerage commissions associated with the purchase of the stock. The Stock Purchase Plan is administered by a broker-dealer firm not affiliated with the Company.
Board Compensation
Directors who are not also employed by the Company are paid Directors' fees of $10,000 per annum, plus $3,000 for each meeting of the Board of Directors and $1,000 for each Committee meeting attended. In addition, Directors are reimbursed for all out-of-pocket expenses incurred in connection with their duties as Directors. The Directors of the Company, including Mr. Scrushy, have been granted non-qualified stock options to purchase shares of the Company's Common Stock. See this Item, "Executive Compensation Stock Option Plans" above.
Chief Executive Officer Employment Agreement
The Company is a party to an Employment Agreement with Richard M. Scrushy, pursuant to which Mr. Scrushy is employed as Chairman of the Board, President and Chief Executive Officer of the Company for a five-year term which ends December 31, 1999. Such term is automatically extended for an additional year on December 31 of each year. In addition, the Company has agreed to use its best efforts to cause Mr. Scrushy to be elected as a Director of the Company during the term of the Agreement. Under the Agreement, Mr. Scrushy received a base salary of $900,000, including incentive compensation of up to $400,000, in 1994 and is to receive the same base salary in 1995 and each year thereafter, with incentive compensation of up to $900,000, subject to annual review by the Board of Directors, and is entitled to participate in any bonus plan approved by the Board of Directors for the Company's management. The incentive compensation is earned at $75,000 per month in 1995, contingent upon the Company's success in meeting certain monthly budgeted earnings per share targets. Mr. Scrushy earned the entire $400,000 incentive component of his corporation in 1994, as all such targets were met. In addition, Mr. Scrushy was awarded $2,000,000 under the management bonus plan. Such additional bonus was based on the Audit and Compensation Committee's assessment of Mr. Scrushy's contribution to the establishment of the Company as the industry leader in rehabilitative healthcare services, including his role in the integration of the NME Selected Hospitals and his role in the negotiation and consummation of the ReLife acquisition. Mr. Scrushy is also provided with a car allowance in the amount of $500 per month and disability insurance through a Company-wide plan or otherwise. Under the Agreement, Mr. Scrushy may be terminated for cause or if he should become disabled. Termination of Mr. Scrushy's employment under the Agreement will result in certain severance pay arrangements. In the event that the Company shall be acquired, merged or reorganized in such a manner as to result in a change of control of the Company, Mr. Scrushy has the right to terminate his employment under the Agreement, in which case he will receive a lump sum payment equal to three years' annual base salary (including the gross incentive portion
thereof) under the Agreement. Mr. Scrushy has agreed not to compete with the Company during any period to which any such severance pay relates. Mr. Scrushy may terminate the Agreement at any time upon 180 days' notice, in which case he will receive one year's base salary as severance pay.
Item 12.


Item 12. Security Ownership of Certain Beneficial Owners and Management.
The following table sets forth certain information regarding beneficial ownership of the Company's Common Stock as of March 3, 1995, (a) by each person who is known by the Company to own beneficially more than 5% of the Company's Common Stock, (b) by each of the Company's Directors and (c) by the Company's five most highly compensated executive officers and all executive officers and Directors as a group.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
HEALTHSOUTH Corporation
By RICHARD M. SCRUSHY --------------------------- Richard M. Scrushy, Chairman of the Board, President and Chief Executive Officer
Date: March 7, 1995
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.