ITEM 1. BUSINESS
Unless the context otherwise requires, when used herein the term "Company" refers to Horizon Health Corporation and its subsidiaries.
GENERAL
The Company is a leading contract manager of psychiatric and physical rehabilitation clinical programs offered by general acute care hospitals in the United States, and a provider of employee assistance plans ("EAP") and behavioral health services to business and managed care organizations. The Company has grown both internally and through acquisitions, increasing both the variety of its treatment programs and services, and the number of its contracts. As of August 31, 2000, the Company had 254 contracts to provide EAP and managed mental health services covering nearly 1.8 million lives. Over the last eight years, the Company has increased its management contracts from 43 to a total of 138 as of August 31, 2000 and currently has contract locations in 34 states and the District of Columbia. Of its management contracts, 114 relate to mental health treatment programs and 24 relate to physical rehabilitation programs. The Company has also developed a proprietary mental health outcomes measurement system known as CQI+. At August 31, 2000 the Company provided outcome measurement services at 107 contract locations as well as 8 database project contracts under various arrangements. The Company was incorporated in 1989 and is the successor to Horizon Health Management Company, which began the development and management of mental health treatment programs for general acute care hospitals in 1981.
The Company's strategy is to enhance its position as the leader in the contract management of mental health treatment programs and to further expand the range of services which it offers to its client hospitals to include other clinical and related services and programs. A significant challenge in obtaining clinical management contracts is overcoming the initial reservations that many hospital administrators have with outsourcing key clinical services. The Company believes its expertise in working with hospital administrators, its reputation in the industry and its existing hospital contractual relationships provide it with a significant advantage in marketing new contracts. The Company also believes it has opportunities to cross-sell management services of mental health and physical rehabilitation programs to client hospitals by marketing its mental health services to client hospitals for which the Company currently manages only physical rehabilitation programs, and by marketing its physical rehabilitation services to client hospitals for which the Company currently manages only mental health programs. The Company is pursuing the development of such opportunities as a primary part of its business strategy. The Company has successfully expanded the breadth of services it offers to include the full continuum of mental health services, including outcome measurement services, and physical rehabilitation services. Its management contracts increasingly cover multiple services. In addition, the Company capitalizes on its expertise in managing the delivery of mental health services by directly offering managed behavioral health care services and employee assistance programs to businesses and managed care organizations. The Company believes it is strategically-sized to deliver national programs, while providing local, individualized service to both employers and health plans and to their respective employees or members.
General acute care hospitals are increasingly outsourcing key clinical departments to independent contract management companies for several reasons, including: (i) the expertise necessary for the development, management and operation of specialized clinical programs differs from that for traditional medical/surgical services, (ii) hospitals often lack access to skilled professionals and the support staff needed to operate specialized clinical programs, (iii) hospitals often lack expertise in the marketing and development activities required to support specialized clinical programs, and (iv) hospitals often lack expertise necessary to design and operate specialized clinical programs that satisfy regulatory, licensing, accreditation and reimbursement requirements.
See Note 13 to the Consolidated Financial Statements of the Company included herein for certain financial information regarding industry segments of the Company.
MENTAL HEALTH SERVICES
The Company believes that there continues to be substantial opportunities to provide mental health contract management services to general acute care hospitals in the United States. A major shift in the delivery of mental health services is occurring as payors are increasingly using managed care methods to review and require pre-approval for mental health treatment and to evaluate alternatives to inpatient hospitalization in order to ensure that each patient's treatment regimen utilizes clinical resources effectively. The Company believes that general acute care hospitals need to be able to offer a broad array of mental health care services in order to develop or participate in integrated delivery systems responsive to the demands of managed care companies and other third-party payors. The Company also believes that it costs general acute care hospitals less to provide inpatient and partial hospitalization mental health services than it costs freestanding psychiatric hospitals in part due to the ability of acute care hospitals to utilize excess capacity. General acute care hospitals are also able to provide their mental health patients with needed medical care on-site and in a more cost effective manner than freestanding psychiatric hospitals. Furthermore, general acute care hospitals are eligible to receive reimbursement under the Medicaid program for mental health care provided to Medicaid-eligible adults, unlike freestanding psychiatric hospitals, which are not presently eligible.
The Company believes that, due to the increasing emphasis on cost-effective treatment, significant demand exists for a complete continuum of mental health services. In response to this demand, it has expanded the mental health programs it manages to include partial hospitalization (or day treatment), outpatient treatment, short-term crisis intervention and residential treatment as alternatives and complements to inpatient care. The Company believes it is uniquely positioned to capitalize on the increased demand for mental health contract management services as a result of its ability to provide a full continuum of mental health services, its proprietary quality and outcomes measurement system and its demonstrated industry expertise. In addition, the Company believes its position as the leading contract manager of mental health programs provides the Company with a significant advantage in attracting and retaining employees and yields several economies of scale such as the ability to consolidate accounting and administrative functions.
The Company intends to continue to emphasize the area of mental health programs for the elderly ("geropsychiatric programs"). At August 31, 2000, 72.1% of the mental health treatment programs managed by the Company were geropsychiatric programs. Many elderly patients with short-term mental illness also have physical problems that make the general acute care hospital environment the most appropriate site for their care. Subject to certain recently enacted caps on reimbursement amounts, the Medicare program reimburses general acute care hospitals for their cost of providing these services, which includes the Company's management fee as well as allocated overhead costs to the facility, and allows reimbursement for partial hospitalization and home health services that permit the patient to be treated in the most cost-effective environment. The Company has developed particular expertise in developing specialized psychiatric programs for the elderly, in operating such programs, and in assisting hospitals to receive approval for inpatient programs as distinct part units ("DPUs") under Medicare. Approval of an inpatient program as a DPU is significant to client hospitals because services provided in DPUs are exempt from predetermined reimbursement rates and are reimbursed by Medicare on an actual cost basis, subject to certain significant limitations described below.
The fees received by the Company for its services under management contracts are paid directly by its client hospitals. The client hospitals receive reimbursement under either the Medicare or Medicaid programs or payments from insurers, self-funded benefit plans or other third-party payors for the mental health and physical rehabilitation services provided to patients of the programs managed by the Company. As a result, the availability and amount of such reimbursement impacts the decisions of general acute care hospitals regarding whether to offer mental health and physical rehabilitation services pursuant to management contracts with the Company.
Amendments to the Medicare regulations in 1997 as part of the Balanced Budget Act, established maximum reimbursement amounts on a per case basis for both inpatient mental health and physical rehabilitation services. In some cases, the reimbursement limitations have resulted in decreased amounts reimbursed to the Company's client hospitals and have led to the renegotiation of a lower contract management fee structure for the Company. In other cases the reimbursement limitations have resulted in the termination or non-renewal of the management contract.
Amendments to the Medicare statutes provided for the elimination of cost based reimbursement of partial hospitalization services and implementation of the outpatient prospective payment system (PPS) effective August 1, 2000. Reimbursement for partial hospitalization now utilizes a fixed reimbursement amount per patient day. The reimbursement rate per patient day is a wage-adjusted rate from a base of $202.19, which has lowered Medicare reimbursement levels to many hospitals for partial hospitalization services. In an effort to lessen the potentially significant decrease in reimbursement, legislation was enacted to allow some hospitals to receive transitional relief effective August 1, 2000, which will be phased out over three years. However, the general decrease in reimbursement has, in some cases, led to the renegotiation of a lower contract management fee structure for the Company and in other cases has resulted in the termination or non-renewal of the management contract.
Revenues from partial hospitalization services were $15.2 million or 16.2% of total contract management revenues for the year ended August 31, 2000. Of the Company's 138 management contracts at August 31, 2000, 78 or 56.5% of the contracts include partial hospitalization services. Of the 78 contracts including partial hospitalization services, 61 program locations had partial hospitalization services in operation, 12 program locations were in operation but the partial hospitalization services were not in operation, and five program locations were not yet in operation for any services. The termination of all partial hospitalization contracts, while unlikely and not expected, could reduce operating income by $5 million or more annually.
CQI+ OUTCOMES MEASUREMENT SYSTEM
The Company has developed and markets a proprietary mental health outcome measurement system. The CQI+ Outcomes Measurement System, (the "CQI+ System") provides outcome information regarding the effectiveness of a hospital's mental health programs. The availability of such information enables a hospital to demonstrate to third-party payors whether patients are improving as a result of the treatment provided, to refine its clinical treatment programs to improve the care provided, and to market such programs to patients and providers. When included with contract management services, it provides the Company with a valuable tool in demonstrating clinical results of the mental health programs managed by the Company and in marketing such management services to other hospitals. In addition, the Company provides outcome measurement services to acute care hospital based programs, free-standing psychiatric hospitals, community mental health centers, residential treatment centers and outpatient clinics. The Joint Commission on Accreditation of Healthcare Organizations ("JCAHO"), as part of its Oryx Initiative, requires each hospital to select at least one acceptable measurement system and multiple clinical performance (outcome) measures. Each year, the requirements for the number of measures will increase. The Company's CQI+ System has met the criteria for inclusion in the Oryx Initiative and is included on JCAHO's list of acceptable systems. The Company is committed to meeting the requirements as established by JCAHO. Since developing the CQI+ System over six years ago, the Company has compiled a database containing outcome measurement data on approximately 60,000 patients. With the growth of managed care and the JCAHO accreditation requirement, the Company believes that its CQI+ System will become an important component of the mental health services it provides.
PSYCHSCOPE OUTCOMES DATABASE SERVICES
The Company developed and began to market in fiscal 1999 PsychScope Outcomes Database Services, which are based on outcomes measurement data collected from approximately 60,000 patients that have participated in the CQI+ Outcomes Measurement System since 1994. The PsychScope Services allow pharmaceutical product marketers and researchers, contract research organizations, and research based teaching universities to access information on the clinical treatment of patients in hospital based behavioral health programs across the U.S. PsychScope Services can be accessed by customers as either standard quarterly reports which track and trend key drug usage variables and associated patient health status, severity of illness, patient functioning, and symptoms, or as custom research studies which are completely customer specified. PsychScope Services support pharmaceutical company drug marketing strategies, the creation of diagnosis based patient and treatment profiles, the development of drug research protocols, and assessment of competitive drug positioning and usage. The healthcare market for database services is an established and growing market that is fueled by the highly competitive and rapidly growing pharmaceutical market.
PHYSICAL REHABILITATION SERVICES
The Company has successfully expanded the types of programs that it manages for its client hospitals to include other related clinical services. The Company's acquisition of Specialty Healthcare Management, Inc. ("Specialty"), in August 1997, expanded the Company's operations to include the contract management of physical rehabilitation programs. The Company believes that many of the same factors driving demand in mental health programs are also driving significant demand for physical rehabilitation programs. The Company provides contract management for a full range of physical rehabilitation services. In addition to acute and sub-acute physical therapy and rehabilitation services, the Company also provides contract management for comprehensive outpatient rehabilitation facility programs. Outpatient rehabilitation services are dominated by the treatment of sports and work related injuries, but also provide the continuum of rehabilitative care necessary to meet the medical needs of a post-acute care patient following a disabling illness or traumatic injury. Pressure from payors to move inpatients to the lowest-cost appropriate treatment setting has helped fuel growth in these outpatient services.
Recent amendments to the Medicare statutes provide for a phase-out of cost-based reimbursement of physical rehabilitation services over a three-year period currently scheduled to begin April 1, 2001. The resulting phase-in of reimbursement for physical rehabilitation services based on the Medicare prospective payment system utilizing a fixed reimbursement amount for specified diagnoses could lower Medicare reimbursement levels to hospitals for physical rehabilitation services. This could adversely affect the ability of the Company to obtain management contracts for physical rehabilitation services and the amount of fees paid to the Company under such contracts.
MANAGED BEHAVIORAL HEALTH CARE SERVICES AND EMPLOYEE ASSISTANCE PROGRAMS
The Company is a provider of managed behavioral health care, utilization management and employee assistance programs (EAP). The Company provides its clients with quality, cost-effective programs for administration and management of behavioral health, substance abuse and psychiatric disability management services. The Company also maintains extensive involvement on a national level in the at-risk management of mental health services under employer plans and commercial programs. Beginning with the acquisition of Florida Professional Psychological Services, Inc. ("Florida PPS"), in August 1996, and continuing with the acquisitions of Acorn Behavioral Health Care Management Corporation ("Acorn"), Inc. in October 1997, and FPM Behavioral Health, Inc. ("FPM") in June 1998, the Company expanded its services to include the provision of full risk, capitated managed behavioral health care services for health maintenance organizations ("HMOs") and self-insured employers, as well as the operation of employee assistance programs for employers. The Company further expanded its services in this area with the acquisitions of ChoiceHealth, Inc. and Resources in Employee Assistance and Corporate Health, Inc., effective October 5, 1998 and April 1, 1999, respectively.
The behavioral health care services are provided by mental health care professionals that are employed by the Company or are under contract with the Company as independent providers. The clinical staff represents a broad range of treatment and case management specialties and is qualified to respond to the complete continuum of behavioral health concerns, pediatric to geriatric. The staff includes psychiatrists, nurses, psychologists, social workers, and other related mental health personnel. The Company believes that its existing relationships with health care providers and its expertise in the provision of mental health care services provide it with the capability to establish, operate and manage the network of health care professionals necessary to economically furnish such services.
In October 2000, Horizon Behavioral Services, Inc. was awarded a three year, Full Accreditation from the National Committee for Quality Assurance (NCQA) under its 2000 standards for managed behavioral health care organizations (MBHOs). NCQA is an independent, not-for-profit organization dedicated to assessing and reporting on the quality of managed behavioral health care organizations, physician organizations, managed care organizations and credentials verification organizations. The NCQA accreditation process is a voluntary review that evaluates how well a managed behavioral health care organization manages all parts of its delivery system in order to continuously improve health care for its members. The NCQA standards for the accreditation of a MBHOs are intended to help organizations achieve the highest level of performance possible, reduce patient risk for untoward outcomes, and
create an environment of continuous improvement. Accreditation decisions include Full Accreditation (the highest level), One-year Accreditation, Provisional Accreditation and Denial.
Employee assistance programs, which are usually provided by employers as a benefit at no cost to employees, give employees the opportunity to have consultations with a health care provider to identify and discuss problems that may be affecting the work performance of the employee and a course of action or treatment to address such problems. The Company also offers a comprehensive array of work life information and referral sources as well HorizOnline, an internet based EAP program, which is available exclusively to its clients. As with its other products, the Company intends to market such programs as an additional service it can offer new and existing client hospitals. In March 2000, the Company's EAP/Employer division received its third successive full, two-year accreditation for utilization management from the American Accreditation HealthCare/Commission (URAC), a non-profit charitable organization founded in 1990 to establish standards for the health care industry.
SERVICES
MENTAL HEALTH SERVICES
The Company has the expertise to manage a broad range of clinical mental health programs, including geropsychiatric, general adult, substance abuse and adolescent programs. The programs use a treatment team concept, with the admitting physician, team psychologist, social workers, nurses, therapists and counselors coordinating each phase of therapy. The programs include crisis intervention, individual therapy, group and family therapy, recreational therapy, occupational therapy, lifestyle education, social services and substance abuse counseling. Family involvement is encouraged. Each treatment program is individually tailored as much as practicable to meet the needs of the patients, the client hospital, physicians and payor groups. Mental health services represented 114 of the Company's 138 management contracts at August 31, 2000.
Elements of the Continuum of Care
The mental health treatment programs managed by the Company are designed to provide a continuum of mental health services, consisting of inpatient, partial hospitalization (or day treatment), outpatient and home health services.
Inpatient Services. Inpatient services are generally provided to patients needing the most intensive mental health treatment and who frequently have accompanying medical care needs. The patient is admitted to the client hospital and remains there on a 24-hour per day basis throughout the course of the inpatient treatment, which is continued until the patient can be stabilized and moved to another level in the continuum of mental health services. Please refer to the Medicare and Medicaid; Reimbursement for Services section below for a discussion of new HCFA rules requiring a HCFA determination that a facility has provider-based status.
Partial Hospitalization. Partial hospitalization services are provided for limited periods per day at established intervals with the patient returning home at the conclusion of each day's treatment. Partial hospitalization services are designed to be both an alternative to inpatient hospitalization services and a key component of care following inpatient hospitalization.
Outpatient Services. Outpatient services consist generally of consultative sessions which can be rendered in a variety of individual or group settings at various locations, including hospitals, clinics or the offices of the service provider. Outpatient service providers can also serve as gatekeepers for persons being evaluated for treatment. Once an individual is assessed for treatment in an outpatient environment, the individual is provided the appropriate level of service in relation to the diagnosis.
Home Health Services. Home health services are provided in the patient's home. Typically, these services are provided on a periodic basis by an experienced psychiatric nurse working under the direct supervision of a psychiatrist. The nurse may provide medication management, vital sign monitoring, individual and family therapy, and other related clinical services. Patients utilizing home health services include individuals whose clinical conditions make it difficult or impossible to leave their homes due to psychiatric illness or a combination of
psychiatric and medical illness. Home health service patients also include patients without access to transportation. Patients over the age of 65 often use psychiatric home health services.
Consulting Services
In late 1999 the Company made a commitment to expand its management contracting capabilities by offering its considerable expertise in the mental health industry to its clients on a consulting basis. Over the past nineteen years, the Company has been involved in the management of every facet of the mental health delivery system: inpatient, partial hospitalization, outpatient, home health and practice management. The Company's consulting services will allow its clients to take advantage of the Company's considerable expertise without a contract management relationship. The Company has also developed three standard consulting modules that it refers to as its Avenues(TM) service modules. The Company's Avenues(TM) service modules provide assessment and ongoing support in key areas from clinical policies and procedures development, to Medicare billing and coding assistance, to comprehensive clinical audits, to outcomes measurement and reporting, to professional marketing and community relations.
CQI+ OUTCOMES MEASUREMENT SYSTEM
The Company began offering its CQI+ Outcomes Measurement System in 1994. The CQI+ System provides a qualitative and quantitative tool for mental health programs to evaluate the clinical effectiveness of treatment and to make adjustments in the programs in order to improve quality and appropriateness of care. In addition, the CQI+ System enables client hospitals to demonstrate to third-party payors the effectiveness of the treatment programs and provides a valuable tool to the hospital in marketing to patients and providers. The CQI+ System also assists the hospitals in complying with the increasing demands of regulatory and accrediting bodies for quality assessment of their mental health programs. JCAHO, as part of its accreditation process, requires each hospital to select at least one acceptable measurement system and multiple clinical performance (outcome) measures under the Oryx Initiative. Each year, the requirements for the number of measures will increase. The Company's CQI+ System has met the criteria for inclusion in the Oryx Initiative and is included on JCAHO's list of acceptable systems. The Company is committed to meeting future requirements as established by JCAHO. At August 31, 2000, 49 of the Company's management contracts included the CQI+ System and there were 58 stand-alone CQI+ contracts. The CQI+ System provides the Company with a valuable tool in demonstrating clinical results of the mental health programs managed by the Company and in marketing such management services to other hospitals.
Since offering CQI+ System, the Company has compiled a database containing outcome measurement data on approximately 60,000 patients. Sample data is collected from randomly selected patients at admission, discharge and 90 to 180 days after discharge. Quarterly outcome reports include a summary of patient characteristics and outcome measures. The Company trains and supervises on-site personnel to ensure the collection of accurate outcome measurement data.
PSYCHSCOPE OUTCOMES DATABASE SERVICES
The Company developed and began to market in fiscal 1999 PsychScope Outcomes Database Services, which are based on outcomes measurement data collected from approximately 60,000 patients that have participated in the CQI+ Outcomes Measurement System since 1994. The PsychScope Services allow pharmaceutical product marketers and researchers, contract research organizations, and research based teaching universities to access information on the clinical treatment of patients in hospital based behavioral health programs across the U.S. PsychScope services are sold to customers in two different service package offerings. The first offering allows customers to purchase standard quarterly reports which report key variables for drug usage by diagnosis as well as patient health status, severity of illness, patient functioning, and symptoms. This service allows customers the opportunity to track and trend the data over time for use in marketing projects and clinical research. The second PsychScope offering allows customers to design customized retrospective and prospective research studies using the PsychScope database. This offering is used to support pharmaceutical company drug marketing strategies, the creation of diagnosis based patient and treatment profiles, the development of drug research protocols, and assessment of competitive drug positioning and usage. The healthcare market for database services is an established and growing market that is fueled by the highly competitive and rapidly growing pharmaceutical market. Due to the
U.S. launches of several new psychiatric drugs, the psychiatric database services market is expected to grow significantly. As of August 31, 2000 the Company had eight contracts to provide outcomes database services.
PHYSICAL REHABILITATION SERVICES
The Company provides contract management for a broad range of physical rehabilitation programs including (i) acute physical medicine and rehabilitation, (ii) subacute physical therapy and rehabilitation, and (iii) outpatient rehabilitation. Physical rehabilitation services represented 24 of the Company's 138 management contracts at August 31, 2000.
Acute Physical Therapy and Rehabilitation. The physical therapy and rehabilitation program incorporates a variety of treatments and services aimed at maximizing an individual's capabilities following a disabling illness or traumatic injury. The treatment program is provided by an interdisciplinary team of health care professionals including physicians, physical, recreational, occupational and speech therapists, rehabilitation nurses, social workers and psychologists. The Company attempts to tailor an acute physical therapy and rehabilitation program for a health care facility to satisfy unmet community and medical staff needs, while maximizing utilization of the facility.
Sub-acute Physical Therapy and Rehabilitation. Rapidly changing reimbursement issues have challenged health care providers to seek alternative services to meet the needs of their patient population requiring lower cost and intensity physical medicine and rehabilitation services. Comprehensive physical medicine and rehabilitation services at the subacute level offer an attractive alternative for acute care hospitals and skilled nursing facilities to meet these needs. The Company evaluates the feasibility of a health care facility providing rehabilitation services at the sub-acute level by analyzing a facility's discharge data, conducting a market analysis of services offered in a facility's community, assessing medical staff needs and evaluating financial viability.
Outpatient Rehabilitation. Outpatient rehabilitation serves as an adjunct to inpatient physical therapy and rehabilitation programs at the acute and/or sub-acute levels. The program provides the continuum of rehabilitative care necessary to meet the medical needs of a post-acute care patient following a disabling illness or traumatic injury.
Please refer to the Medicare and Medicaid; Reimbursement for Services section below for a discussion of new HCFA rules requiring a HCFA determination that a facility has provider-based status.
MANAGED BEHAVIORAL HEALTH CARE SERVICES AND EMPLOYEE ASSISTANCE PROGRAMS
The Company began offering behavioral health care services to HMOs and self-insured employers, and employee assistance programs to employers, with the acquisition of Florida PPS in 1996, and continuing with the acquisitions of Acorn in October 1997, FPM in June 1998, ChoiceHealth in October 1998, and REACH in April 1999. As of August 31, 2000, the Company provided EAP and managed behavioral health care services for nearly 1.8 million lives covered by various health plans and companies with which it had contracted. The Company contracts with HMOs to provide the mental health care component of the general health plans offered by such entities. The contracts are primarily on a full risk, capitated basis under which the Company is paid a set fee per month for each member of the respective health plan. The behavioral health care services are provided by mental health care professionals that are employed by the Company or are under contract with the Company as independent providers. In addition, the Company operates four clinics within the state of Florida, which perform related services. The Company reimburses the independent professionals and institutions on a discounted fee-for-service basis.
The Company utilizes a specialized network of contract providers to operate employee assistance programs for employers. Many of the providers in the managed care network also participate in the EAP network. Employee assistance programs, which are usually provided by employers as a benefit at no cost to employees, generally give employees and their dependents the opportunity to have three to six consultations annually with a health care provider to discuss problems that may be affecting their ability to work. Such problems frequently relate to matters unrelated to mental health care. The purpose of the consultation is to help the employee identify the problem and to recommend a course of action or treatment to address the problem. The Company frequently provides training to employer personnel for identifying troubled employees. Often an employer will refer an employee for consultation after observing a change in work performance. The Company believes that such early identification, consultation
and treatment can frequently minimize the likelihood that the problem will develop into a serious debilitating event requiring extensive treatment. The Company also offers a comprehensive array of work life information and referral sources as well HorizOnline, an internet based EAP program, which is available exclusively to its clients. The Company is paid a set fee per month per employee for its services.
OPERATIONS
GENERAL
The Company operates its mental health management contract business through a regional structure with offices in the Chicago, Dallas and Tampa metropolitan areas and a national support center ("NSC") in Lewisville (Dallas), Texas. The structure is designed to keep key operating employees of the Company in direct contact with clients. Each of the three regional offices is staffed to have the capacity to supervise up to 40 mental health management contract locations. Each regional office is under the supervision of a vice president who in turn supervises regional directors, each of whom has direct responsibility over eight to ten mental health management contract locations. Other regional office personnel include clinical and other specialists, who are available to provide assistance to the local programs and client hospital personnel. Presently, the Company's physical rehabilitation management contracts are operated in the same manner out of its NSC with plans to develop a comparable regional structure as it expands that area of its operations.
At August 31, 2000, the Company had 939 program employees at its contract locations and 146 employees at its regional and NSC offices.
The Company develops and operates its outcomes measurement system primarily out of its NSC. Program personnel are responsible for the completion of the data input forms concerning the various treatment programs. The data is input into the national database using automated technologies from which reports are developed, reviewed and analyzed by the CQI+ System staff of 23 employees, which are also located at the NSC.
During fiscal year 1998, the Company combined its three managed care subsidiaries (Florida PPS, Acorn, and FPM Behavioral Health) into Horizon Behavioral Services to promote a national integrated organization, a stronger market identification and achieve operating efficiencies. Under the new operating structure, the Company's managed care business is located in suburban Orlando, Florida, and its EAP/Employer business is located in suburban Philadelphia, PA.
The Company's managed care operations have 28 licensed clinicians providing services in the four clinic locations in Florida, an additional 147 employees working in clinical management and administrative positions, and has provider network contracts with approximately 5,000 providers and facilities.
The Company's EAP/Employer operation has 57 employees and has contracts with approximately 14,700 individual providers located in all 50 states.
MANAGEMENT CONTRACTS
The Company provides its management services under contracts with its client hospitals. Each contract is tailored to address the differing needs of the client hospital and its community. The Company and the client hospital determine the programs and services to be offered by the hospital and managed by the Company, which may consist of one or more treatment programs offering inpatient, partial hospitalization, outpatient or home health services. Under the contracts, the hospital is the actual provider of the mental health or physical rehabilitation services and utilizes its own facilities (including beds for inpatient programs), nursing staff and support services (such as billing, dietary and housekeeping) in connection with the operation of its programs.
While each of the Company's management contracts is tailored to the specific needs of the client hospital, substantially all of the Company's contracts contain non-compete and confidentiality provisions. In addition, the Company's management contracts typically prohibit the client hospital from soliciting the employment of the Company employees during the contract term and for a specified period thereafter.
Contracts are frequently renewed or amended prior to or at their stated expiration dates. Some contracts are terminated prior to their stated expiration dates pursuant to agreement of the parties or early termination provisions included in the contracts. As of August 31, 2000, 1999 and 1998, the Company had successfully retained 79%, 78%, and 73%, respectively, of the management contracts in existence at the beginning of such fiscal years. The Company believes that among the most frequent reasons why the client hospitals do not renew a contract is that they desire to manage such programs themselves, the economic viability of the programs have changed resulting in their closing the programs, or a change in hospital administration results in a change in philosophy regarding the use of contract managers.
Under each contract, the Company receives a fee for its management services from the client hospital. Management fees may be either a variable fee related in part to patient census at the program or a fixed fee with reimbursement for direct program costs. The management fee is frequently subject to periodic adjustments as a result of changes in the consumer price index or other economic factors. A significant number of the Company's management contracts require the Company to refund some or all of its fee if either Medicare reimbursement for services provided to patients of the programs is denied or the fee paid to the Company is denied as a reimbursable cost. During the fiscal year ended August 31, 2000, the Company refunded $64,260 of its fees in relation to these denials.
Program Development
The Company assists in the development of each clinical program as requested by the client hospital, including such matters as licensing, accreditation, certificate of need approvals and Medicare certification. The Company also develops and implements a marketing plan for the clinical programs to be offered by the hospital. Each program is marketed locally with an emphasis on the hospital addressing the needs of the local community. The Company markets the clinical programs in the community in the name of the client hospital. The Company's name is not used and its role is not publicly emphasized in the operation of the clinical programs offered by its client hospitals. Each patient is admitted by the medical staff of the client hospital, and all charges for clinical services provided to the patient accrue directly to the client hospital or treating physician.
The Company also develops and maintains standardized policy and procedure manuals, initial and ongoing staff training and education, and comprehensive quality assurance procedures. Each local program director receives ongoing support from the Company's National Support Center and regional support staff in all areas including recruiting, finance, reimbursement, development, marketing and quality assurance.
Each operating region is responsible for training new employees, including formalized instruction and on-the-job training. Continuing education programs are also provided to employees. In addition, the Company has a centralized orientation program for new program directors and an annual conference for all program directors.
Program Staffing
Mental health programs typically have an independent psychiatric medical director, a program director who is usually a psychologist or a social worker, a clinical assessment coordinator and additional social workers or therapists as needed. Some programs also include a nurse manager or a community education coordinator. Physical rehabilitation programs generally have an independent medical director, a program director, and additional clinical staff tailored to meet the needs of the program and the client hospital, which may include physical and occupational therapists, a speech pathologist, a social worker and other appropriate supporting personnel. Medical directors generally have a contract with the Company under which on-site administrative services needed to administer the program are provided. These contracts generally include nondisclosure, nonsolicitation and noncompetition covenants pursuant to which the medical director agrees not to solicit the Company employees for specified periods, disclose confidential information of the Company or render certain administrative or management services within specified time periods and geographic areas to any enterprise in competition with the Company or the programs it manages. Except for the nursing staff, which is typically provided by the hospital, the other program personnel are usually employees of the Company. At August 31, 2000, the Company had an average of seven employees per contract location.
Program Education
Because the treatment programs managed by the Company are offered by general acute care hospitals, most patients are referred by the client hospital's medical staff or result from relationships that the client hospital has in the community. Many contract locations have a community education coordinator (CEC) who works with a development committee consisting of Company and hospital personnel to educate physicians, other health professionals and nursing homes in the community of the treatment programs that are available at the client hospital. The CEC also designs and offers community educational programs regarding various health issues.
Internal Clinical Audits
The Company has established a comprehensive internal clinical audit process for its mental health programs. The Company's regional mental health clinical specialists review the services and clinical documentation of the treatment programs to ensure compliance with client hospital, federal and state standards. The Company also has an internal clinical auditor who makes unannounced visits to contract locations on a periodic basis. The auditor reviews medical records and marketing programs, and conducts interviews with physicians, referral sources and client hospital staff members. Results of the audits are independently reported directly to the senior management of the Company, rather than through the operating organization.
Contract Locations
At August 31, 2000, the Company had a total of 138 management contracts with general acute care hospitals located in 34 states and the District of Columbia, as shown below:
Client Hospitals
The Company's clients are primarily small to medium sized hospitals, but do include some large tertiary care hospitals. At August 31, 2000, 23.9% of the Company's management contracts were with proprietary hospitals. The remaining contracts are primarily with community not-for-profit hospitals.
MANAGED CARE AND EMPLOYEE ASSISTANCE CONTRACTS
The Company delivers its EAP and managed care services through provider networks as well as through employees in the Philadelphia and Orlando metropolitan areas. Additionally, the Company operates four clinics in the Orlando area. During the fiscal year ended August 31, 2000, the company closed five clinic locations in the Tampa and Jacksonville, Florida areas. These closures were due to declining membership in these areas. Claims processing is currently done at the Philadelphia and Orlando locations. The Company intends to consolidate all claims processing to the Orlando location during fiscal year 2001.
SALES AND MARKETING
At August 31, 2000, the Company employed seven full-time Vice Presidents of Development and two Senior Vice Presidents of Development for mental health and physical rehabilitation management contracts. In addition, the company has one Vice President of Development for consulting services. As of June 16, 2000 a Senior Vice President of Business and Contract Development was appointed to manage and direct the Company's overall development effort. The Company compiles information from numerous databases, as well as other sources and referrals, to identify prospective clients. The Company has developed profiles of over 6,500 hospitals in the United States, with numerous financial and operating characteristics for each hospital. Potential clients include hospitals without existing mental health, physical rehabilitation, employee assistance or other programs as well as hospitals with existing programs of which the Company could assume management. A select list of candidates is systematically and regularly updated based on criteria indicating which hospitals are the most likely potential clients. A Vice President of Development, who typically acts as the point person on the sales team for such region, directly contacts the prospective clients and, where appropriate, presents a detailed proposal to key decision-makers. The proposal often contains detailed financial projections of the proposed programs. The Company works with the potential client to develop contract terms responsive to the client's specific needs. The typical sales cycle for a management contract is approximately nine months, during which time a Senior Vice President of Development will assist the Vice President of Development and, will generally become involved at the later stages of the sales process and negotiate the final terms of the management contract. The Company believes it can increase sales of rehabilitation management contracts by applying its expertise in winning mental health management contracts to the solicitation of rehabilitation management contracts. In addition, the Company believes it has substantial opportunity to cross-sell a broad range of services to client hospitals and is pursuing the development of such opportunities as a primary part of its business strategy.
The subsidiary Mental Health Outcomes ("MHO") markets the CQI+ Outcomes Measurement System to 1,700 medical/surgical hospitals with psychiatric inpatient units and 300 free-standing psychiatric hospitals nationwide and PsychScope Outcomes Database Services to pharmaceutical companies, contract research organizations, and research based teaching universities. MHO employs a full-time Manager of Market Development who markets the CQI+ System to hospitals through understanding psychiatric unit outcomes measurement needs and application of the most compatible CQI+ System module. MHO also contracts for telemarketing assistance to support initial "cold" calling to prospective customers. In addition, CQI+ is marketed as an "add-on" service to the contract managed psychiatric programs provided by Horizon Mental Health Management through efforts of the seven Vice Presidents of Development. MHO also employs a full-time Director of Market Development and a Senior Vice President who market PsychScope services by providing decision support expertise to researchers and pharmaceutical marketers.
The subsidiary Horizon Behavioral Services ("HBS") markets employee assistance programs and managed behavioral health programs to employers and HMO's nationwide. HBS employs a full-time Vice President of Sales and five Regional Vice Presidents of Sales to market its traditional EAP products, two Regional Sales Representatives to market its emerging business EAP products and a Vice President to market its managed behavioral health care services. The HBS sales staff markets the EAP to employers by assessing the individualized behavioral health benefit needs of their employees and providing the appropriate EAP model. In addition, EAP services are marketed by the Horizon Mental Health Management Vice Presidents of Development to hospitals as a benefit for their employees. The HBS sales staff markets the managed behavioral health care services to HMOs and self-insured employers who wish to outsource management of the behavioral health benefit to an experienced provider.
COMPETITION
The health care industry is highly competitive and subject to continual changes in the method in which services are provided and the types of companies providing such services. The Company competes with several national competitors and many regional and local competitors, some of which have greater resources than the Company. In addition, hospitals could elect to manage their own mental health and physical rehabilitation programs.
Competition among contract managers for hospital-based mental health and physical rehabilitation programs is generally based upon reputation for quality, price, the ability to provide financial and other benefits for the hospital, and the management expertise necessary to enable the hospital to offer mental health and physical rehabilitation programs that provide the full continuum of mental health and physical rehabilitation services in a quality and cost-effective manner. The pressure to reduce health care expenditures has emphasized the need to manage the appropriateness of mental health and physical rehabilitation services provided to patients. As a result, competitors without management experience covering the various levels of the continuum of mental health and physical rehabilitation services may not be able to compete successfully. The Company believes that its reputation and management expertise will enable it to compete successfully in this rapidly changing market.
In addition, general acute care hospitals offering mental health and physical rehabilitation programs managed by the Company compete for patients with other providers of mental health care services, including other general acute care hospitals, freestanding psychiatric hospitals, independent psychiatrists and psychologists, and with other providers of physical rehabilitation services, including other general acute care hospitals, freestanding rehabilitation facilities and outpatient facilities.
The Company also competes with hospitals, nursing homes, clinics, physicians' offices and contract therapy companies for the services of physical, occupational and speech therapists. These specialists are in limited supply and there can be no assurance that the Company will be able to attract a sufficient number of therapists for its growing needs.
The behavioral health care marketplace includes three large national providers who control over half of the market. The rest of the market is highly fragmented and consists of other organizations from medium size regional operations to very small local providers in the EAP business. The primary factor affecting competition in the EAP business is the range of services provided. In addition, quality of service and price are also of importance to EAP customers. Price is the primary factor in obtaining additional managed care customers. All companies involved in behavioral health care must plan to overcome obstacles related to increased customer and government scrutiny. Customers require sophisticated data that provides information regarding clinical outcomes, patient and provider satisfaction, and administrative performance information.
On October 20, 2000, Horizon Behavioral Services, Inc., managed care operations in Orlando, Florida received a three-year, Full Accreditation from the National Committee for Quality Assurance ("NCQA"). NCQA is an independent, not-for-profit organization dedicated to assessing and reporting on the quality of managed behavioral healthcare organizations, physician organizations, managed care organizations and credentials verification organizations. A Full Accreditation is granted for a period of three years to those plans that have excellent programs for continuous quality improvement and meet NCQA's rigorous standards.
GOVERNMENT REGULATION
The Company's business is affected by federal, state and local laws and regulations concerning, among other matters, mental health and physical rehabilitation facilities and reimbursement for mental health and physical rehabilitation services. These regulations impact the development and operation of mental health and physical rehabilitation programs managed by the Company for its client hospitals. Licensing, certification, reimbursement and other applicable government regulations vary by jurisdiction and are subject to periodic revision. The Company is not able to predict the content or impact of future changes in laws or regulations affecting the mental health or physical rehabilitation sectors.
FACILITY USE AND CERTIFICATION
Hospital facilities are subject to various federal, state and local regulations, including facilities use, licensure and inspection requirements, and licensing or certification requirements of federal, state and local health agencies. Many states also have certificate of need laws intended to avoid the proliferation of unnecessary or under-utilized health care services and facilities. The mental health and physical rehabilitation programs which the Company manages are also subject to licensure and certification requirements. The Company assists its client hospitals in obtaining required approvals for new programs. Some approval processes may lengthen the time required for programs to commence operations. In granting and renewing a facility's licenses, governmental agencies generally consider, among other factors, the physical condition of the facility, the qualifications of administrative and professional staff, the quality of professional and other services, and the continuing compliance of such facility with the laws and regulations applicable to its operations. The Company believes that the mental health and physical rehabilitation programs it manages and the facilities of the client hospitals used in the operation of such programs comply in all material respects with applicable licensing and certification requirements.
MEDICARE AND MEDICAID; REIMBURSEMENT FOR SERVICES
Most of the Company's client hospitals receive reimbursement under one or more of the Medicare or Medicaid programs for mental health and physical rehabilitation services provided in programs managed by the Company. The Company is paid directly by its client hospitals for the management services it provides. While fees paid to the Company by its client hospitals are not subject to or based upon reimbursement under the Medicare or Medicaid programs or from any other third-party payor, under many of its management contracts the Company is obligated to refund a portion of its fee if Medicare denies reimbursement for an individual patient treatment, or its fee if the fee paid to the Company is denied by Medicare as a reimbursable cost. Since a substantial portion of the patients of the programs managed by the Company are covered by Medicare, any changes which limit or reduce Medicare reimbursement levels could have a material adverse effect on the Company's client hospitals and, in turn, on the Company.
The Company is not a provider reimbursed by Medicare or Medicaid but provides contract management services to such providers. As such, the Company could be considered subject to such federal and state laws. While the Company believes that its relationships with its client hospitals, medical directors and other providers and the fee arrangements with its client hospitals are consistent with Medicare and Medicaid criteria, those criteria are often vague and subject to interpretation. The federal government has been actively investigating health care providers for potential abuses. There can be no assurance that aggressive anti-fraud enforcement actions will not adversely affect the business of the Company.
The Medicare program was enacted in 1965 to provide a nationwide, federally funded health insurance program for the elderly. The program is divided in Part A and Part B, each of which has separate rules and requirements and separate funding sources. Medicare Part A, the Hospital Insurance Program (42 U.S.C. (delta) 1395c et seq.) is financed primarily through mandatory taxes on workers' wages. Part A pays for hospital, skilled nursing, home health agency, hospice, and dialysis services determined to be medically necessary for the individual patient. Medicare Part B, the Supplementary Medical Insurance program (42 U.S.C. (delta) 1395j et seq.), is a voluntary medical benefits plan in which eligible individuals can enroll to receive benefits in addition to those available under Part A. Under Part B, each beneficiary must pay a monthly premium, meet a deductible towards the cost of covered items and services determined to be medically necessary, and generally pay 20 percent of the Medicare allowable charge as coinsurance on most covered items. Non-institutional services, including physician services, outpatient hospital services, durable medical equipment, and laboratory services, among others, are paid under Medicare Part B. In addition, the 1997 Balanced Budget Act added a new Medicare Part C, which provides Medicare beneficiaries with additional health plan choices, such as managed care plans and medical savings accounts.
The Medicare program is administered by the Health Care Financing Administration ("HCFA") of the U.S. Department of Health and Human Services ("HHS"). HCFA adopts regulations and issues interpretive memoranda and program manuals providing detailed explanation of the Medicare program. The payment operations of the Medicare program are handled by intermediaries (under Part A) and carriers (under Part B) who are insurance
companies and Blue Cross/ Blue Shield plans which contract with the Secretary of HHS (the "Secretary") to make Medicare payments to providers in a particular geographic region. Individual intermediaries and carriers issue transmittals, bulletins, notices, and general instructions to providers and suppliers in their respective areas to facilitate the administration of the Medicare program, but are required to follow the Medicare statute, HCFA regulations, HCFA transmittals, and the program manuals. Within these requirements, intermediaries and carriers are granted broad discretion to establish particular guidelines and procedures for making Medicare coverage determinations and payments, including prior approval, utilization limits, and specific documentation.
The Medicaid program is a joint federal-state cooperative arrangement established for the purpose of enabling states to furnish medical assistance on behalf of aged, blind, or disabled individuals, or members of families with dependent children, whose income and resources are insufficient to meet the costs of necessary medical services. The federal and state governments share the costs of such aid pursuant to statutory formulae. The Secretary has primary federal responsibility for administering the Medicaid program. The responsibility has been delegated to HCFA, whose Medicaid Bureau carries out this delegation. States are not required to participate in the Medicaid program. States which choose to participate, however, must administer their Medicaid programs in accordance with federal law, the implementing regulations and policies of the Secretary and their approved state plans. A state becomes eligible to receive federal funds by submitting to the Secretary a state plan for medical assistance. The federal Medicaid statute establishes minimum standards for state plans in such area as administration, eligibility, coverage of services, quality and provision of services, and payment for services. States have significant latitude, within these standards, to determine the mix of services and structure of their state Medicaid programs. The state plan must be amended by appropriate submission to the Secretary whenever necessary to reflect changes in federal statutes, regulations, policies, court decisions, or material changes in any phase of state law, policy, or operations.
In order to receive reimbursement under the Medicare or Medicaid programs, each client hospital or facility must meet applicable requirements promulgated by HHS relating to the type of facility, personnel, standards of patient care and compliance with all state and local laws, rules and regulations. The Company believes that the programs it manages comply in all material respects with applicable Medicare and Medicaid requirements.
In the mid-1980's, changes in reimbursement rates and procedures included the creation of the Prospective Payment System ("PPS") using predetermined reimbursement rates for diagnosis related groups ("DRGs"). The DRG system established fixed payment amounts per discharge for diagnoses generally provided by acute care hospitals. Mental health and physical rehabilitation services provided by acute care hospitals which qualify for an exemption are deemed to be Distinct Part Units ("DPUs") and are not included in the DRG system. Services provided by DPUs are reimbursed on an actual cost basis, subject to certain limitations. The mental health and physical rehabilitation programs managed by the Company which are eligible for reimbursement by the Medicare program currently meet the applicable requirements for designation as DPUs and are exempt from the DRG system. In the future, however, it is possible that Medicare reimbursement for mental health services, including those provided by programs managed by the Company, could be under the DRG system or otherwise altered as has recently occurred for physical rehabilitation services as discussed below. At August 31, 2000, of the 190 mental health treatment programs managed by the Company at its 138 management contract locations, 137 were geropsychiatric programs for which a substantial majority of the patients are covered by Medicare.
Amendments to the Medicare regulations established maximum reimbursement amounts on a per case basis for both inpatient mental health and physical rehabilitation services. Effective as of October 1, 1997, regulations promulgated pursuant to these amendments establish a ceiling on the rate of increase in operating costs per case for mental health and physical rehabilitation services furnished to Medicare beneficiaries. Prior to these amendments, the reimbursement amounts were tied to each hospital's mental health or physical rehabilitation unit cost during such unit's first year of operations, subject to adjustment. The regulations established a nationwide cap limiting the reimbursement target amount on a per case basis for mental health and physical rehabilitation service, for Medicare fiscal years beginning October 1, 1997, and later, to $10,534 and $19,104, respectively, subject to adjustments based on market indices and on costs for other similar units. The reimbursement amounts have been raised to a wage adjusted rate of $11,364 and $21,393, respectively for Medicare fiscal years beginning October 1, 2000, and later. The limitations have resulted, in some cases, in decreased amounts reimbursed to the Company's client hospitals. This decrease in reimbursement has, in some cases, led to the renegotiation of a lower contract management fee structure for the Company and in other cases has resulted in termination or nonrenewal of the management contract.
In addition, amendments to the Medicare statutes provided for the elimination of cost based reimbursement of partial hospitalization services and implementation of the outpatient prospective payment system (PPS) effective August 1, 2000. Reimbursement for partial hospitalization now utilizes a fixed reimbursement amount per patient day. The reimbursement rate per patient day is a wage-adjusted rate from a base of $202.19, which has lowered Medicare reimbursement levels to many hospitals for partial hospitalization services. In an effort to lessen the potentially significant decrease in reimbursement, legislation was enacted to allow some hospitals to receive transitional relief effective August 1, 2000, which will be phased out over three years. However, the general decrease in reimbursement has, in some cases, led to the renegotiation of a lower contract management fee structure for the Company and in other cases has resulted in the termination or non-renewal of the management contract.
Qualified outpatient rehabilitation services are exempt from the Prospective Payment System. Acute rehabilitation units within acute-care hospitals are eligible to obtain an exemption from the Prospective Payment System, generally after the first year of operation, upon satisfaction of specified federal criteria. Such criteria include the operation for a full 12 months under the Prospective Payment System and the completion of an initial exemption survey. The exemption survey measures compliance with certain criteria applicable to exempt units generally, including approval to participate as a Medicare provider, admission standards, record keeping, compliance with state licensure laws, segregation of beds, accounting standards and certain specific standards applicable to rehabilitation units, including staffing, medical care and patient mix. Upon successful completion of the survey, Medicare payments for rehabilitation services provided in inpatient units are made under a cost-based reimbursement system. As of August 31, 2000, 19 of the Company's 24 managed physical rehabilitation programs were exempt from the Prospective Payment System. The remaining five programs will apply for exemption as soon as they are eligible. A recently enacted amendment to the Medicare statutes provides for a gradual phase-out of cost-based reimbursement for physical rehabilitation services over a three-year period commencing on April 1, 2001. The resulting phase-in of reimbursement for physical rehabilitation services based on the Prospective Payment System could significantly lower Medicare reimbursements to hospitals and thus have a material adverse effect on the business, operations and financial results of the Company.
The Medicare and Medicaid programs are subject to statutory and regulatory changes, retroactive and prospective rate adjustments, administrative rulings and funding restrictions, any of which could have the effect of limiting or reducing reimbursement levels to general acute care hospitals for mental health and physical rehabilitation services provided by programs managed by the Company. The Company cannot predict whether any changes to such government programs will be adopted or, if adopted, the effect, if any, such changes will have on the Company. In addition, a significant number of the Company's management contracts require the Company to refund a portion of its fee if Medicare reimbursement to the client hospital is disallowed for a patient treated in a program managed by the Company or its fee if the fee paid to the Company is disallowed as a reimbursable cost. During the fiscal year ended August 31, 2000, the Company refunded $64,260 of its fees in relation to these denials. Also, Medicare retrospectively audits cost reports of client hospitals upon which Medicare reimbursement for services rendered in the programs managed by the Company is based. Accordingly, at any time, the Company could be subject to refund obligations to client hospitals for prior year cost reports that have not been audited and settled at the date hereof. Any significant decrease in Medicare reimbursement levels, the imposition of significant restrictions on participation in the Medicare program, or the disallowance by Medicare of any significant portion of the client hospital's costs, including the fee to the Company, where the Company has a reimbursement denial repayment obligation, could adversely affect the Company. In addition, there can be no assurance that hospitals which offer mental health or physical rehabilitation programs now or hereafter managed by the Company will satisfy the requirements for participation in the Medicare or Medicaid programs.
Payors, including Medicare and Medicaid, are attempting to manage costs, resulting in declining amounts paid or reimbursed to hospitals for the services provided for inpatient services. As a result, the number of patients served by general acute care hospitals on a per diem, episodic or capitated basis may increase in the future. There can be no assurance that if amounts paid or reimbursed to hospitals decline, it will not adversely affect the Company.
Medicare regulations limit reimbursement for mental health, physical rehabilitation and other health care charges paid to related parties. A party is considered "related" to a provider if it is deemed to be controlled by the provider. One test for determining control for this purpose is whether the percentage of the total revenues of the
party received from services rendered to the provider is so high that it effectively constitutes control. Although the Company believes that it does not receive sufficient revenues from any customer that would make it a related party, it is possible that such regulations could limit the number of management contracts that the Company could have with a particular client.
In April 2000, HCFA adopted new rules requiring a HCFA determination that a facility has provider-based status before a provider can bill for the services rendered at the facility. The new rules have been construed by HCFA to apply to inpatient mental health and rehabilitation units. The rules contain numerous requirements, some specifically applicable to facilities operated under management contracts, that must be satisfied in order to receive a HCFA determination of provider-based status. The rules are applicable to a provider at the beginning of its first Medicare cost reporting year that commences after January 10, 2001. The particular application of the rules to inpatient units managed by the Company is currently unclear in several respects. HCFA has indicated that it intends to issue guidelines under the new rules, which may provide clarification. At the current time, there is uncertainty with respect to both precisely how the new rules are to be applied to inpatient units managed by the Company and uncertainty as to whether the current structure of the management contracts of the Company will satisfy the requirements under the new rules. The Company is unable at this time to definitively determine the effect of the new provider-based rules on its business operations, but it is possible that the new provider-based rules could result in termination or non-renewal of management contracts if, under the new rules, it is not possible for a provider to obtain a determination of provider-based status of an inpatient unit operated under a management contract.
Federal law contains certain provisions designed to ensure that services rendered by hospitals to Medicare and Medicaid patients are medically necessary and meet professionally recognized standards. These provisions include a requirement that admissions of Medicare and Medicaid patients to hospitals must be reviewed in a timely manner to determine the medical necessity of the admissions. In addition, these provisions state that a hospital may be required by the federal government to reimburse the government for the cost of Medicare-reimbursed services that are determined by a peer review organization to have been medically unnecessary. The Company and its client hospitals have developed and implemented quality assurance programs and procedures for utilization review and retrospective patient care evaluation intended to meet these requirements.
PATIENT REFERRAL LAWS
Various state and federal laws regulate the relationships between health care providers and referral sources, including federal and state fraud and abuse laws prohibiting individuals and entities from knowingly and willfully offering, paying, soliciting or receiving remuneration in order to induce referrals for the furnishing of health care services or items. These federal laws generally apply only to referrals for items or services reimbursed under the Medicare or Medicaid programs or any state health care program. The objective of these laws is generally to ensure that the purpose of a referral is quality of care and not monetary gain by the referring party. Violations of such laws can result in felony criminal penalties, civil sanctions and exclusion from participation in the Medicare and Medicaid programs.
The Medicare and Medicaid anti-kickback statute, 42 U.S.C. (delta) 1320a-7b, prohibits the knowing and willful solicitation or receipt of any remuneration "in return for" referring an individual, or for recommending or arranging for the purchase, lease, or ordering, of any item or service for which payment may be made under Medicare or a state health care program. In addition, the statute prohibits the offer or payment of remuneration "to induce" a person to refer an individual, or to recommend or arrange for the purchase, lease, or ordering of any item or service for which payment may be made under the Medicare or state health care programs. The statute contains exceptions for certain discounts, group purchasing organizations, employment relationships, waivers of coinsurance by community health centers, health plans, and practices defined in regulatory safe harbors.
Under a significant number of its management contracts, the Company receives a variable fee related in part to average daily patient census of the mental health or physical rehabilitation program. In addition, the Company has entered into agreements with physicians to serve as medical directors at the mental health and physical rehabilitation programs and facilities managed by the Company, which generally provide for payments to such persons by the Company as compensation for their administrative services. These medical directors also generally provide professional services at such programs and facilities. In 1991, regulations were issued under federal fraud and abuse
laws creating certain "safe harbors" for relationships between health care providers and referral sources. Any relationship that satisfies the terms of the safe harbor is considered permitted. Failure to satisfy a safe harbor, however, does not mean that the relationship is prohibited. Although the contracts and relationships between the Company and its client hospitals and medical directors are not within the safe harbors, the Company believes that such contracts and relationships comply with applicable laws. There can be no assurance, however, that the Company's activities will not be challenged by regulatory authorities.
The Omnibus Budget Reconciliation Act of 1993 contains provisions ("Stark II") prohibiting physicians from referring Medicare and Medicaid patients to an entity with which the physician has a "financial relationship" for the furnishing of a list of "designated health services" including physical therapy, occupational therapy, home health services, and others. If a financial relationship exists, the entity is generally prohibited from claiming payment for such services under the Medicare or Medicaid programs. Compensation arrangements are generally exempted from the Stark provisions if, among other things, the compensation to be paid is set in advance, does not exceed fair market value and is not determined in a manner that takes into account the volume or value of any referrals or other business generated between the parties.
Other provisions in the Social Security Act authorize other penalties, including exclusion from participation in Medicare and Medicaid, for various billing-related offenses. HHS can also initiate permissive exclusion actions for such improper billing practices as submitting claims "substantially in excess" of the provider's usual costs or charges, failure to disclose ownership and officers, or failure to disclose subcontractors and suppliers. Executive Order 12549 prohibits any corporation or facility from participating in federal contracts if it or its principals have been disbarred, suspended or are ineligible, or have been voluntarily excluded, from participating in federal contracts. A principal has been defined as an officer, director, owner, partner, key employee or other person with primary management or supervisory responsibilities.
Additionally, the Health Insurance Portability and Accountability Act of 1996 granted expanded enforcement authority to HHS and the U.S. Department of Justice ("DOJ"), and provided enhanced resources to support the activities and responsibilities of the Office of Inspector General ("OIG") of HHS and DOJ by authorizing large increases in funding for investigating fraud and abuse violations relating to health care delivery and payment. On January 24, 1997, the OIG issued guidelines for the Fraud and Abuse Control Program as mandated by the Act, and on February 19, 1997 issued an interim final rule establishing procedures for seeking advisory opinions on the application on the anti-kickback statute and certain other fraud and abuse laws. The 1997 Balanced Budget Act also includes numerous health fraud provisions, including: new exclusion authority for the transfer of ownership or control interest in an entity to an immediate family or household member in anticipation of, or following, a conviction, assessment, or exclusion; increased mandatory exclusion periods for multiple health fraud convictions, including permanent exclusion for those convicted of three health care-related crimes; authority of the Secretary to refuse to enter into Medicare agreements with convicted felons; new civil money penalties for contracting with an excluded provider or violating the Medicare and Medicaid antikickback statute; new surety bond and information disclosure requirements for certain providers and suppliers; and an expansion of the mandatory and permissive exclusions added by the Health Insurance Portability and Accountability Act of 1996 to any federal health care program (other than the Federal Employees Health Benefits Program).
In addition, federal and some state laws impose restrictions on referrals for certain designated health services by physicians and, in a few states, psychologists and other mental health care professionals to entities with which they have financial relationships. The Company believes that its operations comply with these restrictions to the extent applicable, although no assurance can be given regarding compliance in any particular factual situation. Federal legislation has been considered to expand current law from its application to Medicare and Medicaid business to all payors and to additional health services. Certain states are considering adopting similar restrictions or expanding the scope of existing restrictions. There can be no assurance that the federal government or other states in which the Company operates will not enact similar or more restrictive legislation or restrictions that could under certain circumstances impact the Company's operations.
MENTAL HEALTH CARE PATIENT RIGHTS
Many states have adopted "patient bill of rights" regulations, which set forth standards for least restrictive treatment, patient confidentiality, patient access to mail and telephones, patient access to legal counsel and requirements that patients be treated with dignity. There are also laws and regulations relating to the civil commitment of patients to mental health programs, disclosure of information concerning patient treatments and related matters.
LICENSING REQUIREMENTS
Certain of the services provided by the Company's managed behavioral services subsidiaries may be subject to certain licensing requirements in some states. The Company currently holds various licenses in 12 states. If the business operations of such entities are determined to require licenses in other states, then obtaining such licenses or the inability to obtain such licenses could adversely affect the business operations of such entities. In addition, several states have laws that prohibit business corporations from providing, or holding themselves out as providers of, medical care. While the Company has no reason to believe that it is in violation or has violated such statutes, these laws vary from state to state and have seldom been interpreted by the courts or regulatory agencies.
EMPLOYEES
At August 31, 2000, the Company employed 1,340 people, of which 1,009 were full-time employees, 293 were part-time employees, and 38 were temporary employees. The Company has no collective bargaining agreements with any unions and believes that its overall relations with its employees are good. In addition, at August 31, 2000, the Company had administrative services contracts with 159 physicians to serve as medical directors for clinical programs managed by the Company.
INSURANCE
The Company carries general liability, comprehensive property damage, malpractice, workers' compensation and other insurance coverages that management considers adequate for the protection of the Company's assets and operations. There can be no assurance, however, that the coverage limits of such policies will be adequate. A successful claim against the Company in excess of its insurance coverage could have a material adverse effect on the Company.
ITEM 2.
ITEM 2. PROPERTIES
The Company leases a building consisting of approximately 40,000 square feet for its National Support Center in Lewisville (Dallas), Texas under a lease term expiring on September 26, 2001. In addition, for its contract management business the Company leases an aggregate of 4,573 square feet of space for two regional offices in the Chicago and Tampa metropolitan areas, with lease terms expiring from January 2001 to April 2001. Except for one partial hospitalization program operating in approximately 3,150 square feet of space, the space required for the clinical programs managed by the Company is provided by the client hospitals either within their existing facilities or at other locations owned or leased by the hospitals.
For its managed behavioral health care services and employee assistance programs, the Company leases approximately 54,000 square feet of office space primarily in the Orlando and Philadelphia metropolitan areas, with smaller sales offices in various parts of the country, under lease terms expiring from January 2001 to October 2004. The Company has signed an additional lease for approximately 22,000 square feet in the Orlando area, which is to commence in February 2001 and expires in January 2006. The Orlando area managed care operations will be consolidated into this new space beginning in February 2001. In addition, the Company leases approximately 29,000 square feet in various locations throughout the state of Florida with lease terms expiring from October 2000 to May 2003 for its managed behavioral health care clinical operations.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is, and may be in the future, party to litigation arising in the ordinary course of its business. While the Company has no reason to believe that any such pending claims are material, there can be no assurance that the Company's insurance coverage will be adequate to substantially cover liabilities arising out of such claims or that any such claims will be covered by the Company's insurance. Any material claim which is not covered by insurance may have an adverse effect on the Company's business. Claims against the Company, regardless of their merit or outcome, may also have an adverse effect on the Company's reputation and business.
In late 1999, the Company became aware that a civil qui tam lawsuit had been filed under seal naming the Company's psychiatric contract management subsidiary, Horizon Mental Health Management (Horizon), as a defendant therein. The lawsuit is currently pending in the United States District Court for the District of Columbia. The U.S. Government has not made a decision whether to intervene in the lawsuit which is still under seal. Horizon has not been served and therefore, is not presently a party to the lawsuit.
The lawsuit was brought under the Federal False Claims Act by three individuals. The complaint alleges that certain on-site Horizon employees acted in concert with other non-Horizon personnel to improperly inflate certain Medicare reimbursable costs associated with psychiatric services provided at a Tennessee hospital prior to August 1997. The lawsuit names the hospital, the parent corporation of the hospital and a home health agency as defendants in addition to Horizon.
The lawsuit seeks to recover an unspecified amount of damages relating to allegedly improper Medicare claims submitted by the hospital. If the lawsuit is served on Horizon, the Company will dispute the allegations in the complaint and intends to vigorously defend itself. The Company does not believe that the claims asserted in the lawsuit, based upon present allegations, represent a material liability to the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
EXECUTIVE OFFICERS OF THE REGISTRANT
James W. McAtee has been President and Chief Executive Officer of the Company since November 1, 1998. He has been Secretary of the Company since September 1990 and has been a director of the Company since July 1995. He formerly served as Chief Financial Officer and Treasurer from September 1990 to July 1999. He was Executive Vice President - Finance & Administration of the Company from February 1992 to October 1998 and was a Senior Vice President of the Company from September 1990 to February 1992.
Ronald C. Drabik has been Senior Vice President - Finance and Administration and Treasurer since July 12, 1999. He was previously Senior Vice President, Chief Financial Officer, Secretary and Treasurer of Cuno, Inc., a multinational manufacturer of filtration products, from 1996 to 1999. He was previously Vice President - Finance for Acme Cleveland, a multinational manufacturer of telecommunications and electronic products, from 1995 to 1996. He also served as President and CEO of Met-Coil Systems Corp., a machine tool manufacturer, from 1993 to 1995.
Frank J. Baumann has been Senior Vice President - Operations since March 22, 1999. He has been President - Specialty Rehab Management since March 1999. He formerly served as a Regional Vice President from March 1997 to March 1999. He was also a Regional Director of Operations from November 1996 to March 1997. He was Chief Executive Officer of Mountain Crest Behavioral Healthcare Systems, a free-standing psychiatric hospital, from August 1994 to November 1996.
James K. Don has been Senior Vice President - Business and Contract Development since June 2000. He formerly served as Senior Vice President, Acquisitions and Business Development from April 1997 to May 2000. During the period from October 1996 through March 1997, he served as an acquisitions consultant for Horizon. From May 1990 through September 1996 he was President, CEO and Founder of American Day Treatment Centers, a national company specializing in freestanding partial hospitalization facilities that provide behavioral health care services. American Day Treatment Centers filed a voluntary bankruptcy petition under Chapter 11 of the United States Bankruptcy Code in April 1997.
Linda A. Laitner has been Senior Vice President - Operations since November 1, 1998. She has been President - Horizon Behavioral Services since February 1998. She was previously Vice President Operations - Government Programs for CMG Health, a national managed behavioral healthcare organization, from January 1997 to January 1998. She also served as Vice President Operations - - Implementation for CMG Health from January 1994 to January 1997 and as a Regional Vice President from January 1993 to 1994.
David S. Tingue has been Senior Vice President - Marketing since November 1, 1998. He has been President - Mental Health Outcomes since October 1997. He formerly served as Executive Vice President, Marketing from July 1998 to October 1998. He was previously Vice President Operations for SDMS Inc, a consulting and service company focusing on disease and population management in the managed healthcare marketplace, from January 1997 to September 1997. He also served as Vice President, Strategic Planning for SDMS from March 1996 to December 1996 and Vice President, Marketing from July 1994 to March 1996. Prior to
this, he was a Regional Business Director for Zeneca Pharmaceuticals, a United Kingdom based healthcare company, from September 1992 to June 1994.
David K. White, Ph.D. has been Senior Vice President - Operations since November 1, 1998. He formerly served as Executive Vice President - Operations from February 1998 to October 1998. He was a Regional Vice President from September 1996 to January 1998. He also served as a Regional Director of Operations from April 1995 to August 1996. He was President and Chief Executive Officer of Charles River Health Management, Inc., a contract management company focusing on the public and private sector, from December 1990 to November 1994.
Officers of the Company are elected by the Board of Directors of the Company and serve at the pleasure of the Board of Directors until their respective successors are elected and qualified.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock of the Company is traded on the Nasdaq National Market under the symbol "HORC".
The following table sets forth the high and low sale prices per share for the Common Stock of the Company as reported by the Nasdaq National Market for the periods indicated:
As of October 31, 2000, there were 98 stockholders of record of the Common Stock of the Company. As of September 1, 2000 (the most recent date that data was available to the Company) there were approximately 493 beneficial owners of 100 or more shares of Common Stock of the Company.
The Company has not paid or declared any cash dividends on its capital stock since its inception. The Company currently intends to retain future earnings for use in the expansion and operation of its business. Future borrowings may limit the Company's ability to pay dividends. The payment of any future cash dividends will be determined by the Board of Directors in light of conditions then existing, including the Company's earnings, financial condition and capital requirements, restrictions in financing agreements, business opportunities and conditions and other factors. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources."
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL INFORMATION AND STATISTICAL DATA
The selected historical consolidated financial data presented below for the fiscal years ended August 31, 2000, 1999 and 1998, and at August 31, 2000 and August 31, 1999, are derived from the audited Consolidated Financial Statements of the Company included elsewhere in this Report. The selected historical consolidated financial data presented below for the fiscal years ended August 31, 1997 and 1996, and at August 31, 1998, 1997 and 1996, are derived from the audited consolidated financial statements of the Company not included herein. Effective August 11, 1997, Horizon acquired Specialty Healthcare Management, Inc. ("Specialty") in a share exchange transaction with the stockholders of Specialty which was accounted for as a pooling of interests. The Consolidated Financial Statements of the Company give effect to the Specialty exchange by combining (a) the financial statements of Horizon for the year ended August 31, 1996 with the financial statements of Specialty for the year ended December 31, 1996 and (b) the results of operations of Horizon for the year ended August 31, 1997 with the results of operations of Specialty for the twelve month period ended August 31, 1997, in each case on a pooling of interests basis. Specialty was a division of National Medical Enterprises, Inc. during the year ended December 31, 1994. The operations of Specialty for the four month period ended December 31, 1996 resulting in net revenues and net income of $10.8 million and $849,000, respectively, have been included in the restated statement of operations for both the year ended August 31, 1997 and the year ended August 31, 1996. The effect of including Specialty's net income for the four months in both periods is eliminated in stockholders' equity in the Consolidated Financial Statements of the Company. The selected financial information presented below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and with the Consolidated Financial Statements of the Company and Notes thereto included elsewhere in this Report.
(1) Other revenues for the fiscal year ended August 31, 1996 consist primarily of revenues earned from a psychiatric hospital formerly operated by the Company, patient services and physician contract management fees, or subsequent adjustments for Medicare settlements recognized during the respective period. The Company subleased the operations of the hospital to a third party effective July 31, 1994. Other revenues for the fiscal years ended August 31, 1998 and 1997 consist primarily of physician contract management fees and a favorable cost report adjustment. Other revenues for the years ended August 31, 2000 and 1999 consist primarily of physician contract management fees and revenues related to the Company's Mental Health Outcomes business.
(2) Adjusted to reflect a three-for-two stock split effected by the Company as a 50% stock dividend on January 31, 1997.
(3) Adjusted for the Specialty transaction based on historical share amounts, converting each outstanding share of Specialty Common Stock into 147.4616 shares of Horizon Common Stock.
(4) Intangible assets consist of goodwill and service contracts related to various acquisitions of the Company.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company is a provider of employee assistance plans ("EAP") and behavioral health services to business and managed care organizations, as well as a leading contract manager of psychiatric and physical rehabilitation clinical programs offered by general acute care hospitals in the United States. The Company has grown both internally and through acquisitions, increasing both the variety of its treatment programs and services and the number of its contracts, which totaled 507 as of August 31, 2000. At that date the Company had 254 contracts to provide EAP and managed behavioral health services covering nearly 1.8 million lives. Over the last eight years, the Company has increased its management contracts from 43 to a total of 138 as of August 31, 2000 and currently has contract locations in 34 states and the District of Columbia. Of its management contracts, 114 relate to mental health treatment programs and 24 relate to physical rehabilitation programs. The Company has also developed a proprietary mental health outcomes measurement system known as CQI+. At August 31, 2000, the Company provided outcome measurement services at 107 contract locations as well as 8 database project contracts under various arrangements.
The Company capitalizes on its expertise in managing the delivery of mental health services by directly offering managed behavioral health care services and employee assistance programs to businesses and managed care organizations. The Company believes it is strategically-sized to deliver national programs, while providing local, individualized service to both employers and health plans and to their respective employees or members. The Company's strategy is to enhance its position as the leader in the contract management of mental health programs and to further expand the range of services which it offers to its client hospitals to include other clinical and related services and programs. A significant challenge in marketing clinical management contracts is overcoming the initial reservations that many hospital administrators have with outsourcing key clinical services. The Company believes its expertise in working with hospital administrators, its reputation in the industry and its existing hospital contractual relationships provide it with a significant advantage in marketing new contracts. The Company also believes it has opportunities to cross-sell management services of mental health and physical rehabilitation programs to client hospitals by marketing its mental health services to client hospitals for which the Company currently manages only physical rehabilitation programs, and by marketing its physical rehabilitation services to client hospitals for which the Company currently manages only mental health programs. The Company is pursuing the development of such opportunities as a primary part of its business strategy. The Company has successfully expanded the breadth of services it offers to include the full continuum of mental health services, including outcome measurement services, and physical rehabilitation services. Its management contracts increasingly cover multiple services.
REVENUES
Managed Behavioral Health Care Services and Employee Assistance Programs
Through its subsidiary Horizon Behavioral Services, Inc. ("HBS"), the Company offers an array of managed care products to corporate clients, self-funded employer groups, commercial HMO and PPO plans, government agencies, and third-party payors. Revenues are derived from employee assistance program ("EAP") services, administrative services only contracts, and at risk managed behavioral health services.
Revenues from EAP contracts are typically based on a per employee per month capitated rate multiplied by the number of eligible employees. The rate for EAP plans is dependent upon services provided under the contract terms. Each plan is specifically written to fulfill the clients' needs and can offer different numbers of counseling sessions and other benefits, such as work life services (including child care and elder care consultation), referral resources and critical incident debriefing and intervention.
Revenues for administrative services only contracts relate to the management of behavioral health benefits and are dependent upon the number of contracts and the services provided. Fees are usually a case rate or a per employee per month fee multiplied by the number of eligible members. The client is able to benefit from the mental
health professionals employed or independently contracted by the Company at favorably discounted rates, as well as the Company's expertise in clinical case management.
The primary factors affecting revenues derived from managed care services are the behavioral health benefits provided and the number of members covered. Fees are based on a per employee per month capitated fee. The capitated rate is dependent upon the benefit designs and anticipated utilization of the customer and is set forth in the contract, usually as a per member per month capitated rate, which is multiplied by the number of eligible members to determine a monthly fee.
During the fiscal year ended August 31, 2000, the Company experienced the termination of six significant managed care contracts, one of which occurred in the quarter ended November 30, 1999, three of which terminated during the quarter ending February 29, 2000, and one of which terminated during the quarter ended May 31, 2000. The effects of the sixth termination will occur gradually, with membership being transitioned away over the course of the subsequent year. One of the six contract terminations arose from a client insolvency, which resulted in a $288,000 charge to bad debt during the three months ended November 30, 1999. In the prior fiscal year ended August 31, 1999 the six significant contracts provided annual revenues of approximately $15.4 million, or about 11% of the company's total annual revenues. In the fiscal year ended August 31, 2000 the same six contracts provided revenues of $6.8 million. Because of the timing of the actual termination dates, the full financial impact of the terminations will not be realized until fiscal year 2001. The Company has initiated a number of expense reduction measures to mitigate the financial impact of these terminations. One of the expense reduction measures included closing five of the Company's nine clinic locations.
The four remaining Company owned clinics operated in the state of Florida derive income from counseling and therapy services rendered. They also provide services to patients who are employees of customers under various EAP or managed care contracts.
Mental Health Services
The primary factors affecting revenues in a period are the number of management contracts with treatment programs in operation in the period and the number of services covered by each such management contract. The Company provides its management services under contracts with terms generally ranging from three to five years. Each contract is tailored to address the differing needs of each client hospital and its community and increasingly cover multiple treatment programs and services. The Company and the client hospital determine the programs and services to be offered by the hospital and managed by the Company, which may consist of one or more mental health or physical rehabilitation treatment programs offering inpatient, partial hospitalization, outpatient or home health services. Under the contracts, the hospital is the actual provider of the mental health or physical rehabilitation services and utilizes its own facilities (including beds for inpatient programs), nursing staff and support services (such as billing, dietary and housekeeping) in connection with the operations of its programs. As the Company has expanded the breadth of treatment programs it offers to hospitals, it began to move from managing one treatment program under a single contract with a hospital to managing multiple treatment programs under such contract.
Contracts are frequently renewed or amended prior to or at their stated expiration dates. Some contracts are terminated prior to their stated expiration dates pursuant to agreement of the parties or early termination provisions included in the contracts. As of August 31, 2000, 1999 and 1998, the Company had successfully retained 79%, 78% and 73%, respectively, of the management contracts in existence at the beginning of such fiscal years. The Company believes the most frequent reason its client hospitals do not renew their contracts with the Company is that the hospitals decide to manage such programs themselves. In addition, a number of contracts have not renewed since passage of the 1997 Balanced Budget Act due to a decline in profitability, resulting from unfavorable changes in Medicare reimbursement.
Under each contract, the Company receives a fee for its management services from the client hospital. Management fees may be either a variable fee related in part to patient volume, a fixed monthly fee or reimbursement for direct program costs plus a fixed fee. The management fee is frequently subject to periodic adjustments as a result of changes in the consumer price index or other economic factors. Payors, including Medicare and Medicaid, are attempting to manage costs, resulting in declining amounts paid or reimbursed to hospitals for the
services provided. As a result, the Company anticipates that the number of patients served by general acute care hospitals on an inpatient basis may decrease and, as an alternative, the number of patients served on a per diem, episodic or capitated basis will increase in the future. However, additional changes in Medicare reimbursement may also unfavorably impact these groups as well.
Over the past three years, the Company has increased revenues through acquisitions (discussed below) and through internal growth by adding services, price escalators and volume increases at existing contract locations. The increases have primarily been due to the increased range of services offered per contract and the increased demand for geropsychiatric services as general hospitals have sought to enter this market. An additional factor in the pricing strategy has been the Company's policy of establishing a minimum direct margin threshold for its management contracts.
The Company's mix of programs has changed over the last five years reflecting the increased interest in geropsychiatric programs by general hospitals. Geropsychiatric programs as a percentage of the Company's total mental health programs have increased from approximately 57% to 72% during that period.
The fees received by the Company for its services under management contracts are paid directly by its client hospitals. The client hospitals receive reimbursement under either the Medicare or Medicaid programs or payments from insurers, self-funded benefit plans or other third-party payors for the mental health and physical rehabilitation services provided to patients of the programs managed by the Company. As a result, the availability and amount of such reimbursement impacts the decisions of general acute care hospitals regarding whether to offer mental health and physical rehabilitation services pursuant to management contracts with the Company.
Amendments to the Medicare regulations in 1997 as part of the Balanced Budget Act, established maximum reimbursement amounts on a per case basis for both inpatient mental health and physical rehabilitation services. In some cases, the reimbursement limitations have resulted in decreased amounts reimbursed to the Company's client hospitals and have led to the renegotiation of a lower contract management fee structure for the Company. In other cases the reimbursement limitations have resulted in the termination or non-renewal of the management contract.
Amendments to the Medicare statutes provided for the elimination of cost based reimbursement of partial hospitalization services and implementation of the outpatient prospective payment system (PPS) effective August 1, 2000. Reimbursement for partial hospitalization now utilizes a fixed reimbursement amount per patient day. The reimbursement rate per patient day is a wage-adjusted rate from a base of $202.19, which has lowered Medicare reimbursement levels to many hospitals for partial hospitalization services. In an effort to lessen the potentially significant decrease in reimbursement, legislation was enacted to allow some hospitals to receive transitional relief effective August 1, 2000, which will be phased out over three years. However, the general decrease in reimbursement has, in some cases, led to the renegotiation of a lower contract management fee structure for the Company and in other cases has resulted in the termination or non-renewal of the management contract.
In April 2000, HCFA adopted new rules requiring a HCFA determination that a facility has provider-based status before a provider can bill for the services rendered at the facility. The new rules have been construed by HCFA to apply to inpatient mental health and rehabilitation units. The rules contain numerous requirements, some specifically applicable to facilities operated under management contracts, that must be satisfied in order to receive a HCFA determination of provider-based status. The rules are applicable to a provider at the beginning of its first Medicare cost reporting year that commences after January 10, 2001. The particular application of the rules to inpatient units managed by the Company is currently unclear in several respects. HCFA has indicated that it intends to issue guidelines under the new rules, which may provide clarification. At the current time, there is uncertainty with respect to both precisely how the new rules are to be applied to inpatient units managed by the Company and uncertainty as to whether the current structure of the management contracts of the Company will satisfy the requirements under the new rules. The Company is unable at this time to definitively determine the effect of the new provider-based rules on its business operations, but it is possible that the new provider-based rules could result in termination or non-renewal of management contracts if, under the new rules, it is not possible for a provider to obtain a determination of provider-based status of an inpatient unit operated under a management contract.
Revenues from partial hospitalization services were $15.2 million or 16.2% of total contract management revenues for the year ended August 31, 2000. Of the Company's 138 management contracts at August 31, 2000, 78 or 56.5% of the contracts include partial hospitalization services. Of the 78 contracts including partial hospitalization services, 61 program locations had partial hospitalization services in operation, 12 program locations were in operation but the partial hospitalization services were not in operation, and five program locations were not yet in operation for any of the services. The termination of all partial hospitalization contracts, while unlikely and not expected, could reduce operating income by $5 million or more annually.
Recent amendments to the Medicare statutes provides for a linear phase-out of cost-based reimbursement of physical rehabilitation services over a three-year period, the start of which was previously delayed and has been rescheduled for cost reporting periods beginning on or after April 1, 2001. The resulting phase-in of reimbursement for physical rehabilitation services based on PPS could significantly lower Medicare reimbursements to hospitals and could adversely affect the business operations and financial results of the Company. Regulations specifying the rules and amounts of reimbursement have not as yet been released.
OPERATING EXPENSES
The primary factor affecting operating expenses for the Company's contract management business in any period is the number of programs in operation in the period. Operating expenses consist primarily of salaries and benefits paid to its therapists and supporting personnel. Mental health program managed by the Company generally have a psychiatric medical director, a program director who is usually a psychologist or a social worker, a community education coordinator and additional social workers or therapists as needed. Physical rehabilitation programs managed by the Company generally have an independent medical director, a program director, and additional clinical staff tailored to meet the needs of the program and the client hospital, which may include physical and occupational therapists, a speech pathologist, a social worker and other appropriate supporting personnel. Medical directors have a contract with the Company under which on-site administrative services needed to administer the program are provided. Except for the nursing staff, which is typically provided by the hospital, the other program personnel are generally employees of the Company. At August 31, 2000, the Company had an average of seven employees per contract location.
Operating expenses for the Company's managed behavioral health care services and employee assistance programs are comprised of approximately 39% salaries and benefits and approximately 40% medical claims from providers. Medical claims includes payments to independent health care professionals providing services under the capitated mental health services contracts and employee assistance programs offered by the Company. Other costs and expenses include items such as marketing costs and expenses, consulting, accounting and legal fees and expenses, employee recruitment and relocation expenses, rent, utilities and property taxes.
ACQUISITIONS
Acquisitions during the last five years have significantly affected the Company's results of operation and financial condition. Details of these acquisitions are included in Note 3 to Consolidated Financial Statements included elsewhere herein this Form 10-K.
RESULTS OF OPERATIONS
The following table sets forth for the fiscal years ended August 31, 2000, 1999 and 1998, the percentage relationship to total revenues of certain costs, expenses and income, and the number of management contracts in operation and covered lives at the end of each fiscal year.
FISCAL YEAR ENDED AUGUST 31, 2000 COMPARED TO FISCAL YEAR ENDED AUGUST 31, 1999
Revenue. Revenues for the fiscal year ended August 31, 2000 were $133.7 million representing a decrease of $12.3 million, or 8.4%, as compared to revenues of $146.0 million for the prior fiscal year. Contract management revenue decreased $3.9 million, or 4.0%, due to a decline in the average number of contract locations in operation from 155.8 for fiscal year 1999 to 138.3 for fiscal year 2000, a decrease of 11.2%. However, same store sales, defined as contracts in operation for the entire year in both the current and prior fiscal year, increased by $1.7 million, or 2.6% for fiscal year 2000. Premiums and fees decreased $9.2 million primarily as a result of the termination of the six significant managed care contracts previously discussed. The revenues related to the significant terminated contracts for the fiscal year ended August 31, 2000 were $6.8 million representing a decrease of $8.6 million, as compared to revenues of $15.4 million for the fiscal year ended August 31, 1999.
Salaries and Benefits. Salaries and benefits for the fiscal year ended August 31, 2000 were $71.5 million representing a decrease of $4.2 million, or 5.5%, as compared to salaries and benefits of $75.7 million for the prior fiscal year. Average full time equivalents for the fiscal year ended August 31, 2000 were 1,189 representing a decrease of 104, or 8.0%, as compared to average full time equivalents of 1,293 for the fiscal year ended August 31, 1999. This decrease is a result of cost control initiatives taken by the Company in response to the reduction in revenues. Salary and benefits costs per full time equivalent for fiscal year 2000 were $60,180 representing an increase of $1,602 per full time equivalent, or 2.7%, as compared to salary and benefits cost of $58,578 per full time equivalent for the prior fiscal year.
Depreciation and Amortization. Depreciation and amortization expenses for fiscal year 2000 were $5.1 million representing an increase of $600,000 or 13.3%, as compared to depreciation and amortization expenses of $4.5 million for the prior fiscal year. An increase of $355,000 is due to the accelerated depreciation expense of certain capitalized software that will become obsolete in Fiscal 2001. The remaining increase primarily results from the depreciation expense of additional equipment purchased for the operation of the Company's contract management and managed care businesses.
Other Operating Expenses (Including Medical Claims, Purchased Services and Provision for Bad Debts). Other operating expenses for fiscal year 2000 were $44.3 million representing a decrease of $8.9 million or 16.7%, as compared to other operating expenses of $53.2 million for the prior fiscal year. The following components identify the primary variances between the periods reported.
Medical claims expense for the fiscal year ended August 31, 2000 was $14.3 million, representing a decrease of $6.7 million or 31.9%, as compared to medical claims expense of $21.0 million for the prior fiscal year. This is primarily the result of the termination of the six significant managed care contracts, discussed previously, as well as improved utilization management and review of patients seeking authorization for treatment. The improved utilization management resulted in a decrease in inpatient cost, attained primarily by directing patient care toward lower cost inpatient facilities and the use of outpatient options. Inpatient days per year per one thousand members decreased from an average of 20.2 for the fiscal year ended August 31, 1999 to 16.8 for the fiscal year ended August 31, 2000.
Purchased services for the fiscal year ended August 31, 2000 was $12.3 million, representing a decrease of $1.4 million or 10.2%, as compared to purchased services of $13.7 million for the prior fiscal year. Medical director fees decreased $874,000 for the fiscal year ended August 31, 2000, as compared to the prior fiscal year. This decrease is a result of the decrease in the average number of contract locations in operation as discussed in the revenue section above as well as the expense controls initiated by the Company. Also, fees paid to temporary physicians decreased $320,000 due to the recruitment of permanent physicians at certain contract locations.
Bad debt expense for the fiscal year ended August 31, 2000 was $877,000, representing an increase of $288,000 or 48.9%, as compared to bad debt expense of $589,000 for the prior fiscal year. Bad debt expense, excluding the recovery of $1,750,000 related to one former Specialty Healthcare Management, Inc. contract, was $2.3 million for the prior fiscal year. Excluding the $1,750,000 recovery, bad debt expense decreased $1.4 million for the fiscal year ended August 31, 2000 versus August 31, 1999. This decrease in bad debt expense can be
attributed to the decrease in the reserves related to untimely payments by client hospitals, which resulted from more vigorous collection efforts.
Other operating expense for the fiscal year ended August 31, 2000 was $16.8 million, representing a decrease of $1.1 million or 6.1%, as compared to other operating expense of $17.9 million for the prior fiscal year. Rent expense increased $860,000 primarily due to a one-time charge related to the closing of the five clinic locations, previously discussed, and a one-time charge associated with the acceleration of rent expense for office space in Florida that will be vacated when the managed care operations are consolidated into new leased space. Line of credit loan fees decreased $330,000 due to the full amortization of these fees in the prior fiscal year. Legal settlement expense decreased $490,000 due to a significant decrease in actual and projected legal settlements that were and will be incurred related to fiscal year 2000. Capital contribution expense decreased $272,000 due to the decrease in the number of new capital contributions required per contract with client hospitals. The remaining decrease of $950,000 is a result of certain Company initiated expense reduction measures, which significantly decreased various expense categories, including recruiting expenses, express mail cost and telephone expense.
Interest and Other Income (Expense), Net. Interest income, interest expense and other income for fiscal year 2000 was a net expense of $1.0 million as compared to $1.2 million in net expense for fiscal year 1999. This change results from a decrease in interest expense of $169,000 due to lower outstanding debt and more cash on hand.
Income Tax Expense. Income tax expense for fiscal year 2000 was $4.8 million representing an increase of $200,000, or 0.4%, as compared to income tax expense of $4.6 million for the prior fiscal year. The increase in income tax expense was largely due to a corresponding increase in pre-tax earnings. The effective tax rates for fiscal years 2000 and 1999 were 40.2% and 39.8% respectively.
FISCAL YEAR ENDED AUGUST 31, 1999 COMPARED TO FISCAL YEAR ENDED AUGUST 31, 1998
Revenue. Revenues for the fiscal year ended August 31, 1999 were $146.0 million representing an increase of $22.2 million, or 17.9%, as compared to revenues of $123.8 million for the prior fiscal year. Premiums and fees increased $26.1 million primarily as a result of revenue recorded for FPM, ChoiceHealth, and REACH. Horizon acquired 100% of the voting stock of FPM, ChoiceHealth, and REACH effective June 1, 1998, October 5, 1998, and April 1, 1999, respectively. The increase in premiums and fees were offset by a $3.8 million decrease in contract management and other revenue as compared to fiscal year 1998. This decrease is due to the average number of contract locations in operation decreasing from 172.8 for fiscal year 1998 to 155.8 for fiscal year 1999, a decrease of 9.8%. However, same store sales for contract management revenues, that is contracts in operation for the entire year in both the current fiscal year and prior fiscal year, increased by $2.2 million or 3.2% for fiscal year 1999.
Salaries and Benefits. Salaries and benefits for the fiscal year ended August 31, 1999 were $75.7 million representing an increase of $10.0 million, or 15.2%, as compared to salaries and benefits of $65.7 million for the prior fiscal year. Salaries and benefits increased by $8.9 million, $2.0 million, and $110,000 as a result of the acquisitions of FPM, ChoiceHealth, and REACH, respectively. Salary and benefits cost per full time equivalent for fiscal year 1999 was $58,594 representing an increase of $1,304 per full time equivalent, or 2.3%, as compared to salary and benefits cost of $57,290 per full time equivalent for the prior fiscal year. These increases are offset by a decrease of 29.2 full time equivalents resulting from the 9.8% decrease in the average number of contract locations in operation.
Depreciation and Amortization. Depreciation and amortization expenses for fiscal year 1999 were $4.5 million representing an increase of $1.3 million or 40.9%, as compared to depreciation and amortization expenses of $3.2 million for the prior fiscal year. An increase of $416,000 is due to the amortization of goodwill of $18.8 million, $2.9 million, and $2.1 million resulting from acquisitions of FPM, ChoiceHealth, and REACH, respectively. Amortization expense also increased $201,000 in relation to the value placed on the contracts of FPM, ChoiceHealth, and REACH. The remaining increase results from the depreciation expense of additional equipment acquired by acquisition or purchased for the operation of the Company's contract management and managed care businesses.
Other Operating Expenses (Including Medical Claims, Purchased Services and Provision for Bad Debts). Other operating expenses for fiscal year 1999 were $53.2 million representing an increase of $14.4 million or 37.5%, as compared to other operating expenses of $38.7 million for the prior fiscal year. The major components of the variances between the periods reported are:
Medical claims included an $11.9 million increase for fiscal year 1999 resulting from the acquisitions of FPM on June 1, 1998, ChoiceHealth on October 5, 1998, and REACH on April 1, 1999.
Purchased Services for the fiscal year ended August 31, 1999 were $13.7 million representing a decrease of $389,000, or 2.8%, as compared to $14.1 million for the prior fiscal year.
Bad Debt expense, excluding the recovery of $1.75 million related to one former Specialty Healthcare Management, Inc. contract, was $2.3 million for fiscal year 1999, as compared to $759,000 for fiscal year 1998. Bad debt expense increased $337,000 as a result of the acquisition of FPM, ChoiceHealth, and Reach. In addition, bad debt expense increased $334,000 due to the declaration of bankruptcy of one client hospital and $334,000 relating to the contract termination of two other client hospitals. The remaining increase resulted from an increase in reserves related to the untimely payments of client hospitals.
Other operating expense was $17.9 million for fiscal year 1999, an increase of $3.1 million or 20.9% as compared to $14.8 million for fiscal year 1998. Other operating expenses increased $3.1 million, $450,000, and $68,000 as a result of the acquisitions of FPM, ChoiceHealth, and Reach, respectively. This increase was offset by a decline of $490,000 in other operating expenses resulting from the 9.8% decrease in the average number of contract locations in operation.
Interest and Other Income (Expense), Net. Interest income, interest expense and other income for fiscal year 1999 was a net expense of $1.2 million as compared to $74,000 in net income for the prior fiscal year. This change results from an increase in interest expense of $664,000 related to amounts borrowed under the credit facility primarily for acquisitions. In addition, other income for the prior year 1998 include $623,000 due to the dissolution of Mountain Crest Hospital in the prior fiscal year.
Income Tax Expense. Income tax expense for fiscal year 1999 was $4.6 million representing a decrease of $1.9 million, or 29.2%, as compared to income tax expense of $6.5 million for the prior fiscal year. The decrease in income tax expense was largely due to a corresponding decrease in pre-tax earnings. The effective tax rates for fiscal years 1999 and 1998 were 39.8% and 40.0% respectively.
LIQUIDITY AND CAPITAL RESOURCES
On December 9, 1997, the Company entered into a Credit Agreement (the "Credit Agreement") with Chase Bank of Texas, National Association as Agent (the "Agent") for itself and other lenders party to the Credit Agreement, for a senior secured credit facility in an aggregate amount of up to $50.0 million (the "Credit Facility"). The Credit Facility consisted of a $10.0 million revolving credit facility to fund ongoing working capital requirements (the "Revolving Credit Facility") and an initial $40.0 million term loan facility to refinance certain existing debt and to finance future acquisitions by the Company (the "Term Loan Facility"). At August 31, 2000, the Company had $14.9 million outstanding against the Term Loan Facility, from which it can no longer draw. The Revolving Credit Facility was terminated by the Company on June 30, 2000.
The following summary of certain material provisions of the Credit Agreement does not purport to be complete, and is subject to, and qualified in its entirety by reference to, the Credit Agreement, a copy of which was filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q, for the quarter ended November 30, 1997, as filed with the Securities and Exchange Commission (the "Commission") on December 19, 1997, which is herein incorporated by reference thereto.
The Company is the borrower under the Credit Agreement which is unconditionally guaranteed by all material subsidiaries of the Company. The Revolving Credit Facility was terminated on June 30, 2000 and the Term Loan Facility has a term of five years, with no further draws available after November 30, 1999. Amounts that were
outstanding under the Term Loan Facility on November 30, 1999 are to be repaid in twelve quarterly principal payments, which began February 29, 2000, based upon a five year amortization schedule with the first eleven principal payments being 1/20th of the outstanding balance on November 30, 1999, and the twelfth being the remaining unpaid principal balance. Based on the November 30, 1999 term loan balance of $17.6 million, the minimum quarterly payment will be $880,000. Principal outstanding under the Credit Facility bears interest at the "Base Rate" (the greater of the Agent's "prime rate" or the federal funds rate plus .5%) plus 0% to .5% (depending on the Company's Indebtedness to EBITDA Ratio as defined in the Credit Agreement) or the "Eurodollar Rate" plus .75% to 1.5% (depending on the Indebtedness to EBITDA Ratio), as selected by the Company.
The Company is subject to certain covenants which include prohibitions, unless advance approval or waivers are obtained, against (i) incurring additional debt or liens, except specified permitted debt or permitted liens, (ii) certain material acquisitions, other than specified permitted acquisitions (including any single acquisition not greater than $10.0 million or cumulative acquisitions not in excess of $30.0 million during any twelve consecutive monthly periods), (iii) certain mergers, consolidations or asset dispositions by the Company or changes of control of the Company, (iv) declaring, ordering or paying any sum for any dividend or other distribution or purchasing of the Company's own shares (v) certain management vacancies at the Company, and (vi) material change in the nature of business conducted. In addition, the terms of the Credit Facility require the Company to satisfy certain ongoing financial covenants. The Credit Facility is secured by a first lien or first priority security interest in and/or pledge of substantially all of the assets of the Company and of all present and future subsidiaries of the Company.
As of September 30, 1998, the Credit Facility was amended to allow the Company to finance, under the Term Loan Facility, the redemption or repurchase of its capital stock through November 30, 1999. As of November 30, 1999, the Company had repurchased 1,189,300 shares of its common stock, of which 162,778 and 245,145 shares have been reissued pursuant to the exercise of certain stock options as of November 30, 1999 and August 31, 2000, respectively.
On October 4, 2000, the Company received from Chase Bank of Texas, National Association, a letter of intent to provide the Company with a $15 million three year revolving line of credit. If the pending agreement is finalized, the revolving facility could be used for general corporate purposes, share repurchases, dividends, acquisitions, and to refinance the remaining balance on the existing term loan facility.
Effective September 1996, the Company entered into a lease agreement with a term of five years for a building which had been constructed to the Company's specifications for its National Support Center. In connection with the lease transaction, the Company guaranteed a loan of approximately $900,000. The loan was by a financial institution to the owner. The Company also agreed to purchase the leased building for approximately $4.5 million at the end of the lease term in September 2001 if either the building is not sold to a third party or the Company does not extend its lease. The Company's current intention is to extend the lease.
The Company believes that its future cash flow from operations (including the potential unfavorable impacts of additional changes in Medicare reimbursement discussed previously under "Revenues") and cash of $8.5 million at August 31, 2000 will be sufficient to cover cash requirements over the next twelve months, including estimated capital expenditures of $1.8 million and scheduled repayments of term loan debt of approximately $3.6 million the latter subject to the refinancing described above. The Company generated $12.4 million in net cash from operations during the year ended August 31, 2000. The Company may require additional capital to fund any further share repurchases or acquisitions.
Effective April 1, 1999, the Company acquired all of the outstanding capital stock of REACH for approximately $2.0 million. The acquisition was funded by incurring debt of $2.0 million under the term loan facility.
Effective October 5, 1998, the Company acquired all of the outstanding capital stock of ChoiceHealth for approximately $2.0 million. The acquisition was funded by incurring debt of $2.0 million under the term loan facility.
Effective June 1, 1998, the Company acquired from Ramsay Health Care, Inc. all the outstanding capital stock of FPM for $20.0 million, subject to certain post-closing adjustments. The acquisition was funded by incurring debt of $20.0 million under the term loan facility.
On October 31, 1997, the Company acquired all of the outstanding capital stock of Acorn for approximately $12.7 million. To fund the acquisition, the Company utilized approximately $1.7 million of existing cash and incurred debt of approximately $11.0 million under the revolving credit facility.
Horizon acquired Specialty on August 11, 1997. In the Specialty transaction, 1,400,000 shares of Horizon common stock were issued and exchanged for all outstanding shares of Specialty capital stock. Upon the acquisition, the Specialty outstanding bank indebtedness of approximately $3.2 million was paid in full.
Effective March 15, 1997, the Company purchased all of the outstanding capital stock of Geriatric. The purchase price was approximately $4.6 million, and was paid from existing cash.
Also effective March 15, 1997, the Company purchased all of the outstanding capital stock of Clay Care. The purchase price was $1.0 million, and was paid from existing cash.
In July 1996, the Company acquired 80% of the outstanding common stock of Florida PPS for approximately $3.3 million. In February and March 1998, the Company acquired the remaining outstanding common stock of PPS for approximately $1,030,000.
CERTAIN EARNINGS DATA
The following table sets forth for the fiscal years ended August 31, 2000 and 1999, diluted earnings per share based on net income plus amortization expense related to goodwill, net of tax, and operating cash flow per share based on net income plus depreciation and amortization expense, less capital expenditures.
\
YEAR 2000 ISSUE
The Company has executed a plan designed to make its information technology systems and equipment Year 2000 compliant, the direct costs of which were not material. To date, no significant problems, business interruptions or material adverse effects from the Year 2000 issue have been experienced.
INFLATION
The Company's management contracts and employee assistance contracts generally provide for annual adjustments in the Company's fees based upon various inflation indexes, thus mitigating the effect of inflation. During the last three years, inflation has had no significant effects on the Company's business.
DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS
Certain written and oral statements made or incorporated by reference from time to time by the Company or its representatives in this report, other reports, filings with the Commission, press releases, conferences, or otherwise, are "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements include, without limitation, any statement that may predict, forecast indicate, or imply future results, performance or achievements, and may contain the words "believe", "expect", "estimate", "project", "will be", "will continue", "will likely result", or words or phrases of similar meaning. Such statements involve risks, uncertainties or other factors which may cause actual results to differ materially from the future results, performance or achievements expressed or implied by such forward looking statements. Certain risks, uncertainties and other important factors are detailed in this report and will be detailed from time to time in reports filed by the Company with the Commission, including Forms 8-K, 10-Q, and 10-K, and include, among others, the following: general economic and business conditions which are less favorable than expected; unanticipated changes in industry trends; decreased demand by general hospitals for the Company's services; the Company's inability to retain existing management contracts or to obtain additional contracts; adverse changes in reimbursement to general hospitals by Medicare or other third-party payors for costs of providing mental health or physical rehabilitation services; adverse changes to other regulatory provisions relating to mental health or physical rehabilitation services; fluctuations and difficulty in forecasting operating results; the ability of the Company to sustain, manage or forecast its growth; heightened competition, including specifically the intensification of price competition; the entry of new competitors and the development of new products or services by new and existing competitors; changes in business strategy or development plans; inability to carry out marketing and sales plans; business disruptions; liability and other claims asserted against the Company; loss of key executives; the ability to attract and retain qualified personnel; customer services; adverse publicity; demographic changes; and other factors referenced or incorporated by reference in this report and other reports or filings with the Commission. Moreover, the Company operates in a very competitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible for management to predict all such risk factors, nor can it assess the impact of all such risk factors on the Company's business or the extent to which any factor, may cause actual results to differ materially from those contained in any forward looking statements. These forward looking statements represent the estimates and assumptions of management only as of the date of this report. The Company expressly disclaims any obligation or undertaking to disseminate any updates or revisions to any forward looking statement contained herein to reflect any change in its expectations with regard thereto or any change in events, conditions or circumstances on which any statement is based. Given these risks and uncertainties, investors should not place undue reliance on forward looking statements as a prediction of actual results.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In its normal operations, the Company has market risk exposure to interest rates due to its interest bearing debt obligations, which were entered into for purposes other than trading purposes. To manage its exposure to changes in interest rates, the Company uses both fixed and variable rate debt. The Company has estimated its market risk exposure using sensitivity analyses assuming a 10% change in market rates.
At August 31, 2000, the Company had approximately $14.9 million of debt obligations outstanding with an interest rate of 7.625%. A hypothetical 10% change in the effective interest rate for these borrowings, assuming debt levels as of August 31, 2000, would change annual interest expense by approximately $114,000.
At August 31, 1999, the Company had approximately $20.0 million of debt obligations outstanding with an interest rate of 6.500%. A hypothetical 10% change in the effective interest rate for these borrowings, assuming debt levels as of August 31, 1999, would change annual interest expense by approximately $130,000.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the Consolidated Financial Statements of the Company and the Notes thereto appearing at page to attached hereto, all of which information is incorporated by reference into this Item 8.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The Company will file with the Commission a definitive proxy statement with respect to the annual meeting of stockholders of the Company to be held on January 24, 2001 (the "Proxy Statement"). The Company hereby incorporates into this Item 10 by reference to the Proxy Statement the information required by this Item 10 that will appear in the Proxy Statement under the caption ELECTION OF DIRECTORS.
The information called for by this Item 10 and Item 401 of Regulation S-K with respect to executive officers of the Company appears under the caption EXECUTIVE OFFICERS OF THE REGISTRANT following Item 4 of Part I of this Report, and is incorporated by reference into this Item 10.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The Company hereby incorporates into this Item 11 by reference to the Proxy Statement the information required by this Item 11 that will appear in the Proxy Statement under the caption EXECUTIVE COMPENSATION.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The Company hereby incorporates into this Item 12 by reference to the Proxy Statement the information required by this Item 12 that will appear in the Proxy Statement under the caption SECURITY OWNERSHIP BY MANAGEMENT AND PRINCIPAL STOCKHOLDERS.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Financial Statements - Reference is made to the Index to Consolidated Financial Statements appearing at page of this report.
(2) Financial Statement Schedule - Reference is made to the Index to Financial Statement Schedule appearing at page S-1 of this report.
(3) Exhibits.
NUMBER EXHIBIT
3.1 - Certificate of Incorporation of the Company, as amended (incorporated herein by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K dated August 11, 1997).
3.2 - Amended and Restated Bylaws of the Company, as amended (incorporated herein by reference to Exhibit 3.2 to Amendment No. 2 as filed with the Commission on February 16, 1995 ("Amendment No. 2") to the Company's Registration Statement on Form S-1 filed with the Commission on January 6, 1995 Registration No. 33-88314) (the "Form S-1").
4.1 - Specimen certificate for the Common Stock, $.01 par value of the Company (incorporated herein by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K dated August 11, 1997).
4.2 - Rights Agreement, dated February 6, 1997, between the Company and American Stock Transfer & Trust Company, as Rights Agent (incorporated by reference to Exhibit 4.1 to the Company's Registration Statement on Form 8-A, Registration No. 000-22123, as filed with the Commission on February 7, 1997).
10.1 - Credit Agreement dated December 9, 1997 among the Company, Texas Commerce Bank National Association, as Agent, and the banks named therein (incorporated herein by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended November 30, 1997).
10.2 - Letter Loan Agreement dated December 20, 1995 among North Central Development Company, as borrower, Texas Commerce Bank, National Association, ("TCB") as lender, and Horizon Mental Health Management, Inc., a Delaware corporation, Horizon Mental Health Management, Inc., a Texas corporation, and Mental Health Outcomes, Inc., a Delaware corporation, as guarantors (incorporated herein by reference to Exhibit 10.7 to the Company's Quarterly Report on Form 10-Q for the quarter ended November 30, 1995 (the "November 1995 Form 10-Q").
10.3 - First Amendment to Letter Loan Agreement and Note Modification Agreement dated December 9, 1997 among North Central Development Company and its subsidiaries and TCB (incorporated herein by reference to Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended November 30, 1997.)
10.4 - Second Amendment to Credit Agreement and Third Amendment to Letter Loan Agreement dated as of September 30, 1998, among the Company, Chase Bank of Texas, National Association, as Agent, and the banks named therein (incorporated herein by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended November 30, 1998).
10.5 - Third Amendment to Credit Agreement and Fourth Amendment to Letter Loan Agreement dated as of November 6, 1998, among the Company, Chase Bank of Texas, National Association, as Agent, and the banks named therein (incorporated herein by reference to Exhibit 10.5 to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1999).
10.6 - Fourth Amendment to Credit Agreement and Fifth Amendment to Letter Loan Agreement dated as of October 12,, 1999, among the Company, Chase Bank of Texas, National Association, as Agent, and the banks named therein (incorporated herein by reference to Exhibit 10.6 to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1999).
10.7 - Lease Agreement dated as of December 20, 1995 between North Central Development Company and Horizon Mental Health Management, Inc., a Delaware corporation (incorporated herein by reference to Exhibit 10.8 to the Company's Quarterly Report on Form 10-Q for the quarter ended November 30, 1995).
10.8 - Horizon Health Group, Inc. 1989 Stock Option Plan, as amended (incorporated herein by reference to Exhibit 10.52 of Amendment No. 2 to the Company's Form S-1).
10.9 - Horizon Mental Health Management, Inc. 1995 Stock Option Plan (incorporated herein by reference to Exhibit 10.11 to the November 1995 Form 10-Q).
10.10 - Horizon Mental Health Management, Inc. Amended and Restated 1995 Stock Option Plan for Eligible Outside Directors (incorporated herein by reference to Exhibit 10.12 to the November 1995 Form 10-Q).
10.11 - Amendments to 1989 Stock Option Plan and 1995 Stock Option Plan (incorporated herein by reference to Exhibit 10.5 to the Company's Current Report on Form 8-K dated September 1, 1997).
10.12 - Amendments to 1995 Stock Option Plan and 1995 First Amended and Restated Stock Option Plan for Eligible Outside Directors (incorporated herein by reference to Exhibit 10.6 to the Company's Current Report on Form 8-K dated September 1, 1997).
10.13 - Amendment to 1995 Amended and Restated Stock Option Plan for Eligible Outside Directors (incorporated herein by reference to Exhibit 10.13 to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1999).
10.14 - Horizon Health Corporation 1998 Stock Option Plan (incorporated herein by reference to Exhibit 10.14 to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1999).
10.15 - Horizon Health Corporation Employee Stock Purchase Plan (incorporated herein by reference to Exhibit 4.3 to the Company's Registration Statement on Form S-8 filed with the Commission on November 30, 1999, Registration No. 333-91761).
10.16 - Horizon Mental Health Management Contingent Bonus Plan (incorporated herein by reference to Exhibit 10.37 to the Company's 1996 Form 10-K/A).
10.17 - Horizon Health Corporation Bonus Plan Fiscal 2000 (incorporated herein by reference to Exhibit 10.17 to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1999).
10.18 - Horizon Health Corporation Bonus Plan Fiscal 2001 (filed herewith).
10.19 - Executive Retention Agreement effective September 1, 1997, between the Company and James Ken Newman (incorporated herein by reference to Exhibit 10.4 to the Company's Current Report on Form 8-K dated September 1, 1997).
10.20 - Agreement dated August 31, 1999 between Horizon Health Corporation, Inc. and Ronald C. Drabik regarding severance arrangements (incorporated herein by reference to exhibit 10.1 to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1999).
11 - Statement Regarding Computation of Per Share Earnings (filed herewith).
21 - List of Subsidiaries of the Company (filed herewith).
23 - Consent of PricewaterhouseCoopers LLP (filed herewith).
27 - Financial Data Schedule (filed herewith).
(b) The Company filed no reports on Form 8-K during the last quarter of the period covered by this report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
DATE: NOVEMBER 13, 2000 HORIZON HEALTH CORPORATION
BY: /s/ RONALD C. DRABIK ------------------------------------------- RONALD C. DRABIK SENIOR VICE PRESIDENT - FINANCE AND ADMINISTRATION AND TREASURER (PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of Horizon Health Corporation
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, of changes in stockholders' equity and of cash flows present fairly, in all material respects, the financial position of Horizon Health Corporation and its subsidiaries at August 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended August 31, 2000, in conformity with auditing standards generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP Dallas, Texas October 12, 2000
HORIZON HEALTH CORPORATION CONSOLIDATED BALANCE SHEETS
See accompanying notes.
HORIZON HEALTH CORPORATION CONSOLIDATED BALANCE SHEETS
See accompanying notes.
HORIZON HEALTH CORPORATION CONSOLIDATED STATEMENTS OF INCOME
See accompanying notes.
HORIZON HEALTH CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
See accompanying notes.
HORIZON HEALTH CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
HORIZON HEALTH CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
(A) Acquisition of ChoiceHealth, Inc., Resource in Employee Assistance and Corporate Health, Inc., and the purchase price adjustments of FPM Behavioral Health, Inc. during fiscal year 1999.
(B) Acquisition of Acorn Behavioral Health Care Management Corporation, FPM Behavioral Health, Inc., and additional payments for the acquisition of the remaining 20% of the common stock of Professional Psychological Services, Inc., during fiscal year 1998.
See accompanying notes.
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AUGUST 31, 2000, 1999 AND 1998
1. ORGANIZATION
Horizon Health Corporation ("the Company"), formerly known as Horizon Mental Health Management, Inc., is a provider of employee assistance programs ("EAP") and mental health services to businesses and managed care organizations, as well as a contract manager of clinical and related services, primarily of mental health and physical rehabilitation programs, offered by general acute care hospitals in the United States. The management contracts are generally for terms ranging from three to five years, the majority of which have automatic renewal provisions. The Company currently has offices in the Dallas, Texas; Chicago, Illinois; Tampa, Florida; Orlando, Florida; Denver, Colorado; and Philadelphia, Pennsylvania metropolitan areas. The Company's National Support Center is in Lewisville, Texas.
The Company was formed in July 1989 for the purpose of acquiring all the assets of two companies. One of these companies, known as Horizon Health Management Company, had been formed in 1981 and since that time had been engaged in the mental health contract management business. The other company owned a freestanding psychiatric hospital in California. Effective March 1, 1990, the assets constituting the contract management business and the psychiatric hospital of the two companies were transferred to the Company. On January 3, 1995, the Company acquired the net assets and operations of National Medical Management Services, a division of National Medical Enterprises, Inc.
On July 31, 1996, the Company acquired eighty percent (80%) of the outstanding common stock of Florida Professional Psychological Services, Inc., also known as Professional Psychological Services, Inc. ("PPS") and PPS has been consolidated with the Company as of August 1, 1996. Effective February 27, 1998, the Company acquired an additional sixteen percent (16%) of the outstanding common stock of PPS. On March 10, 1998, the Company acquired the remaining four percent (4%) of the outstanding common stock of PPS. These acquisitions have been consolidated with the Company as of their respective effective dates. Effective June 1, 1998, the Company acquired all of the outstanding capital stock of FPM Behavioral Health, Inc. ("FPM") of Winter Park, Florida. FPM has been consolidated with the Company as of June 1, 1998 (see Note 3). Effective October 5, 1998, the Company acquired all of the outstanding capital stock of ChoiceHealth, Inc. ("ChoiceHealth") of Westminster, Colorado. ChoiceHealth has been consolidated with the Company as of October 5, 1998 (see Note 3). Effective April 1, 1999, the Company acquired all of the outstanding capital stock of Resources in Employee Assistance and Corporate Health, Inc. ("REACH"). REACH has been consolidated with the Company as of April 1, 1999 (see Note 3).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION: The consolidated financial statements include those of the Company and its wholly-owned and majority owned subsidiaries. Investments in unconsolidated affiliated companies are accounted for on the equity method. All significant intercompany accounts and transactions are eliminated in consolidation.
CASH AND CASH EQUIVALENTS: Cash and cash equivalents include highly liquid investments with original maturities of three months or less when purchased.
PROPERTY AND EQUIPMENT: Property and equipment are recorded at cost. Depreciation expense is recorded on the straight-line basis over the assets' estimated useful lives. The useful lives of computer hardware and software are estimated to be three years. The useful lives of furniture and fixtures, office equipment, and transportation are estimated to be five years. Building improvements are recorded at cost and amortized over the estimated useful lives of the improvements or the terms of the underlying lease whichever is shorter. Routine maintenance, repair items, and customer facility and site improvements are charged to current operations.
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONTRACTS: Contracts represent the fair value of management contracts and service contracts purchased and are being amortized using the straight-line method over seven years.
GOODWILL: Goodwill represents the excess of cost over fair value of net assets acquired and is being amortized using the straight-line method over 40 years.
LONG-LIVED AND INTANGIBLE ASSETS: The Company has adopted Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-lived Assets and Assets to be Disposed of." Under SFAS 121, the Company recognizes impairment losses on property and equipment and intangible assets whenever events or changes in circumstances indicate that the carrying amount of long-lived assets, on an individual property basis, may not be recoverable through undiscounted future cash flows. Such losses are determined using estimated fair value or by comparing the sum of the expected future net cash flows to the carrying amount of the asset. Impairment losses are recognized in operating income, as they are determined.
COMMON STOCK REPURCHASE PROGRAM: On September 21, 1998, the Board of Directors of the Company authorized the repurchase of up to 1,000,000 shares of its common stock, and on November 19, 1999 authorized the repurchase of an additional 200,000 shares of its common stock. The stock repurchase plan authorized the Company to make purchases from time to time in the open market or through privately negotiated transactions, depending on market conditions and applicable securities regulations. The repurchased shares were added to the treasury shares of the Company and may be used for employee stock plans and for other corporate purposes. The stock repurchases utilized available cash and borrowings under the Company's bank facilities. The Company repurchased 1,189,300 shares of its common stock as of August 31, 2000, of which 245,145 has been reissued pursuant to the exercise of certain stock options. The Company accounts for the treasury stock using the cost method.
REVENUE: Contract management revenue is reported at the estimated net realizable amounts from contracted hospitals for contract management services rendered. Adjustments are accrued on an estimated basis in the period the related services are rendered and adjusted in future periods, as final settlement is determined. Contract management revenue is based on various criteria such as a per diem calculation using patients per day, a fixed fee, numbers of admissions or discharges, direct expenses, or any combination of the preceding depending on the specific contract.
Premium and fees revenue includes capitated patient services revenues, which are defined by contract and are calculated on a per-member/per-month fee, a fixed fee, and/or a fee for service basis. Capitated revenue is accrued in a similar manner as contract management revenue. For certain contracts the Company bears the economic risk if capitated revenue is insufficient to meet the cost of behavioral health care services incurred by covered members. At August 31, 2000, capitated revenue was more than sufficient to meet these costs.
Some management contracts include a clause, which states that the Company will indemnify the hospital for any third-party payor denials, including Medicare. At the time the charges are denied, the Company records an allowance for 100% of the potential amount to be repaid. Management believes it has adequately provided for potential adjustments that may result from final settlement of these denials.
Except for the state of Florida, where the Company derives approximately 14.5% of its revenues, the customers of the Company are not concentrated in any specific geographic region. The customers of the Company's contract management services are concentrated in the health care industry.
ADVERTISING COSTS: The Company expenses advertising costs as incurred.
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MEDICAL CLAIMS: Outstanding claims include medical claims and related expenses reported but not paid and an estimate of costs incurred but not reported (IBNR) to the Company by health care providers. Management of the Company estimates IBNR costs utilizing the Company's historical experience and current factors.
INCOME TAXES: The Company has adopted Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes." SFAS 109 generally requires an asset and liability approach and requires recognition of deferred tax assets and liabilities resulting from differing book and tax bases of assets and liabilities. It requires that deferred tax assets and liabilities be determined using the tax rate expected to apply to taxable income in the periods in which the deferred tax asset or liability is expected to be realized or settled. Under this method, future financial results will be impacted by the effect of changes in income tax rates on cumulative deferred income tax balances.
EARNING PER SHARE: Earnings per share has been computed in accordance with Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share". Basic earnings per share are computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflect the potential dilution that could occur if the Company's stock options and warrants were exercised. Such dilutive potential common shares are calculated using the treasury stock method.
SEGMENT INFORMATION: In fiscal year 1999, the Company adopted Statement of Financial Accounting Standards (SFAS) 131, Disclosures about Segments of an Enterprise and Related Information. SFAS 131 supersedes SFAS 14, Financial Reporting for Segments of a Business Enterprise, replacing the "industry segment" approach with the "management" approach. The management approach designates the internal structure that is used by management for making operating decisions and assessing performance as the source of the Company's reportable segments. SFAS 131 also requires certain disclosures about products and services, geographic areas, and major customers. The adoption of SFAS 131 did not affect results of operations or financial position of the Company but did result in changes in the disclosure of segment information (see Note 13).
FINANCIAL INSTRUMENTS: Financial instruments consist of cash and cash equivalents, accounts receivable, current liabilities and long-term debt obligations. The carrying amounts reported in the balance sheets for these financial instruments approximate fair value.
USE OF ESTIMATES: The Company has made certain estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period in order to prepare the financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates.
RECLASSIFICATIONS: Certain prior year amounts have been reclassified to conform to the current year presentation.
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. ACQUISITIONS
REACH, INC.
Effective April 1, 1999, the Company acquired all of the outstanding capital stock of Resources in Employee Assistance and Corporate Health, Inc. ("REACH") of Murray Hill, New Jersey, and REACH has been consolidated with the Company as of April 1, 1999. The Company accounted for the acquisition of REACH by the purchase method. REACH provides employee assistance programs and other related behavioral health care services to self-insured employers. REACH had total revenues of approximately $1.4 million (unaudited) for the ten months ending March 31, 1999. As of August 31, 1999, the preliminary allocation of the purchase price exceeded the fair value of REACH's tangible net assets by $2,326,846, of which $2,054,791 is recorded as goodwill and $272,055 as service contracts. Tangible assets acquired and liabilities assumed totaled $150,496 and $477,342, respectively. Pro forma financial data is not presented because the impact of this acquisition is not material to the Company's results of operations for any period presented.
CHOICEHEALTH, INC.
Effective October 5, 1998, the Company acquired all of the outstanding capital stock of ChoiceHealth, Inc. ("ChoiceHealth") of Westminster, Colorado, and ChoiceHealth has been consolidated with the Company as of October 5, 1998. The company accounted for the acquisition of ChoiceHealth by the purchase method. ChoiceHealth provides managed behavioral health care services, employee assistance programs and other related behavioral health care services to health maintenance organizations and self-insured employers. ChoiceHealth had total revenues of approximately $7.6 million (unaudited) for the eight months ended August 31, 1998. As of August 31, 1999, the preliminary allocation of the purchase price exceeded the fair value of ChoiceHealth's tangible net assets by $3,114,436, of which $2,935,427 is recorded as goodwill and $179,009 as service contracts. Tangible assets acquired and liabilities assumed totaled $834,928 and $1,899,666, respectively. Pro forma financial data is not presented because the impact of this acquisition is not material to the Company's results of operations for any period presented.
FPM BEHAVIORAL HEALTH, INC.
Effective June 1, 1998, the Company acquired all of the outstanding capital stock of FPM Behavioral Health, Inc. of Orlando, Florida, and FPM has been consolidated with the Company as of June 1, 1998. The Company accounted for the acquisition of FPM by the purchase method. FPM provides managed behavioral health care services, employee assistance programs and other related health care services to health maintenance organizations and self-insured employers. FPM had total revenues of approximately $19.9 million for the nine months ended March 31, 1998 and, at February 28, 1998, FPM had 46 contracts covering 1,135,000 lives in nine states. FPM provides its services both through health care professionals employed by FPM and through independent health care professionals that have been contracted with FPM on a fee-for-service basis. At April 1998, the FPM provider network was composed of over 2,000 providers. The purchase price was $20.0 million in cash, subject to certain post closing adjustments, and was funded by incurring debt of $20.0 million under the term loan facility. The preliminary allocation of the purchase price exceeded the fair value of FPM's tangible net assets by $22,170,668, of which $20,665,912 is recorded as goodwill and $1,504,756 as service contracts. Tangible assets acquired and liabilities assumed totaled $3,301,876 and $5,472,544, respectively. During the fiscal year ending August 31, 1999, the Company received post-closing adjustments, net of tax effects, of $1,222,193 and $1,201,337. After the adjustments, the purchase price exceeded the fair value of FPM's tangible net assets by $20,293,784 of which $18,789,028 is recorded as goodwill and $1,504,756 as service contracts. Tangible assets acquired and liabilities assumed totaled $3,279,957 and $5,997,271, respectively.
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The unaudited pro forma combined results of the Company and FPM for the years ended August 31, 1997 and 1998 after giving effect to certain pro forma adjustments are presented at the end of this footnote.
ACORN
Effective October 31, 1997, the Company acquired all of the outstanding capital stock of Acorn. The Company accounted for the acquisition of Acorn by the purchase method. Acorn provides employee assistance programs and other related services to self-insured employers. Acorn had total revenues of approximately $7.0 million for the year ended August 31, 1997. The purchase price of approximately $12.7 million in cash was funded from $1.7 million of working capital and $11.0 million from an advance under the Company's existing revolving credit facility with Texas Commerce Bank, N.A., (now known as Chase Bank of Texas, National Association). The purchase price exceeded the fair value of Acorn's tangible net assets by $12,629,261, of which $9,258,513 is recorded as goodwill and $3,370,748 as service contracts. Tangible assets acquired and liabilities assumed totaled $274,929 and $177,832 respectively.
The unaudited pro forma combined results of operations of the Company and Acorn for the years ended August 31, 1997 and 1998 after giving effect to certain pro forma adjustments are presented at the end of this footnote.
PPS
Cash payments for the purchase of eighty percent (80%) of the outstanding common stock of Florida Professional Psychological Services, Inc. ("PPS"), also known as Professional Psychological Services, Inc., net of cash acquired, were $786,767 and $1,898,230 during 1996 and 1997, respectively. The final payment of $200,985 was made on September 30, 1997. On February 27, 1998, the Company acquired an additional sixteen percent (16%) of the outstanding common stock of PPS. The Company accounted for the acquisition of PPS by the purchase method. The purchase price of $831,879 was based primarily on a multiple of the 1997 pre-tax income of PPS. The purchase price exceeded the fair market value of PPS's tangible net assets acquired by $764,400 of which $560,315 is recorded as goodwill and $204,085 as service contracts. Tangible assets acquired and liabilities assumed totaled $147,072 and $79,593, respectively.
On March 10, 1998, the Company acquired the remaining four percent (4%) of the outstanding common stock of PPS, under similar terms, for a purchase price of $207,970. The Company accounted for the acquisition by the purchase method. The purchase price exceeded the fair value of PPS's tangible assets acquired by $192,332 of which $141,311 is recorded as goodwill and $51,021 as service contracts. Tangible assets acquired and liabilities assumed totaled $35,536 and $19,898 respectively. The acquisitions were funded by incurring debt of approximately $1.0 million under the company's term loan facility. Pro forma financial data is not presented because the impact of this acquisition is not material to the Company's results of operations for any period presented.
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following unaudited pro forma financial information gives effect to the acquisition of Acorn and FPM as if the acquisitions occurred on September 1, 1997.
4. PROPERTY AND EQUIPMENT
Property and equipment consist of the following at August 31:
Depreciation expense was $1,988,315, $1,420,704 and $887,706 for the years ended August 31, 2000, 1999, and 1998, respectively.
5. ACCRUED EXPENSES
Accrued expenses consisted of the following at August 31:
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. LONG-TERM DEBT
Long-term debt consisted of the following at August 31:
The aggregate maturities of long-term debt during the next five fiscal years are $3,600,000 in 2001 and 2002; $7,700,000 in 2003; and $0 in 2004 and 2005. On December 9, 1997, the Company entered into a Credit Agreement (the "Credit Agreement") with Chase Bank of Texas, National Association, as Agent for itself and other lenders party to the Credit Agreement for a senior secured credit facility in an aggregate amount of up to $50.0 million (the "New Credit Facility"). The New Credit Facility consisted of a $10.0 million ("Revolving Credit Facility") to fund ongoing working capital requirements and a $40.0 million ("Advance Term Loan Facility") to refinance certain existing debt and to finance future acquisitions by the Company. As of August 31, 2000, the Company had borrowings of $14.9 million outstanding against the term loan facility against which it can no longer draw. The Revolving Credit Facility was terminated by the Company on June 30, 2000. Amounts that were outstanding under the Advance Term Loan Facility as of November 30, 1999 are to be repaid in twelve quarterly principal payments that began February 28, 2000, based upon a five year amortization schedule with the first eleven principal payments being 1/20th of the outstanding balance on November 30, 1999, and the twelfth being the remaining unpaid principal balance. Principal outstanding under the New Credit Facility bore interest at the "Base Rate" (the greater of the Agent's "prime rate" or the federal funds rate plus .5%) plus 0% to .5% (depending on the Company's Indebtedness to EBITDA Ratio as defined in the Credit Agreement) or the "Eurodollar Rate" plus .75% to 1.5% (depending on the Indebtedness to EBITDA Ratio), as selected by the Company. The Company incurred quarterly commitment fees ranging from .25% to .375% per annum (depending on the Indebtedness to EBITDA Ratio) on the unused portion of the Revolving Credit Facility (terminated June 30, 2000) and the unused portion of the Advance Term Loan Facility (expired November 30, 1999). The Company's interest rate under the New Credit Facility was 7.625% at August 31, 2000.
The Company is subject to certain covenants which include prohibitions against (i) incurring additional debt or liens, except specified permitted debt or permitted liens, (ii) certain material acquisitions, other than specified permitted acquisitions (including any single acquisition not greater than $10.0 million or cumulative acquisitions not in excess of $30.0 million during any twelve consecutive monthly periods), (iii) certain mergers, consolidations or asset dispositions by the Company or changes of control of the Company, (iv) certain management vacancies at the Company, and (v) material change in the nature of business conducted. In addition, the terms of the New Credit Facility require the Company to satisfy certain ongoing financial covenants. The New Credit Facility is collateralized by a first lien or first priority security interest in and/or pledge of substantially all of the assets of the Company and of all present and future subsidiaries of the Company.
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
On October 4, 2000, the Company was advised that Chase Bank of Texas, National Association, had committed to provide the company with a $15.0 million three year revolving line of credit. If the pending agreement is finalized, the revolving facility would be used to repay the remaining outstanding balances on the existing term loan facility.
The Company acquired a custom software system upon the acquisition of ChoiceHealth (see Note 3). The software system was financed by a note to Borealis Software Systems, Inc., the company who designed the system. The note was paid in full during fiscal year 2000.
7. STOCK OPTIONS
The 1989, 1995 and 1998 Stock Option Plans and the 1995 Stock Option Plan for Eligible Outside Directors are collectively referred to as the "Plans." In accordance with the Plans, as amended, 2,581,843 shares of common stock have been reserved for grant to key employees, directors and consultants. Management believes the exercise prices of the options granted approximated or exceeded the market value of the common stock at the date of the grant. The options generally vest ratably over five years from the date of grant and terminate 10 years from the date of grant.
On April 28, 1995 the board of directors created the 1995 Stock Option Plan for Eligible Outside Directors for outside directors owning less than 5% of the stock of the Company. 150,000 shares of common stock are reserved for issuance under this plan. This plan has been amended and restated to provide for 3,000 option grants to each eligible director each time he is re-elected to the board after having served as a director for at least one year since his initial grant under the plan. Options vest ratably over five years from the date of grant.
On January 23, 1998, the Stockholders of the Company approved the 1998 Stock Option Plan. The purpose of the Plan is to give the Company a competitive advantage in attracting, retaining and motivating directors, officers, key employees and consultants and to provide the Company and its subsidiaries with a stock option plan providing incentives directly linked to the profitability of the Company's businesses and increases in shareholder value. Under this plan, 500,000 shares of common stock are reserved for issuance.
On September 1, 1998, the Company canceled 351,250 options with exercise prices ranging from $14.167 to $26.00, and granted 141,040 options with an exercise price of $7.00, the fair market value at the date of grant. The following table summarizes the status of the Plans:
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table summarizes information about options outstanding under the Plans at August 31, 2000:
The Company applies APB 25 in accounting for the Plans and recognizes no compensation cost in net earnings from the grant of options as options are granted at exercise prices equal to the current stock price. Had compensation cost been determined under the terms of SFAS 123, the Company's pro forma 2000, 1999 and 1998 net earnings and earnings per share would have been:
In accordance with SFAS 123, the fair value of options at date of grant was estimated using the Black-Scholes option-pricing model with the following weighted average assumptions:
In accordance with SFAS 123, the weighted average fair value of options granted during 2000, 1999 and 1998 was $3.53, $4.07, and $10.59 respectively.
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. RETIREMENT PLAN
The Company sponsors a 401(k) plan that covers substantially all eligible employees. The Company can elect to make matching contributions at its discretion. For the years ended August 31, 2000, 1999 and 1998 the Company recognized matching contributions of approximately $471,000, $466,000, and $254,000 respectively.
9. INCOME TAXES
Deferred taxes are provided for those items reported in different periods for income tax and financial reporting purposes. Income tax expense for the years ended August 31 is comprised of the following components:
The components of the net deferred tax asset at August 31 were obtained using the liability method in accordance with SFAS No. 109 and are as follows:
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
At August 31, 2000, the Company had available estimated, unused net operating loss carryforwards for tax purposes of approximately $1,400,000. These carryforwards, subject to annual utilization limits, may be utilized to offset future years' income and will begin to expire during 2006 if unused prior to that date.
The following is a reconciliation of income taxes at the U.S. federal income tax rate to the Company's effective income tax rate:
10. COMMITMENTS AND CONTINGENCIES
The Company leases various office facilities and equipment under operating leases. The following is a schedule of minimum rental payments under these leases, which expire at various dates:
Rent expense for the years ended August 31, 2000, 1999, and 1998 was $3,174,094, $2,325,321 and $1,385,301, respectively.
The Company leases a building it occupies as its executive offices and National Support Center in Lewisville, Texas. In connection with this lease transaction, the Company guaranteed a loan of approximately $900,000 by a financial institution to the building owner. The Company also agreed to purchase the leased building for approximately $4.5 million at the end of the lease term in September 2001, if it is not sold to a third party, or the Company does not extend its lease. The Company's current intention is to extend the lease.
The Company is insured for professional and general liability on a claims-made basis, with additional tail coverage being obtained when necessary. Management is unaware of any claims against the Company that would cause the final expenses for professional and general liability to vary materially from amounts provided.
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Recently the Balanced Budget Refinement Act of 1999 mandated the elimination of cost-based reimbursement of mental health partial hospitalization services. Implementation began August 1, 2000. The resulting reimbursement for partial hospitalization services based on the Medicare outpatient prospective payment system utilizes a fixed reimbursement amount per patient day. The base reimbursement rate is a wage-adjusted rate of $202.19 per day, which may lower Medicare reimbursement levels to many hospitals for partial hospitalization services. This change may adversely affect the ability of the Company to maintain and/or obtain management contracts for partial hospitalization services and the amount of fees paid to the Company under such contracts.
In addition, recent amendments to the Medicare statutes provide for a phase-out of cost-based reimbursement of physical rehabilitation services over a three-year period beginning no earlier than April 1, 2001. The phase in of a prospective payment system with reimbursement based on a functional patient classification may lower Medicare reimbursement levels to hospitals for physical rehabilitation services. This could adversely affect the ability of the Company to maintain and/or obtain management contracts for physical rehabilitation services and the amount of fees paid to the Company under such contracts.
In late 1999, the Company became aware that a civil qui tam lawsuit had been filed under seal naming the Company's psychiatric contract management subsidiary, Horizon Mental Health Management (Horizon), as a defendant therein. The lawsuit is currently pending in the United States District Court for the District of Columbia. The U.S. Government has not made a decision whether to intervene in the lawsuit which is still under seal. Horizon has not been served and therefore, is not presently a party to the lawsuit. The Company does not believe that the claims asserted in the lawsuit, based upon present allegations, represent a material liability to the Company.
The Company is involved in litigation arising in the ordinary course of business, including matters involving professional liability. It is the opinion of management that the ultimate disposition of such litigation, net of any applicable insurance, would not be significantly in excess of any reserves or have a material adverse effect on the Company's financial position or results of operations.
11. COMMON STOCK
The Board of Directors adopted in October 1999 the Horizon Health Corporation Employee Stock Purchase Plan ("the Plan"). The purpose of the Plan, which became effective January 1, 2000, is to provide employees of the Company and its subsidiaries the opportunity to acquire an ownership interest in the Company through the purchase of Common Stock at a price below current market prices. The Plan offers eligible employees the ability to purchase company stock at a price 15% below the current market price at designated periods. Eligible employees are able to contribute 1 to 10% of their base salary pursuant to two six-month offering periods which are defined as January 1 - June 30 or July 1 - December 31. The Company issued from treasury 14,642 shares of Common Stock for the first offering period ending June 30, 2000.
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. EARNINGS PER SHARE
The Company has adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share." All prior earnings per share data presented have been restated in accordance with SFAS 128.
The following is a reconciliation of the numerators and the denominators of the basic and diluted earnings per share computations for net income for the years ended August 31:
During 2000, 1999, and 1998 certain options to acquire common stock were not included in certain computations of EPS because the options exercise price was greater than the average market price of the common shares. The options excluded by quarter are as follows:
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. SEGMENT INFORMATION
The Company has determined that its reportable segments are appropriately based on its method of internal reporting, which disaggregates its business by services category in a manner consistent with the Company's Consolidated Statements of Income format. The Company's reportable segments are Horizon Behavioral Services, Horizon Mental Health Management, Specialty Rehab Management, and Mental Health Outcomes. See notes (A) through (E) below for a description of the services provided by each of the identified segments. The Company's business is conducted solely in the United States.
The following schedule represents revenues and operating results for the twelve months ended August 31 by operating division/segment:
* Earnings before interest, taxes, depreciation and amortization (divisional operating profit).
** Changes in the reporting relationships of subsidiaries cause fluctuations between periods.
(A) Horizon Behavioral provides managed care and employee assistance programs.
(B) Horizon Mental Health Management provides mental health contract management services to general acute care hospitals.
(C) Specialty Rehab Management provides physical rehabilitation contract management services to general acute care hospitals.
(D) Mental Health Outcomes provides outcomes information regarding the effectiveness of mental health programs and psychiatric data- base services.
(E) "Other" represents the Company's corporate offices and National Support Center located in Lewisville, Texas which provides management, financial, human resource, and information system support for the Company and its subsidiaries.
HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following is a summary of unaudited quarterly financial data for fiscal 2000 and 1999:
INDEX TO FINANCIAL STATEMENT SCHEDULE
Report of Independent Accountants on Financial Statement Schedule..........S-2
Schedule VIII Valuation and Qualifying Accounts............................S-3
S-1
REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE
To the Board of Directors and Stockholders of Horizon Health Corporation
Our audits of the consolidated financial statements referred to in our report dated October 12, 2000 appearing on page F - 2 of this Annual Report on Form 10-K also included an audit of the Financial Statement Schedule as listed in Item 14(a)(2) of this Form 10-K. In our opinion, this Financial Statement Schedule presents fairly, in all material respects, the information set forth herein when read in conjunction with the related consolidated financial statements.
PricewaterhouseCoopers LLP Dallas, Texas October 12, 2000
S-2
HORIZON HEALTH CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
(1) Adjustment reflects reserves in which Horizon is aware that specific hospitals have experienced treatment day denials and to which a corresponding accounts receivable balance does not exist. These amounts are accrued as a liability.
(2) Adjustment reflects reserves in which Horizon is aware that specific hospitals have experienced treatment day denials and to which a corresponding accounts receivable balance does not exist. These amounts are accrued as a liability. In addition, adjustment reflects items reserved as other receivables, therefore their reserve is not included in the allowance for receivables.
(3) Adjustment includes a recovery of $1.75 million related to one former Specialty contract.
S-3
INDEX TO EXHIBITS